Gross domestic product (GDP) is the estimated MARKET VALUE (the price paid for goods and services) of all final goods and SERVICES produced in a country in a year. Generally, only those goods and services exchanged in markets for which there is taxable INCOME are included in GDP; most bartered services, illegal activities, household efforts, and in-kind transactions are not included. Some goods, particularly goods and services produced and sold to government, have no marketplace price. In this situation the cost to government is assumed to be the market value. For example, complex weapons systems only sold to the military are included in GDP at their cost. Final goods and services are those that available to consumers. Since GDP is used to estimate the output of goods and services available to final consumers, primary goods such as raw materials and intermediary goods (which are used in the production of final goods) are not included in GDP. For example, few Americans buy wheat or flour; they purchase bread. Wheat is a primary PRODUCT, and flour is an intermediate product. GDP can be calculated by either the sum of all expenditures for final goods and services or the sum of income received for the goods and services. These are known as the expenditures and income approaches, respectively. Recognizing in the CIRCULAR FLOW MODEL that businesses, households, and government are connected by flows of money, resources, and goods and services, the sum of expenditures for final goods and services will equal the income received for those products (with some statistical adjustment). Using the income approach, GDP equals the sum of wages, interest, rent, corporate PROFITS, capital CONSUMPTION allowance (the estimated value of DEPRECIATION of capital goods used in production), and indirect BUSINESS TAXES (taxes collected by businesses for government agencies), and net-factor income from abroad. Using the expenditures approach, GDP equals the sum of consumption, INVESTMENT, and government spending, plus spending for exports minus spending for IMPORTS. Economics textbooks use the equation GDP = C+I+G+(X–M) to show the expenditures approach. In the United States, consumption expenditures (C) represent approximately two-thirds of all spending. Changes in consumer spending can dramatically change GDP. Reports describing changes in consumer income, confidence, and credit levels are INDICATORS of likely changes in consumption spending. Investment spending (I), spending on capital goods, represents approximately 15 percent of U.S. GDP, but it is often the most volatile component of GDP. Business investment is made in anticipation of growing and changing DEMAND for consumer goods. Investment spending is also influenced by INTEREST RATES, the percentage of factory capacity currently being utilized, and changes in technology. Government spending (G) is that portion of government budgets used to purchase goods and services. The U.S. FEDERAL BUDGET is approximately $2 trillion, but transfer payments, redistribution of purchasing power from one group to another, is not a government expenditure. SOCIAL SECURITY and other government-sponsored WELFARE programs are subtracted from the budget to estimate government expenditures. Net trade (X–M) adds expenditures for exports and subtracts expenditures for imports from GDP. Since GDP measures the value of output in an economy, foreign purchases of U.S. output are part of GDP, but U.S. consumers’ purchases of imports is not part of GDP. Net trade is influenced by EXCHANGE RATES, levels of income in other countries, barriers or reductions in TRADE BARRIERS, and consumer preferences. In the United States, GDP is calculated quarterly by the Department of Commerce. Each quarter the department issues a preliminary estimate, followed by a first and then second revision for GDP. GDP and percentage changes in GDP are the most widely watched measures of economic performance, influencing American business and MONETARY POLICY. GDP is also often used as a measure of the economic well-being of a country and its citizens. But since GDP is a measure of output in an economy, it does not include
• nonmarket activities
• black-market exchanges
• changes in the quality of goods and services over time
• distribution of income and goods and services
• depletion of natural resources
• environmental degradation
• distinction between the use of renewable and nonrenewable resources
• Composition of spending, i.e., spending on negative deterrence (defense and personal safety) versus positive benefits (such as recreation, culture, or education)
Advocates of sustainable development challenge the widespread acceptance of the idea that if GDP is growing, people are better off, and have offered a variety of alternatives to GDP to measure well-being in a society. The most widely quoted alternative is the Index of Sustainable Economic Welfare (ISEW). Created by former World Bank economists Herman Daly and John Cobb Jr., the ISEW adjusts GDP to account for environmental and social factors, including income distribution, value of household Labor, and environmental damage.