GDP measures the monetary value of all the market goods and services (plus some nonmarket production) produced within a country in a given period of time, such as a quarter or year. It’s a measure of economic growth that’s often used to compare economies on an international scale, as well as a key indicator of a country’s overall wealth or standard of living.
The calculation of GDP starts with measuring market goods and services sold to consumers, businesses, or governments. Those market goods and services include final private consumption (C), investment (I), and government expenditures (G). The calculation of GDP also accounts for intermediate consumption (i.e., the cost of materials, supplies, and services used in the production of final goods and services) by subtracting it from gross output. This is known as the production or value added approach to GDP.
In addition to describing overall economic activity, GDP data is useful for understanding the reasons behind booms and busts in the economy, and it’s a critical tool for policymakers as they craft policies meant to spur growth or dampen inflation. However, it’s important to recognize what GDP measurements do and don’t tell us.
Because GDP relies on recorded transactions and official data, it doesn’t capture the value of the informal economy — activities like underground markets or unrecorded cash payments to workers not paying taxes or registered for social security. Likewise, it doesn’t account for unremunerated volunteer work, such as helping neighbors with chores or serving on the board of a nonprofit organization. Finally, by not fully accounting for quality improvements or the introduction of new products, GDP understates true economic growth.