Published on September 1, 2020

Know All About GDP (A-Z)


Define GDP

Gross Domestic production or GDP is the total value of all final goods and services produced in a country, state or region during a given period. GDP is the aggregate income of the final products and it excludes the value of intermediatory products. In 2013, the GDP of the United States was $16,800 billion that means the value of all finished product and services in 2013 within the boundary of the United States of America was $16,800 billion. It is generally used to measure the income of the individual in an economy and the market value of finished goods and services.

GDP can be measured in two ways. First of all by calculating the total economic or monetary value of final goods and services. And the second way is to calculate the aggregate spending by the firms to make the final goods or services. The third way to calculate GDP is to calculate the profit, interest, rent and wages to the worker given by the firms.


Components of GDP

GDP is the sum of consumption(C) investment (I), government purchases (G), and net exports (NX). Let the GDP is Y, then

Y = C + I + G + NX

  • Consumption(C): Consumption is the amount of money spend by the household to purchase goods (food, clothes etc) and services (haircut, body massage etc).
  • Investment (I): Investment is the sum of money spent to purchase business capital, intellectual property etc.
  • Government Purchase (G): It is the amount of money spent by the governing bodies, for example, government employees salaries, public work and so on.
  • Net Export (NX): We get et export value by subtracting the import from export. In simple words, net export is the sum of money came from foreign nations by selling domestic goods and services to them.
E x p o r t     I m p o r t   =   N e t   E x p o r t .

Basic of GDP

  • Nominal GDP: Nominal GDP defines as a total quantity of finished goods and services at current price over a period of time. It is also known as GDP at the current price. We can say Nomina GDP as GDP
  • Real GDP: Real GDP is the sum of the values of all final goods and services produced in the economy, calculated using the prices of a selected base year. Real GDP is also known as GDP at constant price or GDP at base year price.
  • Green GDP: Green GDP is measured by subtracting the environmental damage from GDP.
  • GDP Deflator: The GDP deflator a price level measure for a particular period of time is equal to 100 times the ratio of nominal GDP for that year to real GDP for that year. It is used to measure inflation. It is also called the GDP price Index.

  • G D P   D e f l a t o r   =   N o m i n a l   G D P R e a l   G D P × 100

  • Per Capita GDP: Per capita GDP is measured by divide the Country’s GDP with the country’s population.
  • Depreciation: Depreciation is the loss of value of goods and services due to wear and tear.
  • NDP: NDP or Net Domestic Production is measured by subtracting depreciation from GDP.

Measurement of GDP

Gross Domestic Production (GDP) can be calculated in three ways-

  1. Product census method
  2. Income census method
  3. Expenditure method

1. Product census method

In product method GDP if a country is sum total of money values of all currently produced final goods and services by both domestic and foreign factors within the national boundary of that country during a year.

Product means output. That’s why product census method is also known as the output method or net output method.

This literally means to add the value of different types of finished goods and services produced in a particular area in a certain year. Here we need to add the value of Mangoes, cars, restaurant business and other various types of businesses. If in a year 50 billion mangoes are produced and each of them sells for Rupees 50 then the contribution of corn to GDP is 1000 billion rupees. And the very year 8 million televisions are produced and each of them sells for Rupees 30,000. So the contribution of Television to GDP is Rupees 240 billion.

Goods Produced Quantity Unit Price Total Value
Mango 50 billion ₹20 ₹1000 billion
Television 8 million ₹30,000 ₹240 billion

2. Income census method

In income census, method GDP is sum total of factor incomes within the national boundary.

GDP = Rent + Wage + Interest + Profit

Income census method is also known as a factor cost method.

circular-income.png
Circular Flow of Income

GDP is the flow of money or income. The circular flow of income shows that how the farms pay their employees and that directly go to their households and then the household spend the money to purchase the goods and services the farms produce.

3. Expenditure Method

In expenditure, method GDP is the sum of consumption(C) investment (I), government purchases (G), and net exports (NX). Let Y is the GDP then


Application of GDP

GDP is used to measure three major things-

  • Living standard
  • Economic growth
  • Business cycle

1. Living standard

GDP is used to measure a living standard of a country or a particular region. We can estimate the living standard by the GDP data. In developed countries like the USA, UK the GDP is higher than the developing countries like India, Pakistan.

