Gross Domestic Product (GDP)

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21 Aug, 2024

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Table Of Contents

Meaning of GDP (Gross Domestic Product)

GDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period. It depicts the economic production, activity, and standard of living of the nation in question for a particular year. Furthermore, it serves as an indicator defining the size, growth, or decline of an economy.

It is an acronym for gross domestic product. Its annual calculation allows businesses, investors, and policymakers to assess, forecast, and plan future economic decisions. It only considers finished products and services while excluding their processing and operating expenses. Countries measure it in their native currencies and based on factors, including production, income, and expenditure.

Meaning of GDP (Gross Domestic Product)

GDP is a monetary measure of the total market worth of a country's final output across time. Production, income, and spending are three criteria that nations use to calculate it in their currencies.
It acts as a metric for measuring the total domestic production, standard of living, and foreign trade balance of an economy.
It aids in determining the size, growth, expansion, contraction or decline, and prospects of an economy and plays a crucial part in regulating and planning the economy.
Public and private consumption, corporate investments, government spending, and net exports are its primary components. Nominal, real, per capita, growth rate, PPP, and potential are its four common types.

GDP Explanation

GDP or gross domestic product is the total value of goods and services generated inside a country over an accounting period. In simpler words, it reflects a nation’s total domestic production and foreign balance of trade. It considers factors like demand and supply, inflation, and per capita income in the calculation.

English economist William Petty (1654-1676) was the first to suggest the concept, further improved by English politician Charles Davenant (1695) and modified by American economist Simon Kuznets (1934).

The two common ways to calculate gross domestic product are nominal (not adjusted for inflation) and real (adjusted for inflation/deflation). Since factoring the former with the inflation gives the latter, it is relatively higher than the latter.

In other words, an economy is in good shape or trade surplus if the market value of its goods and services, including net exports, is more than imports. On the other hand, if the total value of domestic product and service production is less than imports, the economy is in a trade deficit and must be regulated. Significantly, the higher the difference between the nominal and real gross domestic product, the greater the risk of inflation or deflation.

The gross domestic product is a crucial aspect in establishing the gross national income. It aids economists, businesses, and the government in determining the current and future state of the economy. Furthermore, it depicts a nation's economic, production, employment, and per capita income positions.

GDP vs GNP Explanation in Video

Gross Domestic Product Characteristics

1. The four main components of the gross domestic product are:

Public and Private Consumption, i.e., retail sales
Investments From Business, i.e., construction and storage
Government Expenditures, i.e., social security benefits, Medicare, defense, education, etc
Net Exports, i.e., export trade – import trade

2. It relies on the monetary worth of goods and services and their consumption, and hence it is subject to inflation and population.

3. Rise and fall in the real gross domestic product represent growth or expansion and decline or contraction of the economy.

4. It is an excellent method for comparing the output of two or more economies.

5. Gross domestic product is not the same as the gross national product (GNP), which refers to all the final production from the resources owned by the residents of a country.

6. Countries worldwide follow the international standard set by the European Commission, International Monetary Fund, the Organization for Economic Cooperation and Development, the World Bank, and the United Nations to compute their gross domestic product.

7. A country with a higher gross domestic product will have a higher living standard.

Types of Gross Domestic Product

Gross domestic product has four categories, each revealing a unique feature of an economy and its gross national income:

#1 - Nominal GDP

Nominal GDP evaluates a country's overall economic output without taking inflation into account. Instead, it assesses all domestically produced goods and services based on current market prices. Furthermore, it is an excellent tool for comparing economic output from different quarters of the same year.

#2 - Real GDP

Real GDP is the most precise indicator of a country's economic activity, such as growth or decline and production of goods and services in a particular year. The calculation of actual gross domestic product uses the GDP deflator, i.e., measuring the difference in the values of all products and services between the current and the base year. It helps compare the gross domestic product of several years by adjusting changes in market prices for inflation or deflation.

#3 - Potential GDP

It is a benchmark set for a country’s economic output that it can achieve in perfect conditions when everything is under control. Examples include low inflation, steady or increased purchasing power of the currency, full employment, optimal resource utilization, and so on.

