Gross Domestic Product

Gross Domestic Product or GDP is referred to as the total monetary value of all the final goods and services produced within the geographic boundaries of a country, during a given period (usually a year).

Gross Domestic Product is one of the most important indicators of the economic status of a country. GDP or Gross Domestic Product is referred to by the economists as the size of an economy.

GPD is used by businesses and economists to determine the economic performance of the economy as a whole. A rising GDP is an indicator that the economy is expanding and the people are spending their money, which shows an economy that is growing stronger.

High GDP also helps investors in taking better investment decisions.

The concept of GDP was developed by an American economist named Simon Kuznets in 1934 and is thereafter recognised as the gold standard for determining the measure of a country’s economic growth since the Bretton Wood Conference held in 1944.

Formula for Calculating GDP

The formula for calculating GDP is

Y = C + I + G + (X − M)

Where

Y= Gross Domestic Product

C = Consumption

I = Investment

G = Government spending

X = Exports

M = Imports

Methods of GDP Calculation

There are three different approaches for calculating GDP which is used by economists. All these approaches produce the same results, theoretically.

  1. Output Approach
  2. Income Approach
  3. Expenditure Approach
  4. Output Approach : The Output approach, commonly known as production approach is the market value of all the goods that are produced within the country.

The formula for calculating GDP by output approach is

GDP = GDP at market price – depreciation + NFIA (net factor income from abroad) – net indirect taxes.

  1. Income Approach : The Income approach of GDP calculation is based on the total output of a nation with the total factor income received by residents or citizens of a nation.

The formula for calculating GDP by income approach is

GDP = Compensation of employees + Rental & royalty income + Business cash flow + Net interest

The compensation of employees is the total payments made to all the labourers and employees.

Rent is earned by the businesses on the land, and profits are made by the business from the sales of goods and services.

Interest is earned on the capital invested by the company.

  1. Expenditure approach : The Expenditure approach calculates the GDP by calculating the sum of all the services and goods produced in an economy.

The GDP can be calculated with the following formulae

Y = C + I + G + (X − M)

Where

Y= Gross Domestic Product

C = Consumption

I = Investment

G = Government spending

X = Exports

M = Imports

The components are described in brief here

  1. Consumption is denoted by C. It stands for all the private spending, which includes services, nondurable and durable goods.
  2. Government expenditure is denoted by G and it includes employee salaries, construction of roads and railways, airports, schools and expenditures in the military.
  3. Investment denoted by I, refers to all the investments which are spent on housing and equipment.
  4. Net exports is denoted by (X-M) which is the difference between total imports and exports.

Types of GDP

Following are the types of GDP:

1. Nominal GDP : Nominal GDP, also known as nominal gross domestic product is the value of all the final goods and services at current market prices, or in other words, it is GDP calculated at the current market prices.

Nominal GDP takes into account these factors such as inflation, price changes, changing interest rates and money supply, at the time of determining GDP.

2. Real GDP : Real GDP is said to be the value of all goods and services determined in an economy after taking into account the rate of inflation.

In other words, it is the inflation adjusted value of goods and services produced in an economy in a year, therefore it is also known as inflation adjusted gross domestic product.

Real GDP in addition to inflation also takes into account the deflation. Real GDP is therefore a more accurate measure of the economy than the other measures, such as Nominal GDP (which measures total output based on the prices).

Importance of GDP

GDP is regarded as the most important of the indicators that are used by economists all over the world for determining the growth of an economy. It takes into account the total production of the country during a year.

It serves as a major factor that is used for determining the development of the economy and a very important parameter for estimating the performance of an economy.

Limitations of GDP

Following are the limitations of GDP:

  1. GDP does not include non-market transactions.
  2. It fails to indicate whether the growth of a nation is sustainable.
  3. It fails to take into account the impact on human health and environment that may arise as externalities from the production or consumption of the output.

Countries with the highest GDP

The following is the list of top 5 countries based on GDP

  1. USA
  2. China
  3. Japan
  4. Germany
  5. India

This completes the concept of GDP, which is one of the most important indicators of economic development of a nation. To read about more such interesting concepts on Economics for Commerce, stay tuned to BYJU’S.

FAQs on GDP

  1. Which country has the highest GDP?

The USA has the highest GDP in the world, followed by China and Japan.

  1. What is the GDP formula?

GDP is calculated using the formula Y = C + I + G + (X − M)

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