What is GDP and how is it measured?

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GDP or Gross Domestic Product is one of the most important tools for looking at how well, or badly, an economy is doing.

It's a measure - or an attempt to measure - all the activity of companies, governments and individuals in a country.

GDP helps businesses judge when to expand and hire more people, and it lets government work out how much to tax and spend.

What is GDP?

In the UK, new GDP figures are produced every month, but the quarterly figures - covering three months at a time - are the most widely watched.

In a growing economy, each quarterly GDP will be slightly bigger than the quarter before, a sign that people are doing more work and getting (on average) a little bit richer.

Most economists, politicians and businesses like to see GDP rising steadily because rising GDP usually means people spend more, more jobs are created, more tax is paid and workers get better pay rises.

If GDP is falling, then the economy is shrinking - bad news for businesses and workers. If GDP falls for two quarters in a row, that is known as a recession, which can mean pay freezes and lost jobs.

The Covid pandemic caused the most severe recession seen in over 300 years, hurting business and employment, and forcing government to borrow hundreds of billions of pounds to support the economy.

The impact is still being felt. In April this year all of the main sectors of the economy - services, manufacturing and production - shrank again, which last happened in January 2021.

In August the Bank of England warned the UK will go into recession again. The economy is forecast to shrink in the last three months of this year and keep shrinking until the end of 2023.

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How does GDP affect me?

If GDP is growing, the government will use that as evidence to say that it is doing a good job of managing the economy. Likewise, if GDP falls, opposition politicians will say the government is running it badly.

But it's not just a report card on how the government is doing. If GDP is going up steadily, people will pay more in tax simply because they're earning and spending more. This means more money for the government to spend on public services, such as schools, police and hospitals.

Governments also like to keep an eye on how much they are borrowing in relation to the size of the economy.

For example borrowing was equivalent to about 14% of GDP in the first year of the Covid pandemic, the highest proportion since World War Two.

How is it measured?

GDP can be measured in three ways:

  • Output: The total value of the goods and services produced by all sectors of the economy - agriculture, manufacturing, energy, construction, the service sector and government
  • Expenditure: The value of goods and services bought by households and by government, investment in machinery and buildings - this also includes the value of exports, minus imports
  • Income: The value of the income generated, mostly in terms of profits and wages.

In the UK, the Office for National Statistics (ONS) publishes one single measure of GDP, which is calculated using all three measurements. But early estimates mainly use the output measure, using data collected from thousands of companies.

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Why is the GDP figure often changed later?

The UK produces one of the quickest estimates of GDP of the major economies, about 40 days after the quarter in question.

At that stage, only about 60% of the data is available, so the figure is revised as more information comes in.

The ONS publishes more information on how this is done on its website.

What are its limitations?

GDP growth doesn't tell the whole story.

There are lots of things the statistics might not take into account:

  • Hidden economy: Unpaid work isn't captured in official figures, such as caring for an elderly relative
  • Inequality: GDP growth doesn't tell us how income is split across a population - rising GDP could result from the richest getting richer, rather than everyone becoming better off

Just because GDP is increasing, it doesn't mean that an individual person's standard of living is improving.

If a country's population increases, that will push GDP up, because with more people, more money will be spent. But individuals within that country might not be getting richer. They may be getting poorer on average, even while GDP goes up.

So the ONS publishes a figure for GDP per head (of population), which can often tell a different story to the main GDP number.

Critics have argued that GDP doesn't take into account whether the economic growth it measures is sustainable, or the damage it might do to the natural world. Alternative measures have been developed.

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Image caption,
Should GDP take more account of the impact on the environment?

In 2010, the ONS started measuring well-being alongside economic growth. This measures health, relationships, education and skills, as well as personal finances and the environment.

In 2019, New Zealand's Prime Minister, Jacinda Ardern, released the country's first "well-being budget", prioritising health and life-satisfaction rather than economic growth.

Despite its limitations, GDP is still the most widely-used measure for most government decisions and international comparisons.