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Updated October 30, 2020
Introduction to the U.S. Economy: GDP and Economic Growth
As a result of the Coronavirus Disease 2019 (COVID-19)
expenditures on goods and services by final users .
pandemic, economic activity declined rapidly in the United
Expenditures are divided into five categories: (1)
States in early 2020 and remains below pre-pandemic
consumption (expenditures by households), (2) investments
levels, despite gross domestic product growth being
(largely expenditures by businesses), (3) government
positive in the third quarter of 2020. The speed of the
spending, (4) imports, and (5) exports. Because GDP is a
economic recovery and projections of longer-term growth
measure of domestic production, this approach subtracts
are of concern to policymakers due to the connection
imports from exports to arrive at net imports.
between the economy’s performance and the overall well-
being of Americans. This In Focus provides an introduction
Alternatively, GDP can be calculated through the income
to the U.S. economy, including how economists measure its
approach in which GDP is calculated by summing all
performance and the factors that influence its long-run
income earned within the economy, including wages, rental
trajectory.
income, interest income, and profits. Measurements of GDP
produced through the expenditure approach and income
What Is Economic Activity?
approach are equivalent because the final market price of a
Economic activity includes any actions involved in the
good or service should reflect all of the incomes earned and
production, distribution, and consumption of goods and
costs incurred throughout the production process.
services.
Potential GDP and Economic Performance
Figure 1. Circular Flow of Resources
GDP is often used as a measure of economic health. One of
the ways in which economic performance is often measured
is by the output gap—the difference between real GDP and
potential GDP. Potential GDP is an estimate of the highest
sustainable level of output the economy can produce. When
actual output is above its potential, it can signal that the
economy is overheating (expanding at an unsustainable
rate). When actual output is below its potential, it can signal
less than full employment and potential recessionary
conditions.
Economic Growth
Notes: This is a simplified representation of the economy. Other
sectors, including the government, financial sector, and imports and
Growth in economic activity brings about benefits to
exports, can also be represented as flows within the economy.
economic actors, and it is the predominant measure of
changes in material living standards. In general, as GDP
grows, individuals’ incomes increase, as does the
Economists generally view economic activity as a circular
production of goods and services; individuals not only have
flow of resources. As shown in Figure 1, businesses
access to more goods and services but also have income to
purchase their factors of production—land, labor, and
purchase those goods and services. However, GDP growth
capital—from households to produce goods and services.
does not give any indication of how income growth is
Households then use the income earned from businesses to
distributed within the economy.
purchase goods and services. Income that households
choose to save remains in the circular flow of resources; it
In the near term, growth in economic activity is largely
is distributed to businesses through the financial sector in
governed by the business cycle, which shifts from
the form of loans rather than through consumption
expansionary phases to contractionary phases (recessions)
spending.
and to recoveries. Policymakers can use monetary and
Measures of Economic Activity
fiscal policies to affect aggregate demand (i.e., total
spending) in an effort to diminish the volatility of changes
The standard measure of economic activity is gross
in economic growth due to the business cycle. However,
domestic product (GDP), which is calculated in the United
these policies are unlikely to have large impacts on the
States by the Bureau of Economic Analysis (BEA). GDP is
long-term growth rate of the economy. For further
defined as the total value of all final goods, services, and
information on the business cycle, refer to CRS In Focus
structures produced by a nation’s economy during a
IF10411, Introduction to U.S. Economy: The Business
specified period—in other words, the total value of the
economy’s output.
Cycle and Growth.
To affect the economy’s long-term growth rate, it is
GDP can be measured in two different ways. The
important to focus on the supply side of the economy
expenditures approach calculates GDP by summing all
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Introduction to the U.S. Economy: GDP and Economic Grow th
instead of factors that impact demand within the economy.
