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What is ‘Gross Domestic Product – GDP’
Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly basis as well (in the United States, for example, the government releases an annualized GDP estimate for each quarter and also for an entire year).
GDP includes all private and public consumption, government outlays, investments, private inventories, paid-in construction costs and the foreign balance of trade (exports are added, imports are subtracted). Put simply, GDP is a broad measurement of a nation’s overall economic activity – the godfather of the indicator world.
The Significance of GDP
GDP is commonly used as an indicator of the economic health of a country, as well as a gauge of a country’s standard of living. Since the mode of measuring GDP is uniform from country to country, GDP can be used to compare the productivity of various countries with a high degree of accuracy. Adjusting for inflation from year to year allows for the seamless comparison of current GDP measurements with measurements from previous years or quarters. In this way, a nation’s GDP from any period can be measured as a percentage relative to previous periods. An important statistic that indicates whether an economy is expanding or contracting, GDP can be tracked over long spans of time and used in measuring a nation’s economic growth or decline, as well as in determining if an economy is in recession (generally defined as two consecutive quarters of negative GDP growth).
3 ways of calculating GDP
National Output = National Expenditure (Aggregate Demand) = National Income
The full equation for GDP using this approach is:-
GDP = C + I + G + (X-M)
where,
- C: Household spending
- I: Capital Investment spending
- G: Government spending
- X: Exports of Goods and Services
- M: Imports of Goods and Services
The Income Method: adding factor incomes
Here GDP is the sum of the incomes earned through the production of goods and services. This is:
- Income from people in jobs and in self-employment +
- Profits of private sector businesses +
- Rent income from the ownership of land =
- Gross Domestic product (by factor incomes)
Only those incomes that come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude:
- Transfer payments e.g. the state pension; income support for families on low incomes; the Jobseekers’ Allowance for the unemployed and welfare assistance, such housing benefit.
- Private transfers of money from one individual to another.
- Income not registered with the Inland Revenue or Customs and Excise. Every year, billions of pounds worth of activity is not declared to the tax authorities.
This is known as the shadow economy or black economy.
The Value Added and Contributions to a Nation’s GDP method
- There are four main wealth-generating sectors of the economy: manufacturing, oil and gas, farming, forestry and fishing and a wide range of service-sector industries.
- This measure of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value added. .
Value added is the increase in the value of goods or services as a result of the production process
Value added = value of production – value of intermediate goods
Advantages:
Using GDP as a measure of a nation’s economy makes sense because it’s essentially a measure of how much buying power a nation has over a given time period. GDP is also used as an indicator of a nation’s overall standard of living because, generally, a nation’s standard of living increases as GDP increases.
Disadvantages:
1. It doesn’t count unpaid volunteer work.
2. Wartime disaster increase the GDP of the country.
3. It doesn’t show the distribution of income among different people.
4. It doesn’t show whether people belonging to a country having high GDP are happy or not.
5. It does not account for quality of goods
