Gross Domestic Product (GDP) is an indicator to measure the economic production and growth of a country.
The term “Domestic” used in Gross Domestic Product indicates that it measures production that takes place within the country’s border. It’s a tool to measure a country’s size of the economy.
Economists suggest GDP as the best measure to understand a country’s economy. In this article, we have explained what is gross domestic products or GDP and how its measures for a country. You will also learn major drawbacks and types of GDP.
What is GDP?
GDP or Gross Domestic Product measures the total rupee value of all goods and services produced over a specific time period by the economy.
Generally, it is compared by year on year rise in Gross Domestic Product.
GDP is calculated by the country itself and by the world bank, international monetary fund and the United nation.
How Gross Domestic Product or GDP is calculated
Gross Domestic Product is measured by using either income approach or expenses approach.
Under the income approach, Gross Domestic Product is calculated by adding employee’s salary and wages, profit of companies, income of firms and taxes less subsidy.
The other approach which is most commonly used is the expenses approach.
In the expenses approach, total personal consumptions, gross investments, government spending and net exports (i.e. total exports – total imports) are added up to find out Gross Domestic Product (GDP) of a country.
Here is the formula to calculate GDP;
Gross Domestic Product or GDP = Personal Consumption + Gross Investment + Government Spending + (Exports – Imports)
Personal consumption is anything that a household or individual would spend money on such as food, clothing and so on.
Gross investment means money invested in new equipements. As the name indicates, government spending includes everything that the government purchases or spends money on. Government spending does not include money spent on welfare or social security.
Export means all the goods that are produced by the country and sold to the rest of the world. Import means all the goods that are produced outside of the country and sold to the country.
GDP Growth Rate
GDP growth rate is calculated in percentage by looking at the increase in Gross Domestic Product quarter on quarter or year on year. By doing this you can know whether the country’s economy is growing or slowing down.
GDP Per Capita
GDP per capita is used to compare a country’s economic output as relates to its standard of living. It’s calculated by dividing a country’s Gross Domestic Product by its number of residents.
This measure cannot be taken into consideration while comparing two country’s economies as we use the denominator “number of residents” in it.
If the country has high GDP then its unemployment ratio will go down as growth in the economy requires business to employ labour into industries.
Wages compared to last year’s is also another yardstick to see whether Gross Domestic Product is increasing or decreasing. If the country or economy is in recession then the GDP growth will be negative.
When the GDP of a country is rising, it means consumers are purchasing more and the country’s income is rising.
Types of GDP
We have 2 different types of GDP. Here are they;
- Real GDP: Real gross domestic product is inflation adjusted total economic output of a nation’s goods and services in a given period of time. It’s considered as a more accurate portrayal of a country’s economy.
- Nominal GDP: Nominal gross domestic product is calculated with inflation. This means prices of goods and services are calculated at the current price levels.
Government uses both real and nominal GDP as a measure for analysing economic growth and purchasing power over time. If inflation is positive, then the real GDP will be lower than normal GDP, and vice versa.
As nominal GDP takes current price into consideration, it becomes easier for analysts to compare quarter on quarter or year on year to analyse the impact.
A growth in GDP quarter on quarter indicates the economy is expanding. If GDP growth is negative quarter on quarter, then it’s considered a recession. Till date the United states has the world’s largest GDP.
Drawbacks of GDP
Like any other measure, Gross Domestic Product metrics have its own limitations.
GDP of a country does not indicate the standard of living. To know the standard of living, you need to calculate GDP per capita, which is calculated by dividing GDP by the total population of that country. If you do that for the USA, then you will find that the United States has the highest GDP per capita. However, it won’t tell you anything about the overall wellbeing, health and happiness of people living in a country.
While calculating GDP, countries do not take those figures that are not reported or accounted for. For instance, goods and services that are bought and sold illegally are not considered in calculation.
GDP is a crucial measure for analysts and economists to know how the economy has performed. Per capita GDP tells you the cost of living of a country. Therefore, stock market participants closely watch these announcements and its impact on the market before taking any position.
