Gross Domestic Product (GDP) - Explained
What is GDP?
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What is Gross Domestic Product (GDP)?
Gross domestic product (GDP) is the total monetary value of finished goods and services produced and offered within a country for a specific year.
GDP versus GNP
Unlike gross national product (GNP) that includes productions of citizens living out of the country, GDP does not include imported goods and services.
How is Gross Domestic Product Used?
Economic analysts use GDP results in comparison of the economic development exhibited by different countries in different geographical regions.
How is GDP Measured?
There are three major methods that are used in the calculation of gross domestic product (GDP) of a country in a period of time (usually quarterly or annually). These are;
- Expenditure or spending approach,
- Income approach, and
- Product or output approach.
When all these three methods are used and are calculated accurately, they yield the same results.
What is the Spending Method of Calculating GDP?
Spending method for calculating GDP is also known as the expenditure method, it takes in account all activities needed in producing a finished output or product for sale. The expenditure approach for calculating GDP has the following formula; GDP = C + G + I + NX.
This means; GDP = Consumer +Government expenditure + Investment + export - import.
The expenditure approach is the most common method which involves the calculation of money spent by consumers, government and production and distribution processes.
The spending of expenditure approach takes into account all the activities that contribute to the GDP of a country. This calculation however excludes imported products and services, this is because imports do not count when calculating the GDP of a country.
The Bureau of Economic Analysis (BEA) is the United States agency that is saddled with the task of estimating the U.S GDP annually. It employs the expenditure approach.
What is the Production Method of Calculating GDP?
The production approach, also referred to as output approach, net product or value-added approach, calculates the total value of economic output for a particular period excluding the cost of goods that are consumed in the process of production.
The Production Approach takes all spendings involved in the production of goods and services in account. GDP based on production considers the processes involved in the production of a completed economic activity.
What is the Income Method of Calculating GDP?
The income approach is a sum of all the factors involved in the production of goods and services. It includes the estimation of the earnings of all factors of production in a particular economy, such as money (rent) earned by land, return on capital in cases of investments, profits made from a product and other factors.
Furthermore, incomes that are not accounted for in the above payment such bas depreciation taxes, indirect business taxes and other forms of income are added to the national income when calculating the GDP of an economy.
What is Gross National Income?
GNI is the total income realized by the citizens of a country including those outside the borders of the country. GDP measures the total income of people within the boundaries of a country excluding those residing in foreign countries.
Indirect business taxes, depreciation taxes and other forms of income are also added when calculating GDP. However, when income received from overseas (net foreign factor income) is added to the calculation of GDP, it then becomes GDI or GNI.
In recent times, countries have realized that GNI is a better metric over GDP because it measures overall economic health of a nation taking into account income earned by people within a country and those outside the country's borders.
In the US, included in the GDP calculation are outputs of all corporations including foreign companies located in the United States. Hence, in this context, GDP and GNI have no substantial difference.
How is Balance of Trade Used in Calculating GDP?
The balance of trade is the difference between the values of imports and exports in a country at a particular time. Since the balance of trade measures the difference between imports and exports, it then becomes a vital ingredient in calculating GDP.
A decline in GDP will occur when consumers spend more on imported products than on domestic product. GDP will increase if consumers buy domestic products more than they buy foreign products.
What is Nominal GDP?
Nominal GDP refers to the measurement of economic output without inflation adjustment.
What is Real GDP?
Real GDP is the measure of economical output that adjusted for inflation and deflation.
Real GDP helps economists detect whether there is any real growth in the economy of a country over a given period.
Nominal GDP is often higher but real GDP expresses long-term economic performance and accounts for change in market value.
Negative Aspects of Using GDP as an Economic Measure
Using GDP as a measure of the economic growth of a nation has attracted some criticisms. Its major criticisms are the following;
- GDP is an inaccurate measure of economic growth since it does not account for the profit a nation earns through companies of its citizens that are located abroad.
- GDP only relies on official documents, it then fails to account for unofficial sources of income, such as the black market that generates a lot of income.
- GDP measure the growth of an economy but excludes population which is an integral part of the economy.
- GDP does not capture the total value of income realized through volunteer work or the services of stay-at-home parents.
Sources of GDP Data
The most reliable sources for GDP are:
- The World Bank, the International Monetary Fund (IMF),
- Statistical Agencies owned by countries,
- Organization for Economic Cooperation and Development (OECD),