One way to measure the performance of any economy is by calculating the total output of goods and services (referred as aggregate output) of that economy. Gross Domestic Product (GDP) is defined as the total value of all goods and services produced within a country. It is the total value of all finished goods and services a country produces within a specific time, usually a year.
Also, the GDP of a nation measures the income and expenditure of the residents of that nation. This makes the income of one man an expenditure of another.
How Does GDP Work?
Here is how Gross Domestic Product (GDP) works. It measures the total income and expenditure of everyone in a country. This is quite essential because a nation’s income should equal its expenditure. Every economic transaction involves two parties (the buyer and seller). Therefore, an individual’s expenditure is another’s income.
Let’s consider this illustration:
Assume an individual sells factor services to a firm. In return, they earn and receives income from that firm. Also, if they use the income they received to purchase other goods and services for themself; the individual becomes the seller while the firm is the buyer.
On the other hand, the firm also sells goods and services to individuals. This enables them to generate the revenue they can use to hire factor service.
This transaction adds to the GDP of an economy, which can be measured as the total income or expenditure of that economy. Also, GDP helps to measure the economic growth of the nation, by examining the previous records of the nation to know if the economy is expanding or contracting.
History of GDP
In studying the concept of GDP, we must take a brief look at the history of GDP. After the inauguration of Franklin Roosevelt in 1933, the Senate started a study on how they can effectively measure the output of the American economy.
This study was carried out by Simon Kuznets and Richard Stone. They eventually came up with the concept of National Income Accounting which was published in 1934. After the great depression of 1930, America had no way of measuring its economic activities. This is because policymakers had no way to aggregate output.
They only made use of informed guessing which was only accurate most of the time. This led to the assigning of Kuznets to come up with a more reliable measure that could help them gauge the macroeconomic growth of the nation properly. The national account brought great breakthroughs for both the policymakers and economists. For the first time, the government was able to manage the macroeconomic framework of the nation.
This was done by collecting proper and reliable data that will help them oversee the growth of the nation.
How Does GDP Affect You?
Although GDP is used as a tool to measure the aggregate output of the economy, it still has a notable effect on individuals. GDP stands to represent the economic production and growth of a country and its individuals. For instance, when there is sustainable growth in the GDP of a nation, firms tend to hire more workers and even pay higher salaries and wages.
Bear in mind that an increase in the wage or salary of an individual corresponds with their purchasing power. This means that such a person will spend more on the consumption of goods and services. Also with a sustainable GDP, firms are motivated to have investments in that economy.
On the contrary, any economy having a declining GDP could affect organizations and industries in turn affecting the individuals in that economy. However, some firms could even retrench workers consequently reducing an individual’s ability to goods and service.
Why Does GDP Matter?
It’s important to know the Gross Domestic Product of an economy. Some of the reasons why GDP matters include:
- Firstly, it helps the nation to know its population and keep track of its progress.
- Secondly, the policymaker keeps a close watch on it to be certain about the health of the economy. To know if there is growth or an immediate threat (like inflation) looming around the corner.
- Also, these policymakers refer to the GDP to make accurate decisions when deciding on issues like interest rates and trade policies.
- It portions the rate at which an economy grows. This could have an effect on business and investment decisions, which could determine if people would get jobs or not.
- Lastly, it enables those in authority to make policies and decisions and how to go about public spending.
Types of GDP Measurement
There are four ways to measure GDP and they are:
- Real GDP: Here, the prices of commodities are calculated at a steady price which is determined by the prices of things in the previous year.
- Nominal GDP: This is calculated alongside inflation. GDP here is calculated by the recent prices of good and services.
- Actual GDP: This measures the economy of a nation at a particular period.
- Potential GDP: This calculates the GDP of a country under suitable conditions. Here all things such as constant currency, employment, low inflation are stable.
Real Gross Domestic Product (GDP) is also referred to as inflation-corrected GDP, constant-dollar GDP, constant-price GDP. It measures the outcome of inflation or deflation of an economy.
The Real GDP of an economy indicates how valuable that economy may have been in its production of goods and services in a year. The changes in the price of an economy may alter the measure of the money value, and nominal GDP into an index for the amount of the total output.
For instance, the Real GDP of America increases at an annual rate of 4.3% in the fourth quarter of 2020.
