Introduction to Gross Domestic Product
Gross Domestic Product, also known as GDP , is the total monetary or market value of all the finished goods and services produced within a nation’s boundaries during a certain time period (which is typically 1 year).
GDP calculates the monetary value of the final goods and services, purchased by consumers, which is produced in a nation during a specific time period. It acts as a means of measurement for all the output produced within a country. GDP is made up of products and services generated for market consumption as well as certain non-market productions, including state provided defense or educational services.
One might get confused between the concepts of Gross Domestic Product and Gross National Product. However, gross national product (GNP) is a different concept that accounts for all national outputs. For instance, if a Nepal-owned corporation like Chaudhary Group operates a factory in India, its output would be counted towards Nepal’s GNP rather than India’s GDP.
What is not included in GDP ?
In addition to that, the GDP does not account for all productive activities. For instance, unpaid works like works done at home or by volunteers and black market operations are excluded since they’re difficult to evaluate and monitor.
Let’s say a baker, who makes a loaf of bread for a client, would contribute to GDP as a transaction occurs among both parties. However, if he makes the same loaf of bread for his family without any charges, then that interaction would not be recorded in the GDP. But, the ingredients he purchased will be counted in the GDP due to a legal transaction between him and the ingredient supplier. Furthermore, GDP does not account for any wear & tear on the equipment, structures, and other assets utilized in the production process. When these sort of depreciations are calculated (subtracted from the GDP to be precise), we tend to get the Net Domestic Product.
Gross Domestic Product Category
Normally, GDP can be categorized into Nominal or Current GDP, which is the face value of output without any inflation adjustment; and Real or Constant GDP, which is the value of output adjusted for inflation or deflation. It enables us to identify whether a change in the output’s worth is the result of greater production or merely rising pricing. GDP growth is calculated using Real GDP.
Gross Domestic Product Calculation Technique
There are three main ways to estimate the GDP of a nation. We can obtain the same result by all three techniques if computed properly. The three key strategies, which we will discuss further below, are the expenditure approach, the output (or production approach), and the income approach.
The Expenditure Approach
The expenditure approach, sometimes referred to as the spending approach, determines how much money is spent by various economic actors. The US GDP mainly focuses on the spending technique as its main method to calculate its GDP. According to this approach, we can use the following formula to calculate GDP:
GDP = C + G + I + NX
C = Consumption
G = Government Spending
I = Investment
NX = Net Exports
Private consumption expenditures, or consumer spending, are referred to as consumption. Spending money on food, groceries, and haircuts is one of the examples of how consumers purchase products and services. Hence, consumer confidence plays a huge role in economic growth. A high level of confidence reveals consumers’ readiness to spend, whereas a low level of confidence shows consumers’ worry about the future and their reluctance to spend.
Government spending consists of both gross investments and consumption costs. Governments spend money on things like infrastructure, equipment, and salaries. When consumer expenditure and corporate investment both see significant declines, the role of government spending in a nation’s GDP may change in relation to other components.
Investments are usually referred to private domestic investments or capital expenditures. Businesses invest money in their operations by making purchases. For instance, a company might purchase equipment or machineries as a form of investment. Since it enhances employment rates and an economy’s capacity for production, business investment is a crucial part of GDP.
The net exports formula (NX = Exports – Imports) reduces total imports from total exports. A nation’s net exports are its manufactured goods and services that are exported to other nations minus its domestic consumer-purchased imports. Even if they are international corporations, all expenses made by local businesses are taken into account in this assessment.
The Output (or Production) Approach
The production strategy basically operates in an opposite direction to the expenditure approach. Production approach calculates the entire value of economic output and subtracts the cost of intermediate items that are consumed in the process rather than evaluating the input costs that go into economic activity (like those of materials and services). The production approach looks backward from the vantage point of a state of accomplished economic activity, in contrast to the spending approach, which projects forward from costs.
The Income Approach
The income approach to measuring GDP serves as a kind of equilibrium between the other two methods. Income approach determines the income generated by each source of production in an economy, including labor’s wages, land’s rent, capital’s return in the form of interest, and businesses’ profits.
The income approach makes certain adjustments for those things that aren’t considered payments given to production factors. For example, there are some taxes that are categorized as indirect company taxes, like sales taxes and property taxes. Depreciation, a reserve that companies set aside to cover the cost of replacing equipment that deteriorates over time, also contributes to the national income. The sum of all of these things is a country’s income.