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Updated January 13, 2022
Introduction to U.S. Economy: GDP and Economic Growth
As a result of the COVID-19 pandemic, economic activity
expenditures on goods and services by final users.
declined rapidly in the United States in early 2020 before
Expenditures are divided into five categories: (1)
rebounding and surpassing pre-pandemic levels in the
consumption (expenditures by households), (2) investments
second quarter of 2021. The speed of the economic
(largely expenditures by businesses), (3) government
recovery and projections of longer-term growth are of
spending, (4) imports, and (5) exports. Because GDP is a
concern to policymakers due to the connection between the
measure of domestic production, this approach subtracts
economy’s performance and the overall well-being of
imports from exports to arrive at net exports.
Americans. This In Focus provides an introduction to the
U.S. economy, including how economists measure its
Alternatively, GDP can be calculated through the income
performance and the factors that influence its long-run
approach by summing all income earned within the
trajectory.
economy, including wages, rental income, interest income,
and profits. Measurements of GDP produced through the
What Is Economic Activity?
expenditure approach and income approach are equivalent
Economic activity includes any actions involved in the
because the final market price of a good or service should
production, distribution, and consumption of goods and
reflect all of the incomes earned and costs incurred
services.
throughout the production process.
Figure 1. Circular Flow of Resources
Potential GDP and Economic Performance
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.
Source: Figure created by CRS.
Economic Growth
Notes: This is a simplified representation of the economy. Other
Growth in economic activity brings about benefits to
sectors—including the government, financial sector, and imports and
economic actors, and it is the predominant measure of
exports—can also be represented as flows within the economy.
changes in material living standards. In general, as GDP
Economists generally view economic activity as a circular
grows, individuals’ incomes increase, as does the
flow of resources. As shown in Figure 1, businesses
production of goods and services; individuals not only have
purchase their factors of production—land, labor, and
access to more goods and services but also have income to
capital—from households to produce goods and services.
purchase those goods and services. However, GDP growth
Households then use the income earned from businesses to
does not give any indication of how income growth is
purchase goods and services. Income that households
distributed within the economy.
choose to save remains in the circular flow of resources; it
is distributed to businesses through the financial sector in
In the near term, growth in economic activity is largely
the form of loans rather than through consumption
governed by the business cycle, which shifts from
spending.
expansionary phases to contractionary phases (recessions)
to recoveries. Policymakers can use monetary and fiscal
Measures of Economic Activity
policies to affect aggregate demand (i.e., total spending) in
The standard measure of economic activity is gross
an effort to diminish the volatility of the business cycle.
domestic product (GDP), which is calculated in the United
However, these policies are unlikely to have large impacts
States by the Bureau of Economic Analysis (BEA). GDP is
on the 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
Cycle and Growth.
economy’s output.
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
instead of factors that impact demand within the economy.
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Introduction to U.S. Economy: GDP and Economic Growth
In the long run, the rate of economic growth is largely
Technology
dependent on the economy’s ability to increase its
Technological improvements and efficiency gains allow
productive capacity over time.
individuals to use the different factors of production in a
more efficient manner, producing more or improved goods
Determinants of Long-Term Growth
with the same amount of resources. For example, the
The long-term growth rate is largely determined by the
discovery of chemical fertilizer increased the productive
amount of physical capital and human capital and the rate
capacity of agriculture. Economists tend to use technology
of technological change in the economy.
as a catch-all term for any changes that impact the
productivity of the economy. Changes in regulatory
Physical Capital
structure, trade policies, or patent laws, which may impact
Physical capital includes all the man-made resources
the productivity of the economy, are often discussed
workers use to produce goods and services, including tools,
alongside technological changes.
machinery, and other infrastructures. The current amount of
United States Economic Growth
physical capital available in the economy, or the stock of
Policymakers generally use growth in real GDP—the total
physical capital, impacts the economy’s productive
value of economic output adjusted for inflation—to
capacity. For example, giving each member of a
understand changes in economic output over time.
construction crew a set of tools allows them to produce far
Failing
to adjust for inflation would typically result in an
more than if they had to share only one set.
overstatement of the economy’s output as prices rise.
Therefore, real GDP is used to make more accurate
The stock of physical capital in an economy is largely
comparisons of economic growth over time.
dependent on the rate of investment in the economy.
Physical capital depreciates over time as machines break
An alternative measure of economic activity is real GDP
down or become obsolete. Therefore, to maintain a certain
per capita, a country’s real GDP divided by its population.
level of capital stock, there must be sufficient investment in
For comparisons over time or across countries, real GDP
new capital over time to replace any depreciated capital.
per capita is often an improved measure of economic
The higher a country’s investment rate, all else equal, the
growth because it accounts for differences in population.
faster its capital stock will grow.
Figure 2. Real GDP and Real GDP per Capita
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 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
economy. As workers receive higher levels of education or
Source: U.S. Bureau of Economic Analysis (BEA).
training, they will tend to be more productive. This higher
Note: Data are presented in 2012 dollars.
level of productivity among workers increases the
productive capacity of the economy and may spur economic
As shown in Figure 2, real GDP at the end of 2019 was
growth. Improvements in the productivity of the labor
roughly 9.5 times as large as it was at the beginning of
supply are generally referred to as investments in human
1947. Real GDP per capita increased by roughly four times
capital.
over the same period. In 2020, due to COVID-19, both real
GDP and real GDP per capita fell in the first half of the
Similar to investments in physical capital, investments in
year but have since recovered and surpassed pre-pandemic
human capital also face a tradeoff between current and
levels in second quarter 2021. The 2020 second-quarter
future consumption. Consider an individual who is deciding
drop in real GDP and 2020 third-quarter increase in real
whether to attend a four-year college or to enter the
GDP were both the largest single-quarter loss and gain
workforce immediately after high school. If he or she
since BEA began collecting these data in 1947.
chooses to attend college, he or she will likely be more
productive when entering the labor market after college but
Mark P. Keightley, Specialist in Economics
would forgo all of the consumption he or she could have
Lida R. Weinstock, Analyst in Macroeconomic Policy
financed by working for those four years instead. In
addition to investments in human capital, increases in the
IF10408
size of the labor supply can increase the productive capacity
of the economy, potentially leading to economic growth.
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Introduction to U.S. Economy: GDP and Economic Growth
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