Few numbers are as closely watched — or used to drive discussions about politics, business and international affairs – as gross domestic product (GDP). It’s a measure of the market value of all the goods and services produced in a country during a certain period. And it’s a key indicator of how the economy is doing.
GDP is calculated in several different ways. One is the expenditure approach, which divides GDP into Consumption (household spending), Investment (household and business investments), and Government Spending (federal, state and local government spending). Another way to calculate GDP is to focus on what is produced, rather than who is doing the purchasing: This is called the production method.
Both the expenditure and the production methods count all output produced in a country, whether it’s made by individuals for their own consumption, or bought by businesses to use as inputs in producing other goods and services. They also include the depreciation of fixed assets, and net exports (exports minus imports).
But there are some important limitations to GDP. Because it relies on recorded transactions and official data, it doesn’t capture all economic activity. For example, work performed for free by members of a family or a charity doesn’t get counted, as does much informal economic activity like black-market activities or unrecorded purchases of counterfeit goods.
In addition, GDP doesn’t take into account external costs or waste (such as pollution) or the cost of consuming nonrenewable natural resources. This is why it’s a good idea to look at a country’s GDP in conjunction with other indicators, such as the Human Development Index, which attempts to measure quality of life.