1. gross domestic product

gross domestic product

what is gdp?

• gross domestic product (gdp): market value of all final (new) goods and services produced within a country in a year

  • most popular measure of economic activity in a timeframe

  • also tracks total spending and income

  • “of all”: counts every price of goods and services (comparable and incomparable)

• market value: how much something costs in the marketplace (what you pay)

  • an item’s worth in gdp is determined by its price

• final goods and services: will not be sold again as another good/service or to make something else

  • capital goods: items used to create other things that are considered final goods

    • pizzeria buys an oven to make pizzas

what gdp doesn’t account

• not a perfect measure of everything that is important

• value of services/goods gained (internal value)

measuring gdp

• perfect data means all approaches equal the same value

  • all approaches are the same but different ways of looking at economic activity

expenditure approach

• adds up total spending on final goods and services produced within the economy

  • c - consumption (clothes, snacks)

    • make up most of gdp

  • i - investment (company machinery, capital goods)

    • not stocks or bonds

  • g - (direct) government purchases (school or parks)

  • n - net exports = exports - imports

    • x - net exports (sold to other countries)

    • m - net imports (goods bought from other countries)

      • don’t contribute to gdp

income approach

• gross domestic income: all income earned by households and businesses from producing goods and services

  • wages for workers

  • profits for businesses

  • tax collected by the government

• add up income earned by factors of production or inputs

  • every dollar spent is income for someone else (money flow)

total spending = total income

• how much everyone in the economy is making (change in gdp = change in income)

• gdp/capita: how much income each person in the country have

  • gdi/population

production (value-added) approach

• sums up the value added by each industry in the economy (total output of an economy)

  • value added = revenue - cost of intermediate inputs

  • intermediate inputs: production costs

9.1 gdp and the macroeconomy

• macroeconomics: studies the economy as a whole rather than individual markets

  • built on microeconomics: individual decisions still matter, but focus shifts to totals

• key macro questions focus on:

  • total income

  • total output

  • total spending

• gdp: is the main tool used to measure overall economic activity
  
  

from micro to macro

• microeconomics: individual income, output, and spending

• macroeconomics: economy-wide income, output, and spending

• same concepts, different scale
  
  

the circular flow

• shows interdependence between households and businesses

• households:

  • supply labour and capital

  • receive wages and profits

• businesses:

  • demand labour and capital

  • produce goods and services

• money flows in the opposite direction of goods and services

• every flow of resources is matched by a flow of money
  
  

key implication of the circular flow

• total spending = total output = total income

• gdp measures this shared value
  
  

definition of gdp

• market value of all final goods and services

• produced within a country

• in a given year
  
  

breaking down the definition

• market value

  • goods are valued using market prices

  • allows comparison of very different goods using dollars

• all

  • includes goods and services

  • includes government production

  • excludes non-market activity (imports)

• final goods and services

  • counts only finished goods

  • avoids double counting intermediate goods

    • double counting: intermediate goods and final goods are included

• produced

  • includes newly produced goods

  • excludes resale of existing goods

• within a country

  • includes domestic production even if foreign-owned

  • excludes production abroad even if canadian-owned

• in a year

  • gdp is a flow, not a stock

  • measures activity over time, not total wealth
    
    

gdp per person

• gdp divided by population

• used for comparisons across countries and over time

• interpreted as average income, output, and spending
  
  

9.2 gdp measures spending, output, and income (expenditure approach)

• gdp can be measured in three equivalent ways:

  • total spending

  • total output

  • total income
    
    

gdp as total spending

• gdp includes spending on final goods only

• unsold goods (inventories) are included because they are produced
  
  

four components of spending

• consumption (c)

  • household spending on goods and services

  • includes durable goods and imputed rent for homeowners

• investment (i)

  • spending on new capital goods

  • includes machinery, buildings, r&d, inventories

  • includes new housing

  • excludes stocks, bonds, and resale of existing assets

• government purchases (g)

  • spending on goods and services by government

  • includes wages of public workers

  • excludes transfer payments

• net exports (nx)

