Eli5 If a nation’s GDP is essentially simply how much businesses are charging for products and services, then why is it such a closely followed metric?


Is it simply a matter of, “This is how much money consumers can spend”? Because if so, that seems arbitrary to me, given the fact that it’s the business giving the money to the consumers to begin with.

In: 5

A lot of businesses are very sensitive to changes in the economy. Look at a business that manufactures stuff only used in new houses. If house building is strong, the company is making a lot of money. If the economy crashes and the house builders can’t get construction loans, house building goes nearly to zero and this company is in danger of bankruptcy.

GDP is a measure of how much money changes hands, which (to your point) does not seem particularly meaningful on its own. I’ve always enjoyed this joke: https://www.reddit.com/r/Jokes/comments/qp49wz/two_economists_are_walking_in_a_forest_when_they/

It measures productivity. When a worker goes to work, they don’t produce a salary. They produce a service or a product, and that service or product is traded for an amount of money to a consumer. The value of that service or product was “created” by the worker. A better product is going to be worth more money, so a better product adds more money to the GDP. The GDP is just the sum of the values created by all the labor in a country. A country with more people will have more GDP, and a country with better production technology (such as better factories) will also have more GDP.

GDP measures how much a country makes. A country that can make more ‘stuff’ (per person) is usually better off. (More food, more haircuts, more/better cars, etc.)

It’s also the country’s total income, because everything that gets produced is income for someone. When a new car is sold, all that money goes somewhere: to shareholders, executives, labor, suppliers, caterers, and so on.

Because of this, it’s usually easier to measure GDP by looking at ‘final’ spending. When you buy a meal at a restaurant, the restaurant isn’t creating that entire chunk of GDP. It usually doesn’t grow the ingredients, but adds value by cleaning, chopping, and cooking those ingredients. But the price of the meal incorporates all those previous steps, the prices paid to (and income of) the farmers, butchers, and transportation companies, as well as the value the restaurant adds.

Because GDP is gross *domestic* product, we also subtract imports. (For example, a Mexican-grown tomato is part of Mexico’s GDP even if it ends up in my US meal, but the service of preparing that tomato in the restaurant is part of US GDP.)

You’ll notice one obvious problem. This only applies to goods and services that are sold in a market. The restaurant’s services count in GDP, but my services in cooking a meal for friends don’t. So GDP doesn’t capture literally *all* production, but it does a pretty good job under most circumstances.

GDP by itself isn’t useful because it needs to be adjusted for inflation and per Capita.

GDP adjusted for inflation and per Capita is a good measure of how big the pie is to be split amongst a nations people. Bigger pie = more prosperity to share around.