How do you measure the size of an entire economy?
Let’s say I buy a coffee here in London for £3.
Those £3 are factored into the United Kingdom’s GDP.
And so is this barista’s salary.
And this espresso machine.
In fact, most of what’s around you is part of GDP.
GDP is an important gauge of the overall health of an economy. It stands for:
Simply put, GDP measures the total value of all goods and services in a country.
That means it measures a lot of stuff worth a lot of money.
Here in the U.K., GDP is around two-and-a-half trillion dollars per year.
In the United States, the world’s biggest economy, it's around $19 trillion every year.
How do you get to these numbers?
Well, you can calculate GDP in a few different ways, but the most commonly used equation goes like this:
consumption plus investment plus government spending plus net exports equals GDP.
Let’s break that down.
Consumption is another way of saying consumer spending.
It’s the money you or I spend on physical goods, like coffee, and on services, like a haircut.
In many developed economies like the U.K. or the U.S.,
consumer spending makes up more than half of a country’s GDP.
The second part of the GDP equation is investment.
This measures how much businesses spend on things like buildings, land and equipment.
It also includes a major consumer investment - buying a home.
Investment can take a hit when the economy is suffering.
You can see that in this chart domestic business investment
plummeted in the U.S. during the financial crisis.
That’s because companies were trying to save money instead of
putting it toward things like factories, machinery and equipment.
Okay, now we get to government spending.
This is the money local, state and national governments spend on things like roads, schools and defense.
Government spending varies a lot depending on each country’s approach to public goods and services.
Take for example France, where government spending amounts to roughly 56% of GDP.
That’s compared to 41% in the U.K. and 38% in the U.S.
That brings us to the final part of the GDP calculation: net exports, or exports minus imports.
A lot of countries have negative net exports, meaning they bring in more products than they send out.
For example, the U.K. imports around $1 billion worth of coffee every year
but only exports around $315 million, meaning its net exports of coffee are negative.
Countries around the world collect data on consumption, investment, government spending and net exports.
This makes GDP a universal measurement and a way for countries to stack up against one another.
But it’s not just the sum of the equation people look at.
You'll often hear about the GDP growth rate, or the percentage change in GDP over time.
Generally, if an economy is healthy, GDP growth expands.
If an economy is in bad shape, GDP growth contracts.
Two consecutive quarters of negative GDP growth are referred to as a recession.
But GDP doesn’t always give a full picture of the economy.
Critics say the equation puts too much weight on production and manufacturing,
and not enough on services and the digital economy.
Just think of Spotify. For $10 a month you can listen to unlimited music from a huge range of artists.
In the past, you would have had to buy all of those albums separately, with each one contributing to GDP.
It’s hard to factor a digital service like Spotify into the GDP equation
which is used to measuring physical goods.
GDP also doesn’t measure economic equality and well-being.
So even if a country is really rich according to GDP, wealth may be spread unevenly.
Plus, GDP excludes unpaid work like volunteering for charity or child care.
And it doesn't factor in costs like pollution or illegal activity.
Some experts have come up with alternative measures to GDP
that measure overall happiness and quality of life.
But so far, none of these have stuck.
Maybe it’s just too hard to put an economic value on that first sip of morning joe.
Hey everyone, Elizabeth here. Thanks so much for watching our video.
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Talk to you later!