  • exports - imports

  • imports are subtracted because they are not domestically produced

gdp identity

• gdp = c + i + g + nx

  • this is always true by definition
    
    

9.3 gdp as total output (production (value-added) approach)

• gdp equals the total value of what is produced measured using value added
  
  

value added

• contribution each firm makes to production

  • value of sales - cost of intermediate inputs

why value added matters

• prevents double counting

• shows how production is spread across stages

• adding value added at all stages equals final price
  
  

structure of production

• service sector dominates modern economies

• goods production is a smaller share of gdp

• helps identify which industries are largest or growing
  
  

9.4 gdp as total income (income approach)

• every dollar spent becomes income for someone else

• gdp equals the sum of all incomes earned
  
  

main components of income

• wages and salaries paid to workers

• profits earned by business owners
  
  

what is excluded

• capital gains from selling assets

• resale of existing assets

• speculative gains
  
  

income distribution

• labour share: portion of gdp paid to workers

• capital share: portion paid to owners of capital

• changes over time affect inequality and living standards
  
  

9.5 what gdp captures and what it misses

• gdp is widely used because it is measurable and consistent

• but it is not a perfect measure of well-being
  
  

major limitations of gdp

1. prices are not values

   • market prices do not reflect true importance or usefulness

   • consumer surplus is ignored

   • free digital services add little to gdp (since users don’t pay for them)

2. nonmarket activities are excluded

   • housework, childcare, volunteering not counted

   • paying someone to do the same work increases gdp artificially

3. shadow economy is missing

   • cash jobs, illegal activities, unreported income excluded

   • can be a significant portion of actual economic activity

4. environmental degradation is ignored

   • resource depletion counted as production

   • pollution and climate damage not subtracted

5. leisure is not counted

   • more work increases gdp but may reduce quality of life

6. distribution of income is ignored

   • gdp per person is an average

   • does not show who benefits from growth
     
     

9.6 gdp as a measure of living standards

• gdp per person measures average income, not happiness

• higher gdp gives societies more resources to pursue well-being
  
  

why gdp still matters

• strongly correlated with:

  • higher life satisfaction

  • better health outcomes

  • longer life expectancy

  • more education

  • lower infant mortality

• higher income improves access to necessities and opportunities
  
  

key takeaway

• gdp does not measure everything that matters

• it measures the resources available to improve living standards

• how those resources are used determines quality of life

• high gdp means a higher means to improve better living standards, not that everyone already has high living standards

four reasons why gdp is a useful number

1. gdp is a good measure of productive capacity

2. gdp correlates strongly with things people care about

3. gdp is measured consistently & objectively

4. gdp tracks changes over time very well

what gdp is

• gdp measures the total market value of final goods & services produced within a country in a given period

• it focuses on production & income generated, not directly on happiness or well-being

• commonly criticized for “not measuring what matters,” but the article argues this misunderstands gdp’s purpose
  
  

gdp is a good measure of productive capacity

• gdp captures how much an economy can produce using its labor, capital, & technology

• higher gdp generally means a country can:

  • feed more people

  • build more infrastructure

  • fund healthcare, education, & defense

• productive capacity matters because it constrains what a society can realistically achieve

  • a country with a low gdp WANTS better education, but does not have the means to achieve it

• even if gdp doesn’t measure happiness, productive capacity strongly affects living standards
  
  

gdp correlates strongly with things people care about

• countries with higher gdp per capita tend to have:

  • longer life expectancy

  • lower infant mortality

  • better health outcomes

  • higher education levels

• while gdp does not guarantee well-being, low gdp almost guarantees hardship

• many social improvements historically followed economic growth, not the other way around
  
  

gdp is measured consistently & objectively

• gdp relies on market transactions with observable prices

• this makes it:

  • comparable across countries

  • comparable across time

  • less dependent on subjective judgments

• alternative measures (happiness, life satisfaction, “quality of life”) depend on surveys & personal interpretation

• objective measurement is valuable for policymaking & economic analysis
  
  

gdp tracks changes over time very well

• even if gdp is imperfect in level terms, it is especially useful for tracking growth & recessions

