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If I pick up a stone there and sell it to you for 1 million dollars, 1 million dollars added value is created and added to GDP. If you sell it to me for the same price, virtually nothing has happened but GDP increased by 1 million dollars.

We can increase GDP by any number we want.

Why do we care about GDP?

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    $\begingroup$ Did you manage to find someone buying stones for \$1m each? Asking for a friend. $\endgroup$ – Ubiquitous Apr 17 at 8:08
  • $\begingroup$ @Ubiquitous That is just an example. With the government's promotion, it is possible for some companies to do huge trading with each other. Governments can increase their GDP as much as they like. $\endgroup$ – satoukibi Apr 17 at 9:32
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    $\begingroup$ Are you aware that GDP counts only final sales? (Plus change in inventories, at price of other sales.) Companies doing “huge trading” with each other wouldn’t, as a matter of fact, increase GDP. $\endgroup$ – dismalscience Apr 17 at 11:39
  • $\begingroup$ @dismalscience For example, Company X pays a huge consultant fee to company Y, Y pays to Z and Z pays to X. $\endgroup$ – satoukibi Apr 17 at 15:13
  • $\begingroup$ @satoukibi Yes, I understand. That would add zero dollars to GDP. Each of those would count as an intermediate input and be subtracted from final output. I recommend that you read up on GDP as a concept and how it’s calculated— people have given a lot of thought to addressing concerns such as the ones you raise. You can read about intermediate inputs here: en.m.wikipedia.org/wiki/Intermediate_consumption $\endgroup$ – dismalscience Apr 17 at 15:16
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Yes, GDP can indeed be inflated by meaningless circular transactions. Furthermore, GDP growth completely ignores underlying changes to a country's asset base. Corporate accounts are considerably less naive. Any company that only ever reported growth in turnover wouldn't be trusted: turnover is vanity, profit is sanity.

Real increases in GDP can be a useful proxy for economic growth, because it measures the total transaction value within the economy, and historically that's been closely correlated to general perceptions of economic growth. So much so, that it's now pretty much used as the definition of economic growth.

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  • $\begingroup$ I’m not downvoting, but parts of this answer are factually inaccurate. Circular transactions would appear as intermediate inputs and would not be counted in GDP by definition. Further, GDP is not “total transaction volume,” which is many times larger— it is final sales only. What you’re describing is much closer to “gross output,” which is also smaller than total transactions, but would include circular transactions. $\endgroup$ – dismalscience Apr 23 at 17:17
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Economic transactions are recorded from registered businesses only. That is, informal trades are not recorded. In your example, trading a stone wouldn't be a registered business activity. However, let's assume it is.

GDP is the final value of goods and services produced, so as dismalscience says, intermediate goods are not recorded. Let company A sell a stone to company B. The stone that company B holds would be seen as an intermediate good, as the product that company B sells uses that stone as an input. In this example, the intermediate good is coincidentally also the final good (no value is added). The value of the stone will only be counted once.

That being said, stones don't get sold for \$1 million. Even if two parties signed a contract that forces the second party to sell the stone back to the first party, they would both be in the same situation after the two transactions—the first party would have the stone, and the second party would have their \$1 million. (There is a disincentive to do this because the government will tax it.) The same logic can be extended to a collection of parties who pass on the stone to each other in a circle. In the end, they all are back at square one. It is plausible that (given the difficulty with which one secures \$1 million credit) people aren't motivated to skew GDP figures by engaging in this type of activity, also given the costs involved with the activity such as tax.

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This goes back to the basics of GDP measurement. Ideally you want to say, this year my country produced 2 cars and 3 calculators (of some specific model). But then there needs to be a way to aggregate all this up to measure the size of the economy. How many calculators does a car worth?

One simple solution is to convert it to money, since it's a unit of account anyways. An important underlying assumption is that the price of the goods we're measuring is priced "reasonably." One way to ensure that goods are reasonably priced is to take prices from a competitive market. So in your case the $1 million would be undercut by almost anyone.

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