GDP

In short

A friend of mine once asked me if the country was doing well, and I realized I had no good way to answer him. GDP is the tool most people reach for when they ask that question. It is one big number that adds up what the country made and sold in a set stretch of time. You will hear it announced as a growth rate, such as a quarter that grew or shrank by some percent. Look at the rate of change first, because the raw dollar figure is huge and hard to picture. Check whether the news is quoting a real number, which removes price changes, or a nominal one, which does not. Then remember what the number leaves out, like unpaid work at home and how the money is shared. The number does not cover those things.

The whole of it

What it is

I once watched a neighbor keep a ledger of every egg his hens laid and every dozen he sold. He never called it economics, but that was the idea. Gross domestic product is that ledger for a whole country. It is the total market value of the final goods and services made inside a nation's borders in a given period, such as a quarter or a year. The word final matters. If a baker buys flour to make bread, only the bread is counted, not the flour too. Otherwise we would count the same wheat three or four times. The word domestic matters as well. It means made inside the country, no matter who owns the factory. A car built in Ohio by a foreign company counts toward American GDP.

The number is put together by the Bureau of Economic Analysis, which is part of the U.S. Department of Commerce. You may feel that a single figure cannot say much about a country of many millions of people. You would be right to feel that. It is a summary, and a summary always leaves things out.

How it works

If you have ever balanced a checkbook, you already know the basic shape of this. Money spent in the economy is also money earned by someone. So GDP can be counted by looking at spending, and the spending method is the one you hear about most. It adds four pieces. The first is consumption, which is what households spend on things like groceries, rent, and haircuts. The second is investment, which is what businesses spend on equipment and buildings, plus new homes that get built. The third is government spending on goods and services, like roads and school buildings. The fourth is net exports, which is what we sell abroad minus what we buy from abroad.

The short version is this. GDP equals consumption plus investment plus government spending plus net exports.

I have heard folks say that when the government hands out a check, GDP goes up. Not so fast. Transfer payments like Social Security move money from one pocket to another, and they do not count as government spending in this formula. Only purchases of actual goods and services count. What the family then spends the check on will show up under consumption.

Then there is the matter of real versus nominal. Suppose your grocery bill rose because prices rose, not because you bought more food. Nominal GDP would rise, yet the country did not make more. Real GDP fixes that by adjusting for price changes, so it tracks the actual amount produced. When you hear that the economy grew, the figure being quoted is normally the real one, and it is worth checking.

The numbers, and where to find yours

You have probably seen the headline figure and wondered where it comes from. The official source is the Bureau of Economic Analysis. Its website posts the national accounts, including quarterly GDP and the pieces that make it up. The agency gives an early look, then revises it as more data comes in. So the first number you hear is rarely the last one.

The growth rate you see in the news is usually stated at an annual rate, even for a single quarter. That means the agency takes one quarter's change and expresses it as if the pace held for a full year. It can surprise people. A quarter that grew a little can sound big once it is annualized, so read the fine print.

If you want a sense of size, the latest total for U.S. nominal GDP is the current figure, which the official source publishes each year. Check that figure against the Bureau of Economic Analysis page for its date and source. If you want to compare across countries, the World Bank and the International Monetary Fund both publish GDP figures for many nations. Their methods differ a little from ours, so do not mix sources in one comparison.

A worked example

A woman I will call Maria runs a small bakery, and she makes a fine loaf. Let us walk through a tiny imaginary economy that has only a few activities, so you can see the arithmetic.

In one year, households in this town spend 600 dollars on bread and other goods and services. That is consumption. Maria buys a new oven for 100 dollars. That is business investment. The town pays 150 dollars for a repaved street. That is government spending on a real project. The town sells 80 dollars of goods to a neighboring town and buys 50 dollars of goods from it. Net exports are 80 minus 50, which is 30 dollars.

Now add the four pieces. 600 plus 100 plus 150 plus 30 equals 880. So this little town's GDP for the year is 880 dollars.

Next year, the town makes the same amount of stuff, but prices rise by 10 percent across the board. Nominal GDP would be 880 times 1.10, which is 968 dollars. That looks like growth of 88 dollars. But nothing extra was made. Real GDP, measured in last year's prices, stays at 880. Growth is zero. Maria did not bake one extra loaf. That gap between 968 and 880 is exactly why the real number matters.

Where it goes wrong

I would be doing you no favors if I let you leave thinking GDP is a report card on how well people are living. It was built to measure production, not happiness, and its makers have said as much. It leaves out unpaid work. The parent who stays home with the kids adds real value, yet none of it shows up. Volunteer work is missing too.

It also says nothing about how the money is shared. A country's GDP can rise while many families see little change. The total is a total, and it hides the spread beneath it. And it counts things that do not make us better off. Money spent rebuilding after a flood adds to GDP, though nobody would call the flood a gain.

A few smaller cautions belong here. First revisions can be large enough to change the story, so be slow to judge on one release. A rate that is annualized can look bigger or smaller than the quarter felt. And comparing dollar totals across countries depends on exchange rates, which move around. None of this makes GDP useless. It makes it a good tool with clear limits, like a ruler that measures length but not weight.

Questions to answer before you leave this page

When you hear that GDP grew, do you know whether the figure was real or nominal, and can you say why it matters? If a news story quotes a quarterly growth rate, can you tell it has been annualized and what that does to how big it sounds? Can you name the four pieces of spending that add up to GDP, and explain why a Social Security payment is not one of them? Do you know which agency publishes the official U.S. figure, and have you looked at its site to see the latest release and how it was revised? And when someone says the economy is strong, are you asking what GDP leaves out, such as unpaid work and how the gains are shared, before you decide what it means for your own household?