Technology
In the long run, the rate of economic growth is largely
Technological improvements and efficiency gains allow
dependent on the economy’s ability to increase its
individuals to use the different factors of production in a
productive capacity over time.
more efficient manner, producing more or improved goods
with the same amount of resources. For example, the
Determinants of Long-Term Growth
discovery of chemical fertilizer increased the productive
The long-term growth rate is largely determined by the
capacity of agriculture. Economists tend to use technology
amount of physical capital and human capital and the rate
as a catch-all term for any changes that impact the
of technological change in the economy.
productivity of the economy. Changes in regulatory
structure, trade policies, or patent laws, which may impact
Physical Capital
the productivity of the economy, are often discussed
Physical capital includes all the man-made resources
alongside technological changes.
workers use to produce goods and services, including tools,
United States Economic Growth
machinery, and other infrastructures. The current amount of
Policymakers generally use growth in real GDP—the total
physical capital available in the economy, or the stock of
value of economic output adjusted for inflation—to
physical capital, impacts the economy’s productive
understand changes in economic output over time. Failing
capacity. For example, giving each member of a
to adjust for inflation would typically result in an
construction crew a set of tools allows them to produce far
overstatement of the economy’s output as prices rise.
more than if they had to share only one set.
Therefore, real GDP is used to make more accurate
comparisons of economic growth over time.
The stock of physical capital in an economy is largely
dependent on the rate of investment in the economy.
An alternative measure of economic activity is real GDP
Physical capital depreciates over time as machines break
per capita, a country’s real GDP divided by its population.
down or become obsolete. Therefore, to maintain a certain
For comparisons over time or across countries, real GDP
level of capital stock, there must be sufficient investment in
per capita is often an improved measure of economic
new capital over time to replace any depreciated capital.
growth because it accounts for differences in population.
The higher a country’s investment rate, all else equal, the
Figure 2. Real GDP and Real GDP per Capita
faster its capital stock will grow.
Physical capital investment comes at a cost. Resources that
are diverted to investment in physical capital can no longer
be used to purchase present goods or services. Investment
in physical capital leads to greater economic activity in the
future but less consumption of goods in the present. For
more investment information, see CRS In Focus IF11020,
Introduction to the U.S. Economy: Business Investment.
Human Capital
Just as increasing the amount of physical capital available
to workers can help the economy to grow, so can increasing
the amount of human capital. Human capital refers to the
skills, knowledge, and abilities of the workers within the
Source: U.S. Bureau of Economic Analysis (BEA).
economy. As workers receive higher levels of education or
Note: Data is presented in 2012 dol ars.
training, they will tend to be more productive. This higher
level of productivity among workers increases the
As shown in Figure 2, real GDP at the end of 2019 was
productive capacity of the economy and may spur economic
roughly 9.5 times as large as it was at the beginning of
growth. Improvements in the productivity of the labor
1947. Real GDP per capita increased by roughly four times
supply are generally referred to as investments in human
over the same period. In 2020, due to COVID-19, both real
capital.
GDP and real GDP per capita fell in the first half of the
year and recovered partially in the third quarter of 2020.
Similar to investments in physical capital, investments in
GDP levels, however, are still below those pre-pandemic.
human capital also face a tradeoff between current and
The second quarter drop in real GDP and third quarter
future consumption. Consider an individual who is deciding
increase in real GDP were both the largest single quarter
whether to attend a four-year college or to enter the
loss and gain since BEA began collecting this data in 1947.
workforce immediately after high school. If he or she
(Note: Jeffrey Stupak, former CRS Analyst in
chooses to attend college, he or she will likely be more
Macroeconomic Policy, contributed to this In Focus.)
productive when entering the labor market after college but
would forgo all of the consumption he or she could have
Mark P. Keightley, Specialist in Economics
financed by working for those four years instead. In
Lida R. Weinstock, Analyst in Macroeconomic Policy
addition to investments in human capital, increases in the
size of the labor supply can increase the productive capacity
IF10408
of the economy, potentially leading to economic growth.
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Introduction to the U.S. Economy: GDP and Economic Grow th
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