Gross domestic product is the standard measure of the size of an economy. Its four components — consumption, investment, government spending, and net exports — are the standard decomposition. Understanding what GDP measures, and what it does not, is the beginning of macroeconomic literacy.
- 01State the four components of GDP.
- 02Distinguish nominal from real GDP.
- 03Explain three things GDP does not measure.
The identity
GDP = C + I + G + (X − M). Consumption is roughly two-thirds of American GDP. Investment is roughly a fifth. Government is roughly a fifth. Net exports have run negative for decades. The identity is definitional; the mix is descriptive.
Nominal versus real
Nominal GDP is measured in current-year dollars. Real GDP adjusts for inflation using a base year's prices. Growth in real GDP is the meaningful economic measurement; growth in nominal GDP conflates inflation and output.
What GDP does not measure
Household production. Volunteer work. Environmental degradation. The distribution of income. GDP measures market transactions well and everything else poorly. Its persistence as the headline number is partly institutional inertia and partly the absence of a better one.
- C + I + G + (X − M). Memorize the identity.
- Real GDP is the meaningful growth measurement.
- GDP measures market activity, not welfare.