How To Measure GDP?

GDP or Gross domestic product is the market value of all services and goods produced within a specific timeframe.

The concept of GDP was introduced in the 18th century. In 1934, American economist Simon Kuznets modernized this concept. In 1944, it was the official metric for measuring national economic growth. This article will help you in understanding what is GDP and how you can measure it.

Table of Contents

1. Definition
2. