Significance

The most important measure of economic activity in a country, the Gross Domestic Product is the crossing point of three sides of the economy: expenditure, output, and income.

As a measure of well-being of a country for international and temporal comparisons, it provides a good first approximation. Still, it ignores many crucial elements of general well-being, like environment conservation, safety, life expectance, and population literacy. In this respect, one should rather look at the Human Development Index.

Composition

To measure economic activity, one needs a meaningful aggregation of all kinds of productions. The territory's productions are the crossing result of 1) effective demand, 2) production capabilities, and 3) income. Income arises from payments distributed to production factors and it provides the necessary finance for demand.

A numerical example will explain the fact that GDP is expressive of these three sides or, in other words, of the contemporary action of buyers, sellers, producers and the income receivers.
Italy's GDP in 1996 can be computed as a sum from three lists of components [1]:

In the first column, attention is given to the buyers. GDP is then measured as the sum of all domestic and foreign effective demand for national goods. Domestic demand is the sum of household, government, and firm expenditure (respectively called: consumption, public expenditure, and investment). Foreigners buy national goods as exports.

Domestic demand is attracted not only by national goods but also by imports, which reduce the GDP sum. A minuscule additional element is the change in inventories (the goods that nobody wants at the moment).

The second column shows the position of the sellers and the kind of things they sell: GDP is now obtained by summing up "value added" over the economic branches of the economy. VAT revenue is added to obtain GDP.

The third column points at the remuneration of production factors (labour and capital) with the share of the state. The same income serves as source of finance for the demand of the first column.

This identity expenditure = output = income holds always as a matter of definition and national accountancy conventions [2].

Determinants

The three sides of GDP interact to determine the aggregate. An increase of effective demand (consumption, investment, public expenditure, exports) will increase GDP, provided national producers can meet the quality/price requirements of buyers. If not, imports will grow instead. If national production cannot grow for physical reasons, firms producing already at full capacity probably will decide to raise prices, vanishing effective demand with inflation.

The diffusion of technological and organizational innovation can impact on productivity, on product/process quality and on costs (thus potentially on value added). Capital accumulation and the increase of labour quality and motivation are important ingredients for a growing GDP.

Short term business cycles and long term trends can be - to a certain extent - traced back to the individual growth path of heterogeneous firms, as this paper points out.

Impact on other variables

Long-term trends

Never is GDP at the same level year after year. The most common GDP trend is a continuous growth with periods of acceleration and deceleration. Some episodes of absolute fall are afterwards overwhelmed by further growth. Decades can be quite different in terms of average rate of GDP growth.

In many countries, especially small and in the Third World, growth is hectic and irregular, with frequent and deep absolute falls and booms.

Wars are a distinctive source of GDP sinking. Oil crises have exerted recessionary pressure all over the world (with the partial exception of oil producer countries).

On a global scale, the distance between the richest and the poorest countries is increasing, whereas locally there exist "convergence clubs" in which distances are getting smaller. A few developing countries have taken off and reached a high development stage.

Business cycle behaviour


To a large extent, GDP evolution "is" the cycle. It is in fact with respect to GDP dynamics that other variables are defined as pro-cyclical (if they follow a similar path) or anti-cyclical. A recession is often defined as a two-quarter absolute reduction of GDP.

Data

GDP data from 136 countries: a long term time series
GDP and per-capita GDP in all countries of the world since centuries ago
Data for all the variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)
National income and gross national product, by components - Canada (1926-1976)
Human Development Index (162 countries)

Formal models

An interactive map of how the economy works according to a basic macroeconomic scheme: the IS-LM model

A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility

Links

Recent GDP figures all over the world

Recent world GDP forecast

NOTES

[1] Some simplifications apply. Data source: ISTAT.

[2] Looking at the same transaction two identities hold: The quantity sold is always equal to the quantity bought. Money spent is always equal to money obtained.

I buy an apple. The seller has sold an apple. I've spent a dollar. He has got a dollar. Even if I don't like apples or I think that a dollar is too much for an apple.