ChatGDP

Explaining Gross Domestic Product

The Bureau of Economic Analysis (BEA) recently published its first estimate of GDP for the fourth quarter of 2024.¹ According to this first estimate, real GDP grew at a seasonally adjusted annualized rate of 3.3 percent from the end of September, 2024 to the end of December, 2024. That is generally good news and provides additional evidence that the economy appears to be on solid footing.

Seeing GDP in the news once again, there may be many who think “what is GDP exactly?” As a professor of economics, I often take for granted that others are not as well-acquainted with the acronyms of macroeconomics as I am. More importantly, I am very aware that my students are often loath to admit they do not remember or understand key macroeconomics concepts. Thus, in this post, Macrosight provides a quick briefing on GDP, explaining the key parts of its definition, as well as why GDP represents a “flow” and not a “stock”(and what those two terms mean).

GDP is Macroeconomics. Macroeconomics is GDP

What is GDP? GDP stands for “Gross Domestic Product.” It is a statistic that measures the total value of economic activity taking place within a defined region over a specific period of time. Typically, the defined region is a country, and the specific period of time is a quarter of a year, or a year. The BEA publishes data on GDP at the quarterly frequency going back to 1947. A typical textbook definition of GDP is as follows:

Aggregate value of all, new and final goods and services produced within a country over a specific period of time, measured at current or constant prices.

The bolded words in this definition are very important to understanding GDP.

• All means that the BEA counts up every good and service legally produced and sold in an economy. And by “everything”, I mean everything, from toothpicks to tanks.

• New means that the good or service is newly produced, where “newly” is defined by a specific period of time. Anything produced within 2024, say, will count in the GDP statistic for 2024. Any previously owned (used) good that is re-sold in 2024—such as a 2015 Ford truck—will not be counted in GDP for 2024 (that used item was already counted in GDP in the year it was newly produced).

• Final means that the BEA only counts the end product. For example, the value of a car produced in 2024 is included in GDP for 2024. The value of the tires, the steel, the leather, the electronics, the wiper fluid, or any other component of the car is not counted separately. The separate values of those components are already represented in the value of the car.

• Within a country means that GDP for the United States counts only those goods and service produced within the geographic borders of the country.² This is true for any good or service, regardless of whom or which company is doing the producing. Cars produced in Texas or South Carolina by Toyota or BMW, for example, are included in GDP for the United States.

• Period of time means that over a specific time-frame. In the United States, the BEA produces a value for GDP every quarter (every third month of the year). Once the year is completed, the BEA also produces an annual GDP value. The “period of time,” as mentioned above, is crucial for defining what is new.

• Current or Constant refers to the strategy for valuing GDP. The former is the practice of counting up the number of all the goods and services and multiplying those items by their prices in the current year (this method provides the estimate of “nominal GDP”). The latter is the practice of converting current year values to constant prices. To do so, the BEA chooses one year’s prices to represent all years—currently that “constant” year is 2017. The BEA then values all years’ goods and services at those 2017 prices. This process gives us the estimate for “real GDP.”³

GDP is a Flow, not a Stock

Aside from the definition of GDP, an additional, and remarkable, aspect of GDP is important for understanding what the concept reveals about our economy. Real GDP represents a flow, as opposed to a stock. What is the difference?

A stock represents a pile of stuff accumulated over multiple time periods. Think of all the clothes, furniture, TVs, computers or whatever you have in your house (or in the house in which you grew up). Chances are that most of those items were purchased in different years, with some bought many years ago, and some obtained very recently. The collection of all of your things represents a stock.

The flow includes the additions and subtractions to that stock. A flow is defined by a time period, say, a year. Whichever items are purchased in a given year—clothes, a new TV, a new couch—are additions to what you already have collected in prior years. These new items represent part of the flow for that year. Or, any items that wear out during the year, or things you throw away that will never be used again (items that end up in a landfill instead of another person’s home) are subtractions. Subtractions are also part of the flow.

Consider, for example, Figure 1, which shows real GDP for each year from 2019 through 2023.

For 2023, real GDP equaled $22.4 trillion. That implies that there was $22.4 trillion worth of new goods produced and services provided in 2023. That is, $22.4 trillion worth of new stuff and experiences on top of all the other stuff we accumulated and kept from previous years. Recall the definition of GDP at the beginning of this chapter. GDP represents all newly produced items over a specific period of time. Hence, GDP is a flow.

Notice also the year 2020, highlighted in red. For that year, real GDP totaled $20.2 trillion. That amounted to about $460 billion fewer goods and services than were produced in 2019. But, the flow was still positive. Even though the economy was not as strong as the year prior, we still created about $20 trillion worth of new things and experiences for ourselves—it is not as if the onslaught of Covid-19 that year resulted in zero new things produced. We still produced a lot of stuff, just not as much as the prior year (nor as much as the years that followed).

The fact that real GDP is a flow underscores the enormity and productive capacity of our economy—we are not simply adding a little bit of stuff each year. Rather, we are adding a massive amount of goods and services year after year, in good times and in bad. That is why I used the word “remarkable” earlier when introducing the idea of a flow versus a stock. That our economy—or we, since we are all of part of this process—produces such an enormous amount of goods and services every year, in my view, is nothing short of remarkable.

Why is GDP important?

GDP is the primary gauge of our macroeconomic health. It leads the list of factors that determine whether or not the Federal Reserve raises or lowers its target interest rate; whether or not the U.S. Congress passes a stimulus bill in an attempt to revive an ailing economy; and, whether or not we can conclude that our economic way-of-life is improving or regressing. With respect to the Federal Reserve, for example, given real GDP growth came in at 3.3 percent for the last quarter of 2023—which is above the average over the past couple of decades—I am guessing that means the Fed will not be lowering its interest rate target anytime soon.

Finally, there is a lot more that can be said about GDP, such as what it does not tell us about our economy. This post is long enough, however, so Macrosight will chat about additional GDP-related topics in future posts.

1. The BEA will publish a second estimate for the fourth quarter of 2023 in late February and a third and final estimate in late March.

2. GDP is also calculated for U.S. states. Here I focus on “country” for the purpose of explanation.

3. Real GDP may also be referred to as “inflation-adjusted” GDP. For the purposes of explanation, I am simplifying the process of producing real GDP. The BEA explains their processes in great detail here.