#4 - GDP Per Capita

It measures a nation's total economic output by dividing its nominal gross domestic product for a specific period by its total population. As a result, it shows the average per capita income, living standards, and worker productivity.

#5 - GDP Growth Rate

It measures changes in a country's overall economic production on a quarterly or annual basis to aid in managing issues such as unemployment and inflation. A negative real-gross domestic product growth rate suggests economic contraction, recession, or depression, whereas an overly positive growth rate indicates inflation.

#6 - GDP Purchasing Power Parity (PPP)

It determines a country’s gross domestic product based on the purchasing power parity (PPP) of numerous nations' economic production, market prices of goods and services, incomes, living costs, and living standards.

Calculate GDP

The following are the three most common methods for calculating gross domestic product that provides comparable results:

Production (Output or Value Added) Approach: Subtracting total sales from the value of intermediate inputs used in the manufacturing process, i.e., the total of the "value-added" at each step of production.
Income Approach: Summing up incomes earned from production factors.
Expenditure (Speculated or Spending) Approach: Totaling the amounts spent by end-users on goods and services.

The expenditure approach estimates GDP by summing all the money citizens spend on goods and services over a year. It also considers spending by other economic participants, including businesses and the government. It uses the following formula for calculation:

GDP = C + I + G + NX

Where,

C = Private and public consumption expenditures/spending by households and nonprofits for goods and services//home purchases.
I = Private domestic investments/capital expenditures by businesses on construction, production, and storage of goods and services.
G = Government consumption expenditures/spending/gross investments on products and services.
NX = Net Exports/foreign balance of trade (Exports – Imports).

The nominal value obtained from this GDP formula is then calibrated with the inflation rate to arrive at the real figure.

Examples of GDP

The following examples will help understand the GDP much better:

Example #1

External variables can have a significant impact on a country's total economic output. For instance, the COVID-19 pandemic has wreaked havoc on the world economy, putting it in a near-recessionary state. As a result, the International Monetary Fund expects global economic growth in 2021 to be significantly lower than its July prediction of 6%.

Many negative economic trends have resulted from the pandemic, including increasing global debt burdens and interest rates, inflation and rising food costs, and vaccine shortages, particularly in emerging and developing economies. It does, however, recommend debt restructuring, trade liberalization, incentives for COVID-19 immunization, and a shift to renewable energy to boost global GDP.

Example #2

On the contrary, developed economies, are seeing an economic resurgence due to their aggressive measures to manage the coronavirus and its negative implications. According to the business group Confindustria, Italy's overall domestic production might expand by 6.1% in 2021 and 4.1% in 2022, which would be much higher than pre-pandemic levels.

The group states it is feasible because the COVID-19 Delta variation has less influence in Italy, and economic indicators have been greater than projected. This growth estimate is notable in light of the nation's economy contracting by 8.9% in 2020 due to the COVID-19 pandemic, resulting in its deepest postwar recession.

Frequently Asked Questions (FAQs)

What GDP means?

GDP or gross domestic product is the total worth of products and services produced within a country over a given accounting period. It only takes into account final goods and services, ignoring processing and running costs. Demand and supply, inflation, and per capita income are all elements that go into its computation.

How is GDP calculated?

Nominal (not adjusted for inflation) and real (adjusted for inflation/deflation) are the two most popular methods of calculating GDP. Other commonly used approaches for estimating gross domestic product that yield similar results are:

• Production Approach - Adds together the outputs of all types of businesses.
• Income Approach - Sums incomes from productive components, equaling the value of goods and services produced.
• Expenditure Approach - The overall product's worth must equal the sum of consumers' purchases. The formula for this is:

Gross domestic product = Consumption + Investment + Government + Net exports

Why is GDP important?

The annual calculation of GDP enables firms, investors, and policymakers to evaluate, forecast, regulate, and plan for future economic decisions. It also assists in assessing the growth, expansion, contraction, or decline of an economy. Furthermore, it helps determine an economy's total domestic production, living standard, and international trade balance.