Gross Domestic Product
Episode #6 of the course Fundamentals of economics by Dr. Michael McDonald
Welcome to the sixth lesson of the course!
Today, we’ll explore GDP, or Gross Domestic Product, one of the most important and complex concepts in all of economics, used by modern economists to monitor and measure economic growth.
Understanding GDP is crucial to understanding how the modern world is evolving and why some countries and regions are becoming more central to the global economy while others are becoming less important.
What Is GDP?
GDP is the value of all goods and services produced by a country in a given year. This concept is usually applied to individuals by dividing GDP by the number of people in a country to produce a figure called GDP per capita. Economists then look at the change in GDP per capita over time to determine if a country is doing a good or bad job of improving the lives of its citizens.
GDP per capita ranges from as little as a few hundred dollars for poor countries in places like sub-Saharan Africa, to more than $30,000, $40,000, and even $50,000 in rich nations like the US, Australia, Switzerland, and other areas in Western Europe.
In recent decades, China, South Korea, Taiwan, Japan, and several other Asian nations have made impressive strides in improving the lives of their citizens and growing GDP per capita. In China, for example, GDP grew by 10% or more for much of the 1990s.
GDP is also used to measure relative importance of a country’s overall economy. There are various ways to calculate GDP, but by most methods, the world’s largest economies are the United States, the European Union, China, and Japan. Because the EU is not a single country, the US is usually referred to as the largest economy in the world, followed by China, which recently overtook Japan to move from the third largest economy to the second largest.
GDP and the Growth of the Economy
While economic recessions get a great deal of press and attention, the real key to long-term economic prosperity is consistent GDP per capita growth.
GDP per capita growth is driven by many factors, including growth rate of technology and the amount of human capital and physical capital in an economy. Countries that devote resources to educating their citizens and allowing them to save and accumulate capital to invest and improve technology ultimately see faster rates of GDP growth. To illustrate this, consider the following.
Over the last 100 years, GDP growth in the US has been anywhere from 2-4%. This has led many to assume that 3% growth is a reasonable long-run growth rate. Yet, history shows that growth has frequently been much slower.
While we don’t have exact figures, we can perhaps assume that per capita GDP in ancient Rome was around $500 per person. This is consistent with a modern-day poor country where people essentially live in shacks without plumbing or electricity. Estimates differ, but Italian GDP in the year 2000, roughly two thousand years after the Romans, is perhaps around $33,000. What rate of GDP growth does that imply?
The answer is around 0.21%—less than one-tenth the level of average growth over the last century. (To work the math out for yourself, try using the following equation: Future GDP per capita = Historical GDP per capita *((1+average GDP growth) raised to the power of the number of years of growth. In this case, $500*(1.0021^2000 years) = $33,200.)
Put differently, if the world had been able to grow GDP per capita more consistently, the world should be a much richer place.
Tomorrow, we will examine another metric of economic well-being at the national level: unemployment.
Recommended book
How an Economy Grows and Why It Crashes by Peter D. Schiff, Andrew J. Schiff
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