Big figures sound scary. Our governments spend billions of euros/dollars/you name it every year in lots of different things. You might even know a few things about GDP, deficit and a vast array of terms related to economics in general. In this series, my aim is to make it easier for everyone to get a grasp of macroeconomics. So, fasten your seat belts and get ready to learn!
“GDP” can be a lot of things. Simply put, it is “the value of all final goods and services produced in an economy during a period of time” (typically a year, but there are estimates for quarterly GDP and even monthly GDP!). Economists like to use the expression aggregate output, because they aggregate (!) all the goods and services produced by individual agents and get a huge number as a result.
Why is GDP such an important number? Because it tells us how powerful our economy is. We’ll go through more details and “but’s” in future articles. Under normal circumstances, the bigger the number, the more powerful the economy (it can produce a great amount of goods and services). But things are not that simple: GDP is measured in local currency, so it takes both quantity and price into consideration.
I’m sure you have already found a possible trick to manipulate the final value. We can either produce more goods (hard to do, requires more labour force and resources in general) or increase the price of the goods we’re able to produce now. If I am able to produce 10 cars and sell them for $10,000 each, my GDP would be $100,000. However, I could choose to sell them for $20,000 next year, and it would double my GDP without any effort!
If we want to measure production and eliminate the effects of increasing prices, we have to construct another value called real GDP. Real because it focuses on the real things (i.e. my cars) and doesn’t care about the increasing (or decreasing) prices. This can be achieved by using a reference year, whose prices are taken as… reference (you knew it!).
When economists want to know more about the situation of a certain economy, they use real GDP as the best estimate of development and performance. Real GDP per capita measures the average “standard of living” in an economy. Just divide real GDP by total population and you’ll get the value!
So, just to wrap it up (although there is a lot more on this topic):
- GDP measures the value of final goods and services during a certain period of time.
- Real GDP = Nominal GDP without the effect of increasing prices.
- Real GDP per capita serves as an indicator of “quality of life” in a country.
Our next article will focus on a very important economic factor that affects GDP (and much more!): inflation. Let me know what you think about this entry in the comments below. Stay tuned, stay Economic!