What is gross domestic product (GDP)?
GDP is the most common measure for the size of an economy. It measures the total value of goods and services produced by that economy during a specific time period, typically a year or a quarter, so it helps us understand the size of an economy and the standard of living of its population.
It can be calculated for a country, a region (such as Tuscany in Italy or Burgundy in France), or for groups of countries, such as the EU.
Policymakers, businesses, and institutions use GDP to make key economic decisions. In the EU, GDP is calculated for different reference periods. Generally, it is commonly referred to as annual GDP, but it is also calculated every 3 months, called quarterly GDP.
GDP covers all goods and services produced for final use, without counting intermediate goods that are used in the production process.
Example: If an engineering company produces some special machines for its own use, a building company builds new offices for itself, or a business develops software for in-house use, these goods and services are included in GDP, even though they are not actually sold.
The same applies if Josefina makes a major change to her house by herself. Just as any construction work done by (unpaid) volunteers, it would be counted as part of GDP.
Furthermore, GDP also includes all goods which are produced by households for own use.
Example: If Kamila grows some vegetables at home, brews some beer or makes clothes or furniture — all for her own personal use — all this work contributes to GDP in her country. In practice, this type of work tends to be very small in scale in developed economies, and only some major categories will be surveyed or estimated for inclusion in GDP.
However, there are a few types of work that are not included in GDP and they mainly concern services such as housework, everyday domestic services and personal care.
Example: When Alessandro is at home and cleans the house, cooks dinner, washes and irons clothes or babysits for his younger brothers or sisters, none of that contributes to GDP.
However, if he is paid to do any of those services for someone else, for example, cleaning, cooking, ironing or babysitting in a hotel, this would contribute to GDP.
In fact all volunteer services — as opposed to the volunteer production of goods — are excluded, regardless of who benefits from the work, whether it is you and your family or an organisation, like a charitable or sports/youth organisation.
What about the black/grey or informal economy?
GDP includes estimates of all unreported transactions happening beyond the formal economy, for example untracked cash payments to a worker whose work is not declared to the authorities (therefore not registered for taxes and not eligible for social security). Other activities considered illegal in most countries are also estimated to calculate GDP, such as buying counterfeit goods, smuggled cigarettes and drugs, and prostitution.
Making these estimates for unreported transactions and illegal activities is not easy: more in-depth information on this topic can be found in the Statistics Explained article: Building the System of National Accounts.
Who is interested in GDP and why?
The change in GDP over time is currently the most important indicator of economic growth in a country.
GDP is essential for anyone involved in economic decision-making, whether at national, international, or individual level. It provides a snapshot of a country's economic performance and future prospects.
Governments use GDP data to design economic policies
- fiscal policy (taxes and government spending)
- monetary policy (interest rates and money supply)
They monitor GDP to assess whether the economy is growing, stagnating, or shrinking. This influences decisions on public spending, taxation, and interest rates.
Central banks, e.g., the European Central Bank, closely track GDP growth to determine interest rates and money supply. If the economy is growing too fast, they might raise interest rates to prevent inflation. If the economy is shrinking, they might lower interest rates to stimulate growth.
Economists use GDP to analyse the health of an economy, understand economic cycles, and predict future growth. Researchers might also use GDP data to compare the economies of different countries or to study the effects of different economic policies.
Businesses and investors use GDP data to forecast economic conditions and plan their strategies. A growing GDP suggests a healthy economy, which could lead to increased consumer spending, benefiting businesses. On the other hand, a shrinking GDP might signal an economic downturn, leading to more cautious business decisions.
Foreign governments and trade partners are interested in GDP to assess the stability and potential of another country's economy, which can influence trade agreements, investments, and foreign policy decisions.
How is GDP used as a reference?
As well as being a useful analytical tool in its own right, GDP can also be used as a reference for many other types of statistics and indicators.
