Intermediate Macroeconomics: Basic Definitions and Accounting

Gross domestic product (GDP) is the current dollar value of all final goods and services that are produced within a country within a given period of time. “Goods” are physical things that we consume (like a shirt) while “services” are intangible things that we consume but which are not necessarily physical (like education). “Final” means that intermediate goods are excluded from the calculation. For example, rubber is used to produce tires, which are used to produce cars. We don’t count the rubber or the tires in GDP, as these are not final goods – people do not use the tires independently of the car. The value of the tires is subsumed in the value of the car – counting both the value of the tires and the value of the car would “double count” the tires, so we only look at “final” goods. “Current” means that the goods are valued at their current period market prices (more on this below in the discussion of the distinction between “real” and “nominal”). GDP is frequently used as a measure of the standard of living in an economy. There are many obvious problems with using GDP as a measure of well-being – as defined, it does not take into account movements in prices versus quantities (see below); the true value to society of some goods or services may differ from their market prices; GDP does not measure non-market activities, like leisure (or things that are illegal); it does not say anything about the distribution of resources among society; etc. Nevertheless, other measures of well-being have issues as well, so we’ll focus on GDP. Let there be n total goods and services in the economy – for example, candy bars (a good), haircuts (a service), etc. Denote the quantities of each good produced in year t by yi,t for i = 1, 2, . . . , n and prices by pi,t for i = 1, 2, . . . , n. GDP in year t is the sum of prices times quantities: