What is GDP?

What is GDP?

GDP stands for gross domestic product. It has become widely used as a reference point for the health of national and global economies. When GDP is growing, especially if inflation is not a problem, workers and businesses are generally better off than when it is not. GDP is important because it gives information about the size of the economy and how an economy is performing.

What GDP measure?

  • GDP measures the monetary value of final goods and services, i.e. those that are bought by the final user—produced in a country in a given period of time (say a year).
  • It counts all of the output generated within the borders of a country.
  • GDP is composed of goods and services produced for sale in the market and also includes some nonmarket production, such as defence or education services provided by the government.
  • However, not all productive activity is included in GDP. For example, unpaid work (such as that performed in the home or by volunteers) and black-market activities are not included because they are difficult to measure and value accurately. It means, if a baker who produces a loaf of bread for a customer would contribute to GDP, but would not contribute to GDP if he baked the same loaf for his family (although the ingredients he purchased would be counted).
  • Moreover, “gross” domestic product takes no account of the “wear and tear” on the machinery, buildings, and so on (the so-called capital stock) that are used in producing the output. If this depletion of the capital stock, called depreciation, is subtracted from GDP we get net domestic product.
  • GDP in a country is usually calculated by the national statistical agency, which compiles the information from a large number of sources. In making the calculations, however, most countries follow established international standards. The international standard for measuring GDP is contained in the System of National Accounts, 1993, compiled by the International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank.

Theoretically, GDP can be viewed in three different ways:

  • The production approach sums the “value-added” at each stage of production, where value-added is defined as total sales less the value of intermediate inputs into the production process. For example, flour would be an intermediate input and bread the final product; or an architect’s services would be an intermediate input and the building the final product.
  • The expenditure approach adds up the value of purchases made by final users—for example, the consumption of food, televisions, and medical services by households; the investments in machinery by companies; and the purchases of goods and services by the government and foreigners.
  • The income approach sums the incomes generated by production—for example, the compensation employees receive and the operating surplus of companies (roughly sales less costs).

What is Real GDP? How it is Determined?

It is not easy to know by people whether its total output of goods and services is growing or shrinking. But because GDP is collected at current, or nominal, prices, one cannot compare two periods without making adjustments for inflation.

To determine “real” GDP, its nominal value must be adjusted to take into account price changes to allow us to see whether the value of output has gone up because more is being produced or simply because prices have increased. A statistical tool called the price deflator is used to adjust GDP from nominal to constant prices.

The growth rate of real GDP is often used as an indicator of the general health of the economy. In broad terms, an increase in real GDP is interpreted as a sign that the economy is doing well. When real GDP is growing strongly, employment is likely to be increasing as companies hire more workers for their factories and people have more money in their pockets.

When GDP is shrinking, employment often declines. In some cases, GDP may be growing, but not fast enough to create a sufficient number of jobs for those seeking them. But real GDP growth does move in cycles over time. Economies are sometimes in periods of boom, and sometimes in periods of slow growth or even recession (with the latter often defined as two consecutive quarters during which output declines).

What GDP does not Reveal?

GDP is not a measure of the overall standard of living or well-being of a country. Although changes in the output of goods and services per person (GDP per capita) are often used as a measure of whether the average citizen in a country is better or worse off, it does not capture things that may be deemed important to general well-being.

For example, increased output may come at the cost of environmental damage or other external costs such as noise. Or it might involve the reduction of leisure time or the depletion of non-renewable natural resources. The quality of life may also depend on the distribution of GDP among the residents of a country, not just the overall level. To try to account for such factors, the United Nations computes a Human Development Index, which ranks countries not only based on GDP per capita, but on other factors, such as life expectancy, literacy, and school enrolment.

Other attempts have been made to account for some of the shortcomings of GDP, such as the Genuine Progress Indicator and the Gross National Happiness Index, but these too have their critics.

What is GNP?

Gross national product (GNP), counts all the output of the residents of a country. So, if a Japan-owned company has a factory in the India, the output of this factory would be included in Indian GDP, but in Japan GNP.

(Source: IMF)

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