A report says the economy grew this year. In the same period a household’s pay bought less food, fuel and transport. Gross domestic product, or GDP, measures production across the economy. To understand a household’s experience you also need to know what happened to its income and the prices it pays.
What the GDP number measures
GDP records the value added by producing goods and services in an economy over a period. Think of a baker buying flour for $2 and selling a loaf for $5. In this stripped-down example the bakery adds $3. Counting value added helps keep the flour from being counted again as a separate final sale when it is already part of the loaf’s price.
The Bank of England explains three approaches to estimating GDP. Statisticians can look at output, at the incomes generated by producing it or at expenditure on final goods and services. These are ways of estimating the same economic activity. Early estimates draw on incomplete information, which helps explain why the numbers can change as data arrive.
What population changes
Imagine an economy produces 100 units for a population of ten. Output per person is ten units. A year later it produces 102 units and has 11 residents. Total output rises by 2%, while output per person falls to about 9.27 units, down roughly 7.3%. Assume the figures already account for price changes. The example is fictional and holds prices out of the calculation so the effect of population is easy to see.
Real GDP adjusts for price changes. GDP per person divides output by population. The combined measure, real GDP per person, shows average production on a price-adjusted basis. The average can move differently from production as a whole, as it does in this example.
Follow income closer to households
The OECD’s household disposable income measure deducts income and wealth taxes and social contributions and includes cash benefits. That brings it closer to the resources households can spend or save. GDP and household income can move differently as taxes, benefits and the division of company earnings between wages, dividends and retained profits change.
Compare the same periods and look for an inflation-adjusted household income measure if the question is purchasing power. Then look at distribution. Income growth for households near the middle of the distribution can differ from the average. GDP gives the production context, while household income and distribution help explain who experienced a change in resources.
Sources & further reading
- Bank of England guide to GDP
Explains GDP and the output, income and expenditure approaches.
- OECD growth and economic well-being methodology
Defines real GDP and household disposable income per person and explains why they can diverge.