GDP Growth Rate
The GDP growth rate as the name implies measures the growth rate or how rapidly a country’s economy grows. This rate is calculated by comparing the recent quarter output of a country to its previous quarter. The economic output of a country is measured by GDP.
For example, in China, the GDP grew to about 2.3% in the last quarter of 2020 and there’s an expected growth rate of 8.1% from January 2021. In addition, this illustration shows that the economy of China is expected to have increased to 8.1% by January.
GDP Per Capita
GDP per capita is used by economists to calculate the economic growth of a country. It analyzes a country’s wealth by dividing the country’s GDP by its population. In short, this is done annually.
Usually, small countries, well-developed and rich countries tend to have the highest GDP per capita. With GDP per capita, you’re can determine the standard of living for a country.
Calculating Gross Domestic Product
When calculating the GDP of a country, you compare the Real GDP and the Nominal GDP of a country. However, the formula to calculate the Gross Domestic Product (GDP) of a country is expressed as:
GDP = C + I + G + (E – I)
C = Private Consumption
I = Gross Investment
G = Government Investment
E = Exports
I = Imports
How To Calculate Nominal GDP
Nominal GDP is the gross market value of a country’s goods and services generated within a time frame. Compared to the other GDP measurements available, the Nominal GDP is not modified to give account for the price changes (inflation and deflation) of the economy.
The Nominal GDP is calculated by multiplying the Real GDP of a country by the GDP deflator. It’s expressed as:
Nominal GDP = (Real GDP × GDP deflator)/100
Whereas, the GDP deflator can be gotten by (Nominal GDP/Real GDP) x 100
How To Calculate Real GDP
There’s a fine line between the Real GDP, Nominal GDP, and the GDP deflator. The Real GDP takes into consideration the economic price changes that may occur as a result of inflation and deflation. It accounts for these changes using the GDP deflator or the prices in a year.
In simpler terms, the Real GDP is the Nominal GDP modified for changes in the price of goods and services. It’s expressed as:
Real GDP = Nominal GDP/GDP Deflator
What Isn’t Measured In GDP?
As explained above GDP measurements are broken up into four separate types (Real GDP, Nominal GDP, Actual GDP, and Potential GDP). However, there are certain economic impacts that are not accounted for when calculating the GDP.
Unpaid Services Aren’t Measured
By unpaid services we mean, those “invisible” household jobs carried out in the home. This includes the idea that women do majority of the housekeeping. However, this bias was brought to light by the keen observation of Phyllis Deane when she was employed by Meade and Stone to help implement their policy in the new British colonies.
She argued that the contribution of women in the maintenance of the household should not be excluded in the computation of the GDP. These unpaid services rendered by women go a long way to ensure that the economic services carried out by the men are done effectively and efficiently.
GDP Doesn’t Include Environmental Cost
In a bid to bring about sustained economic growth, we forget to make provisions for the after effect that some of the tools or equipment we use may have on the environmental health of the economy.
We tend to treat our natural resources — air or water, as things that can be exploited. Such a mindset turns out to have an unbearable consequence on the climate condition of the nation and the world at large.
The GDP of an economy should be amended to cater to the environmental cost of the nation. Or the intended growth may not have a long-term effect.
The Underground Economy Isn’t Accounted for
By underground economy, we are talking about income that is generated illegally. Also, it refers to the payments made to those who tender factor services. The underground economic transactions in developing countries make up one-third of their total income.
Since this income goes unreported, the nation’s GDP is affected making it difficult for the government to properly implement its monetary policies. One of the major ways the government generates revenue is through Tax and if these underground workers are duly taxed. Therefore, it should help the nation in rebuilding social amenities and funding a lot of projects that will benefit citizens of the country.
Where Can You Find GDP Data?
You can find GDP data from the National Account Dataset portal. The Data Table tab of the International Financial Statistic dataset portal also contains GDP information.
Understanding the GDP of any nation is important. With the GDP information, you can make informed decisions regarding investments. In short, this means that you can determine when the economy of a nation is blooming and contracting.
If you are unaware on how to calculate the GDP of an economy, then we recommend that you consult a financial advisor. A financial advisor will guide you through understanding a country’s GDP and how to make good investments.