Research and development (R&D)
R&D intensity is a common indicator when looking at the competitiveness of different economies. This is because there is a general connection between how innovative and competitive a country is and the amount it invests in science and innovation. R&D intensity is calculated by comparing spending on R&D with overall GDP.
Gross domestic expenditure on research and development, 2023
Government finance statistics
Another use of GDP is in government finance statistics. As well as borrowing or lending money, governments can also owe money and increase public debt. When government expenditure is greater than its income, a government deficit is recorded. Both measures are often compared to GDP.
These are just 2 examples where GDP is used as a reference: there are many more cases. More information on the various uses of national accounts in general and GDP in particular is here: Main users of national accounts.
How is GDP calculated?
GDP is a key measure within a wider framework of economic statistics which is often simply referred to as national accounts. The European system of national and regional accounts (ESA) defines the binding standards and methods used for compiling these accounts, whereas the global standard set by the United Nations (UN) is called the System of National Accounts (SNA).
GDP can be calculated in 3 ways, but the most common is the production method.
Production method
To calculate GDP, the production method adds up the value added at basic prices of all industries, plus taxes on goods or services, subsidies on goods or services are subtracted, in order to obtain GDP at market prices.
To help to understand the production method, see the boxes below which explain what value added and basic prices are.
Box 1: What is value added?
Example: Leonie is a taxi driver and charges a customer €10 for a trip and that is the value of her service. In order for Leonie to provide this service she must pay for petrol, car insurance and a number of smaller items which all together for this trip cost her €3; this is her intermediate consumption.
Her value added for this trip is the production or service value minus the cost of the intermediate consumption: €10 - €3 = €7.
Box 2: What are basic prices?
The actual price of goods and services that balances needs from the seller and the buyer is the market price. However, in national accounts, other prices can be used depending on how taxes (money that people or businesses have to pay the government) and subsidies (money paid by a government to help or encourage businesses) on products are recorded.
The basic price is the amount of money actually received and kept by the producer. It excludes all taxes on the final products, but includes any subsidies the producer receives from the state as an encouragement to lower the prices. There is not a single way to calculate GDP. In fact, there are 2 other methods to obtain the value for GDP: the "expenditure" and the "income" method. However, the 3 methods should all lead to the same result.
Expenditure Method
Another way to measure how well a country’s economy is doing is to look at how much money is spent on different things. This is called the Expenditure Method for calculating GDP
The formula is:
GDP = Consumption + Investment + Government Spending + Net Exports
Let’s break that down:
Consumption – This includes all the money people (households) spend on goods and services, such as
- Durable goods – things that last a long time, like cars or furniture
- Non-durable goods – everyday items like food and clothing
- Services – activities like going to the doctor, getting a haircut, or paying for education
Investment
Investment is money spent on things that help businesses make more products in the future, this includes
- Machines and tools
- Building new factories or offices
- Building houses or apartments
Government Spending
This is what the government spends money on, such as
- Paying teachers, police, and firefighters
- Building roads, bridges, and hospitals
- Providing services like public schools and healthcare
(But it doesn’t include things like pensions or unemployment benefits, because those aren’t payments for goods or services.)
Net Exports
This means the value of what a country sells to other countries (exports) minus what it buys from other countries (imports).
If a country sells more than it buys, that adds to the GDP.
If it buys more than it sells, that takes away from the GDP.
Income method
Another way to find out GDP is by adding up all the money people earn in the country. This is called the Income Method. What do we add together?
Wages and Salaries: This is the money people earn from their jobs, like teachers, doctors, and workers in factories.
Rent: This is the money earned by people who own land or buildings and rent them out to others.
Interest: This is the money people earn when they lend their money to others, like a bank earning interest on loans.
Profits: This is the money businesses make after they pay for everything they need, like paying workers and buying supplies.
Taxes (minus subsidies): This is the money the government collects through things like sales taxes, but we take away the money the government gives back to help businesses.
Explore further
Other articles
Related articles in Statistics 4 beginners:
Related articles in Statistics Explained: