GDP is a measurement that people obsess over. It is often used to tell us about the health of an economy. Growth in GDP is a sign that things are on the up, whereas flagging GDP may well be mean troubled times ahead. But what does it actually mean, beyond the way that politicians and journalists use it?
GDP stands for Gross Domestic Product. But that means naff all to us non-economists. So let’s start with the idea that its a measurement. Well, what’s it measuring?
GDP is supposed to measure the value of what a country has produced over a certain time period. Economists look at the value that has been added to the economy over the last year or financial quarter (meaning a quarter of the year).
The figure is often presented as a percentage. This is the percentage of growth relative to the total value of the economy. So when the news presenter says, ‘UK GDP grew by 0.7% in the third quarter of this year…’, what they are say is that the value of the UK economy as a whole has grown by 0.7% over the last three months.
It’s important to remember that GDP measures the added value to an economy. This means that we take the total output and then we minus the value of the investments that were needed to achieve that output.
Imagine a cafe. The cafe makes £100,000 over a year. But in order to make that money, it has had to pay for coffee beans, cakes, electricity etc. If all the cost of those things (called intermediate inputs) came to £80,000, then the growth in value is only £20,000.
If we didn’t minus these intermediate inputs then our growth figures for the whole economy would be warped. The cafe buys its cakes from the baker, its coffee beans from an importer and they, in turn, buy their raw materials from other companies. Failing to minus these costs means that the cakes and the coffee beans would be counted multiple times.
However, GDP only minuses the costs of consumable goods, things that can only be used once like coffee beans or cake. What it doesn’t take account of is reusable investments (or capital goods) such as the coffee making machines or the till. Because they can be used over and over again they are measure differently using a measurement called Net Domestic Product.
But don’t worry, we won’t go there.