What Does GDP Really Mean?

Gross Domestic Product (GDP)  is among the most used statistics in the field of economics. In essence, GDP is a numerical measure of economic activity. With GDP, a country’s progress can be compared with itself and with other countries.

It is measured in the country’s currency. According to Investopedia, it represents  the “value of all finished goods and services made within a country during a specific period.”

But what does GDP exactly compute for? What factors does it use to measure economic activity?

Arup details it fully in their paper, Have You Wondered What GDP Means?. 

Here, we will condense the key ideas.

Arup divides GDP into four components that are factored in for its computation:

  1. Jobs, energy and economic volume flows
  2. Transport
  3. Population and jobs
  4. Balance of payments

Let’s look into them one by one.

1. Jobs, energy and economic volume flows

The infrastructures and other physical assets in the country make up what is known as fixed capital. These assets are long-lived yet expensive to create. Some examples of fixed capital are buildings, machinery, and equipment.

It is in fixed capital where economic flows — the conversion of various inputs into outputs. In other words, it is in fixed capital where production occurs.

Among the chief inputs in the economy are energy and labour — both of which are highly important in maintaining an efficient economic flow. It is easy to how these factors are fit in as component metrics to a country’s overall economic activity.

2. Transport

Transport is also a type of fixed capital. Needless to say, it is highly important for an economy to properly function.

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Like the other previously mentioned examples of fixed capital, transport is long-lived and expensive to construct. However, it differs from the previous examples in a sense that transport is not stationary.

Quantifying transport requires data which is not given by typical measures of fixed capital. Hence, Arup decided to classify transport differently as a component.

3. Population and jobs

To measure economic activity, it is also important to measure the availability of jobs as well as the number of employed people.

The descriptions of the household — size, composition by employment, and composition by age — are also important factors to measure an economy’s labour force which as mentioned earlier, is a key input to maintain a healthy economic flow.

By taking into account these factors, the population can be measured in terms of how much is active (i.e., employed) and how much is inactive (i.e., unemployed)

4. Balance of payments

This component concerns itself with the flow of money within the economic boundary. How much of the trade flow is going inward? How much is going outward? Is the net balance of trade positive or negative? These are some of the questions that can be answered by taking an economy’s balance of payments into account.

Gaining insights from the obscure metric

For most people, the GDP is quite an obscure metric to measure economic activity. This is because what it exactly measures may be confusing.

GDP is not exactly a bad metric. However, it is highly accessible to the general public. Arup’s approach of decomposing the GDP into its components is one way to make the metric more comprehensible. This will also aid in gaining more insights from the numbers shown to us by the GDP.

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