I n t h I s c h a p t e r y o u w I l L

Gross domestic product (GDP)
is the market value of all final goods and
services produced within a country in a given period of time.
This definition might seem simple enough. But, in fact, many subtle issues arise
when computing an economy’s GDP. Let’s therefore consider each phrase in this
definition with some care.
“ G D P I S T H E M A R K E T VA L U E . . . ”
You have probably heard the adage, “You can’t compare apples and oranges.” Yet
GDP does exactly that. GDP adds together many different kinds of products into a
single measure of the value of economic activity. To do this, it uses market prices.
Because market prices measure the amount people are willing to pay for different
goods, they reflect the value of those goods. If the price of an apple is twice the price
of an orange, then an apple contributes twice as much to GDP as does an orange.
“ O F A L L . . . ”
GDP tries to be comprehensive. It includes all items produced in the economy and
sold legally in markets. GDP measures the market value of not just apples and
oranges, but also pears and grapefruit, books and movies, haircuts and health care,
and on and on.
GDP also includes the market value of the housing services provided by the
economy’s stock of housing. For rental housing, this value is easy to calculate—the
rent equals both the tenant’s expenditure and the landlord’s income. Yet many
people own the place where they live and, therefore, do not pay rent. The govern-
ment includes this owner-occupied housing in GDP by estimating its rental value.
That is, GDP is based on the assumption that the owner, in effect, pays rent to him-
self, so the rent is included both in his expenditure and in his income.
There are some products, however, that GDP excludes because measuring
them is so difficult. GDP excludes items produced and sold illicitly, such as illegal
g r o s s d o m e s t i c p r o d u c t
( G D P )
the market value of all final goods
and services produced within a
country in a given period of time

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drugs. It also excludes most items that are produced and consumed at home and,
therefore, never enter the marketplace. Vegetables you buy at the grocery store are