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What Does GDP Mean? Why Is It Important?

Updated on April 27, 2016

GDP, is a term that you may frequently hear used by Governments and economists alike, however, you may not know what it really means. The dictionary defines it as 'a monetary measure of the value of all final goods and services within a country over a specific period of time'. Whilst this may come across as quite confusing at first, it is actually a lot easier to understand than the dictionary makes it sound.

Broadly speaking, it is taken to mean the amount of money that a country makes for all of its goods and services sold over a particular year. It is a very basic measure of how well the economy of a country is doing in comparison to other countries. It might also be referred to as Nominal GDP.

Governments may use some form of GDP comparison when looking to see how well they are doing. Some say that it is wrong to judge performance on this though. There are a number of factors that Nominal GDP measurements do not take into account. As well as this, it may be difficult for different governments to try and compare their respective GDP's. Factors such as population size differences will cause problems with these Nominal GDP comparisons.


Problems With Nominal GDP

There are a number of issues that will arise if you start to look deeper into the reliability of GDP measurements;

- Firstly, it may be seen that Nominal GDP does not take into account the distribution of wealth. This means that although a country may have a high GDP, there may still be huge amounts of inequality in it's society. To solve this, another measurement called GDP per capita can be taken. To find this, you have to take the Nominal GDP value and divide it by the population of that country for the year. This will produce a much smaller value that can be taken to represent the average output per person in a country. However, even this measurement will throw up problems as it still does not accurately reflect the distribution of wealth.

- Another problem with Nominal GDP is that it does not take into account hidden economies within a country. For example, it does not take into account illicit activities such as drug use or prostitution within a country. This could cause problems depending on the size of a country's hidden economy.

A good example of this could be in Russia, where it is estimated that hidden economies account for around 15-20% of it's output. It is hard to know if this is in fact true. In any case, that would add a sizable amount to the Russian GDP if it were to be measured.

- Also, it is said that Nominal GDP does not take into account other factors such as inflation and the cost of living. Thus, it could never be used on its own as a standard for a country's quality of living.

Nominal GDP values worldwide (2014)
Nominal GDP values worldwide (2014) | Source

Why Use GDP?

When taken into account with other factors, GDP can be a good way to see how a country is performing. It is when Nominal GDP is used on its own as a measure that we start to see problems.

Countries such as the United Kingdom have started to use another measure called Total Ouput. This figure may be seen to be more reliable a measure of wealth because it tries to take in more of the factors that Nominal GDP missed. Estimates are made on the size of hidden economies for example, and these are taken into account in the total output. This gives a slightly more reliable figure as to a country's output than traditional measures of GDP. The USA also uses a similar measure but has named this Gross Output. Essentially, they are both the same.

GDP can be quite helpful when looking to compare the output of a country over different years. In this situation it can be used to make conclusions as to whether the economy of that country has grown. However, as we mentioned earlier, there are obvious disadvantages to relying on this as a sole measument of growth alone.

Top 5 Nominal GDP Countries (IMF 2015)

Rank
Country
Nominal GDP (Millions of USD)
1
USA
17,947,000
2
China
10,982,829
3
Japan
4,123,258
4
Germany
3,357,614
5
UK
2,849,345

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