CHAPTER 21 Sizing Up the Economy Using GDP

GDP data can help Inga Koster figure out which markets are ripe for smoothies.

Chapter Objective

Measure and analyze total economic activity.

• 21.1 GDP and the Macroeconomy

  Learn how to measure the size of an economy using gross domestic product.

• 21.2 GDP Measures Total Spending, Output, and Income

  Analyze GDP as a measure of total spending, output, and income.

• 21.3 What GDP Captures and What It Misses

  Assess GDP as a measure of living standards.

• 21.4 Real and Nominal GDP

  Distinguish between real changes in quantities and the effects of changing prices.

• 21.5 Millions, Billions, and Trillions

  Scale large numbers into something more manageable.

Inga Koster was a business student enjoying a semester abroad in Scotland when she discovered a university shop selling a simple pleasure that she had never encountered in her native Germany: a smoothie. It was a delicious blend of fresh fruit and vegetable juices. Even better, the extra vitamins provided a welcome boost in the face of the bleak Scottish weather.

Six months later she was back in Germany, trying to figure out what to do with the rest of her life. Her attention soon returned to that smoothie. She couldn’t find a similar product in nearby supermarkets, and soon, the idea for her business was born. She teamed up with two friends to write a business plan, and they founded True Fruits, which today is a successful smoothie company with over $40 million in annual sales.

True Fruits has now grown to the point that Inga and her team are looking to expand internationally. But where? True Fruits smoothies are a small everyday luxury, so they’re most likely to sell well in countries with high incomes. That sets Inga’s team searching for data that can tell them which countries have high incomes. This is where GDP comes in.

Our task in this chapter is to figure out how to measure the size of the entire economy. We’ll focus on a measure called gross domestic product—or GDP for short—which measures a country’s total income. It’s the most closely tracked measure of macroeconomic performance. People track GDP because it provides valuable insight into how much is being produced, spent, and earned. That information can help policy makers, investors, and entrepreneurs like Inga Koster make good decisions. We’ll also see how GDP is used to track how the size of an economy is changing over time. In the next chapter we’ll dig into the determinants of those changes. Our first step is learning how to measure the size of an economy.

You’ll also need to know how to interpret what these numbers are telling you. We’ll evaluate what GDP counts, what it misses, and how useful it is as a measure of what really matters, which is our living standards. Finally, because this chapter is about how best to size up an economy, we’ll develop a few tricks that will help you make better sense of economic numbers.