Gross Domestic Product (GDP)

 

GROSS DOMESTIC PRODUCT

Gross Domestic Product (GDP)

The total market value of all the finished goods and services produced within a nation (or country) in a specific period of time i.e. monthly, quarterly or annually is called as Gross Domestic Product (GDP). It indicates the nation’s health of the economy. If GDP is rising, the economy is in rigid form, and the country is in moving forward. On contrary, if GDP is falling, the economy might be in trouble, and the country is in losing form. If a country shows negative GDP for consecutively two periods, it indicates that the country is in economic recession. GDP enables investors, policymakers and central banks, etc. to judge whether the economy is falling or growing, and to take strategic decision making. GDP can be calculate through the following three methods :-

 

1. GDP based on Production :-

Under this method, GDP calculates based on the total value of all the firms’ finished goods (products) and services, and not consider intermediate goods which are used to produce finished products.

 

2. GDP based on Income :-

Under this method, GDP calculates based on the total value of income earned by all the factors of production i.e. those which are the inputs needed for the creation of goods or services in an economy such as wages paid to workers, rent received, interest on capital, profit of the firm, etc. 

 

3. GDP based on Expenditure / Spending :-

Under this method, GDP calculates based on the total value of expenditure on goods and services produced. In other terms, total amount spent on consumption and investments of goods and services of the country in a specific period of time. The formula to obtain GDP is mentioned below :-

 

GDP = C + I + G + (X – M)

 

Where,

Consumption (C) :-

Here, consumption means personal consumption expenditure i.e. total money spent on finished products and services by private individuals and households for personal use such as durable goods (consumer goods which are tend to last for at least three years i.e. Vehicles, home, office furnishing, clothing, electronics etc.), non-durable goods (food, condiments, cosmetics, office supplies, fuel, medications, etc.) and services (i.e. transportation services, information services, etc.).

 

Investments (I) :-

Here, investments mean the total money spent for capital expenditure i.e. an acquisition of fixed assets, inventories, for replacing fixed assets that have depreciated, etc.

 

Government Expenditure (G) :-

This includes the total money spent by government of the country to purchase of goods and services of equipment, infrastructure, pay roll, etc. of their departments such as Education, Defence, Police, etc.

 

Net exports (X – M) :-

Here, Net exports = total exports (X) – total imports (M).

The goods and services sent by domestic country to abroad is called as Exports, whereas the goods and services received by domestic nation from abroad is called as Imports. In other words, exports mean Amount paid and/or payable inclusive of dividend and interest, if any to domestic country by foreign countries, whereas imports mean Amount paid and/or payable inclusive of dividend and interest, if any by domestic country to foreign countries. If more exports than imports, it is called as surplus which boosts a country’s GDP. Whereas, if less exports than imports, it is called as deficit which drags the country’s GDP.

Note :-

It should be noted that the below 3 points while calculating GDP :-

(a) Exclude intermediate products,

(b) Exclude non-market output such as house wives services, and

(c) Include imputed value of goods also, i.e. formers produce and kept for self-consumption, rent of self-occupied house, etc.

 

Difference between GDP and GNP :-

GDP (Gross domestic Product) :-

Whatever is produced by within the domestic territory of a country (no matter even if the foreign companies might have contributed) is called as GDP.

 

GNP (Gross National product) :-

Whatever is produced by domestic nationals whether inside the country or outside the country, will form the GNP of domestic nation. Also, part of the product produced in domestic nation by non-domestic nationals (foreigners) will have to be excluded in case of GNP.

 

Difference between Normal GDP and Real GDP :-

Normal GDP :-

The total market value of all the finished goods and services produced within a nation (or country) in a specific period of time, un-adjusted for inflation is called as Nominal GDP or Normal GDP. If prices change from one period to the next and the output does not change, the nominal GDP would change even though the output remained constant. Rising prices will tend to increase GDP, whereas falling prices will make GDP decrease. Therefore, just by looking at an economy’s un-adjusted GDP, it is difficult to say whether the GDP increased as a result of production expanding in the economy or because of prices raised. In order to overcome this and to get correct GDP growth, we have to follow Real GDP.

 

Real GDP :-

The total market value of all the finished goods and services produced within a nation (or country) in a specific period of time, adjusted for inflation is called as Real GDP. By adjusting the output in any given period for the price levels that prevailed in a reference (or base) period, economists adjust for inflation's impact. So that, it is possible to compare a country’s GDP from one period to another period and see if there is any real growth in the economy. It is calculated by using the GDP price deflator which is a price index that measures inflation or deflation in an economy by calculating a ratio of nominal GDP to real GDP, and it is the difference in prices between the current period and the base period. For example, if prices raised by 4% since the base period, the deflator would be 1.04.

GDP deflator = [(Nominal GDP / Real GDP) x 100]

Nominal GDP is usually higher than real GDP because inflation is typically a positive number. Nominal GDP is higher than Real GDP in the case of inflation, whereas Real GDP is higher than Nominal GDP in case of Deflation. Nominal GDP is used when comparing different quarters of output within the same year. When comparing the GDP of two or more years, real GDP is used because, by removing the effects of inflation, the comparison of the different years focuses solely on volume.

Limitations of GDP :-

(a) It does not account for several unofficial income sources such as amounts which are not paid for taxes, volunteer work, and household production, Black money, etc.

(b) GDP considers only final goods production and new capital investment and intentionally left out the amounts spent on intermediate goods.

 

Verdict :-

The information provided in below table will give you a brief understand about nation’s economy :-

 

Description	$	Amount (billion $)
Expenditure on personal consumption	910
Domestic investment	302
Net exports (Exports - Imports)	11
Purchases by Government	145
Gross National Product (GNP)		1368
Less : depreciation or Capital consumption		127
Net national Product (NNP)		1241
Less : Indirect business taxes	188
Less : Business Transfer Payments	11
Add : Subsidies less surplus of Govt. enterprises	7	192
National income (NI)		1049
Add : Govt. Transfer payments to persons	145
Add : Government interest payments	26
Add : Business transfer Payments	32
add : Inventory valuation adjustment	18
	221
Less : supplements to labour income	75
Less : Social security contributions by Govt.	135
	210	11
Private Income		1060
Less : Corporate tax	88
Less : Retained earnings or corporate savings	75	163
Personal income (PI)		886
Less : Personal taxes	76
Less : Employee contribution to pension fund	19	95
Disposable Income (DI)		791
less : Consumption	700
Less : Interest paid by consumers	27
Less : Personal transfer abroad	3	730
Personal Savings		61

 

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