In this case, per capita GDP is measured that is GDP per individual. According to World Bank Data 2013, China’s per capita was $6,807 and Japan’s per capita GDP was $38,634. Although China’s produce twice more goods and services than Japan. But China’s population is 10 times higher than Japan’s population. When nations GDP was divided by its population Japan’s per capita GDP become greater than China.

2. Economic Growth

GDP is an economic barometer for a country or region. We can measure the economic growth by the GDP data or the real GDP data. Because when inflation occurs the GDP got to rise and this phenomenon does not depend on the number of goods and services produced in the economy. That’s why Real GDP is measured by adjusting the inflation.

3. Business cycle

A business cycle is a short-run fluctuation in an economy. A business can be expanded or contracted over time. GDP data is an indicator of business expansion or recession.


Relationship between Nominal GDP and Real GDP

We can calculate the GDP of a country in a particular year by using the actual market price of that year that is called GDP or nominal gross domestic production or GDP at the current price.

Real GDP get after subtracting inflation or change in the price of the goods and commodity over time. Hence, the nominal GDP depends on the changing price whereas the real GDP is calculated by removing the change in price.

The price level is the average of all produced goods and services over time in an economy.

Nominal GDP = Price level × Real GDP

Let 2011 – 12 is the base year and 2020 – 21 is the current year. Suppose 100-kilogram paddy was cultivated in the 2020 – 21 and the per kilogram price of the paddy is 10 rupees but the base year’s price was 8 rupees per kilogram.

  • N o m i n a l   G D P   =   100   K i log r a m   × 10   R s / K i log r a m =   R u p e e s   1000
  • R e a l   G D P   =   =   100   K i log r a m   + 10   R s / K i log r a m   =   R u p e e s   800

Relationship between GDP and GNP

GDP is the sum of the values of final goods and services produced by all the individuals despite their nationality within the countries boundaries in a particular year. Although gross national production or GNP is the sum of the value of all produced goods as services by the citizens and the migrant individuals reside in the foreign land in a year.

Production by Indians abroad included in the Gross National Production (GNP) in India but it excluded in GDP of the country where they are producing.

graph_gdp.png

Let A, B and C are three Indians. A and B live in India but C lives in the USA. In a year the revenue of A and B is 10 million and 20 million rupees respectively and C’s revenue is 15 million rupees.

Country GDP GNP
India 10 + 20 = 30 Millions 10+20+15 = 25 Millions

In a closed economy, the value of GDP and GNP is the same. In the case of Open economy, GDP can be greater than or less than or equal to the GNP.

  • GDP + Net Factor Income Abroad ≡ GNP
  • Here, Net Factor Income from Abroad = Factor Income from Abroad(not export) – Factor Income goes to Abroad(not import).

Drawback of GDP

Now the utmost question is should we really care about GDP as it really does not do any good to improve the healthcare and child education. It measures the value of newly-produced goods and services in a particular year. GDP does not give an idea about the income distribution of the country.

People in richer countries didn’t appear to be any happier than people in poor countries. In research beginning in the 1970s, University of Pennsylvania economist Richard Easterlin found no evidence of a link between countries’ income—as measured by GDP per person and peoples’ reported levels of happiness. More recent research suggests GDP isn’t quite so bad. Using more data and different statistical techniques, three economists at the University of Pennsylvania’s Wharton School—Daniel Sacks, Betsey Stevenson and Justin Wolfers found that a given percentage increase in GDP per person tends to coincide with a similar increase in reported well-being. The correlation held across different countries and over time.

Mark Whitehouse

Bibliographical Sources:

  • PRINCIPLES OF MACROECONOMICS, SECOND EDITION, COPYRIGHT © 2018 DIRK MATEER & LEE COPPOCK, NORTON & COMPANY, INC.
  • THE ECONOMICS OF MONEY, BANKING, AND FINANCIAL MARKETS, ELEVENTH EDITION, COPYRIGHT © 2016 FREDERIC S. MISHKIN, PEARSON
  • MACROECONOMICS, GLOBAL EDITION, 7TH EDITION, BY OLIVIER BLANCHARD, COPYRIGHT 2017, ISBN 9781292160504
  • MACROECONOMICS, 6TH EDITION, ISBN 978-0-13-447211-9, BY STEPHEN D. WILLIAMSON, PUBLISHED BY PEARSON EDUCATION © 2018.

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