• changes in gdp reliably indicate:

  • economic expansions

  • economic downturns

  • recoveries after crises

• policymakers use gdp trends to decide on:

  • stimulus spending

  • interest rate changes

  • fiscal & monetary policy responses
    
    

common criticisms of gdp (and responses)

• “gdp ignores inequality”

  • true, but gdp was never meant to measure distribution

  • inequality can be studied using separate tools (gini coefficient, income shares)

• “gdp ignores unpaid work”

  • true, but including unpaid work would require subjective valuation

  • market-based measures remain clearer & more consistent

• “gdp ignores environmental damage”

  • gdp measures production, not sustainability

  • environmental costs can be added through separate environmental accounts or regulations
    
    

why gdp should not be replaced

• no alternative measure has matched gdp’s:

  • clarity

  • consistency

  • predictive usefulness

• replacing gdp with a single “well-being index” would mix many value judgments into one number

• gdp works best as a foundational measure, supplemented by other indicators
  
  

how gdp should be used

• gdp should be treated as:

  • a core economic indicator

  • not a complete measure of human welfare

• best practice is to pair gdp with:

  • inequality measures

  • health & education statistics

  • environmental indicators

• misuse of gdp comes from overinterpreting it, not from the measure itself

beyond gdp

main argument

• gdp is an important economic indicator but is inadequate as a measure of overall well-being

• policymaking that focuses narrowly on gdp can lead to distorted priorities

• societies should adopt broader metrics that reflect how people actually live & feel
  
  

limits of gdp as a measure

• gdp measures market production, not quality of life

• it ignores how income is distributed

  • rising gdp can coincide with stagnant or falling living standards for most people

• it does not account for unpaid work

  • household labor, caregiving, & volunteer work are excluded

• environmental degradation can increase gdp

  • cleanup after pollution raises gdp even though well-being declines

• gdp treats “bads” as “goods”

  • spending due to crime, illness, or accidents increases gdp

disconnect between gdp growth & lived experience

• in many advanced economies, gdp has grown while:

  • median wages stagnated

  • job insecurity increased

  • economic anxiety rose

• people judge economic success by their own circumstances, not national averages

• this gap fuels mistrust in institutions & economic policy
  
  

importance of distribution

• well-being depends not just on total income, but on who receives it

• inequality affects:

  • social cohesion

  • health outcomes

  • political stability

• a dollar gained by a low-income household increases well-being more than a dollar gained by the wealthy

• ignoring distribution leads to misleading conclusions about progress
  
  

health, education, & security as core components of well-being

• good health is central to quality of life, independent of income

• education affects:

  • future opportunities

  • civic participation

  • economic resilience

• economic security matters

  • fear of unemployment or medical costs reduces well-being even if income is stable

• gdp does not capture these dimensions adequately
  
  

environmental sustainability

• current gdp ignores long-term environmental costs

• growth that depletes natural resources undermines future well-being

• climate change & ecological damage represent a failure of current metrics

• true progress requires accounting for sustainability & intergenerational equity
  
  

subjective well-being

• people’s own assessments of their lives provide valuable information

• happiness & life-satisfaction data:

  • capture aspects of life missed by income statistics

  • reveal mental health & social stress

• subjective measures should complement, not replace, objective indicators

alternative frameworks & indicators

• well-being should be measured across multiple dimensions, including:

  • income & consumption

  • health

  • education

  • environmental quality

  • security

  • social connections

• composite dashboards are preferred over a single index

• this avoids hiding trade-offs behind one number
  
  

policy implications

• what governments measure shapes what they prioritize

• better metrics lead to:

  • more inclusive growth strategies

  • stronger social safety nets

  • greater focus on sustainability

• measuring well-being improves democratic accountability

  • citizens can better judge whether policies improve their lives
    
    

overall conclusion

• gdp remains useful for measuring economic activity

• it should not be treated as a proxy for social progress

• a shift toward well-being metrics allows for more accurate, humane, & forward-looking policymaking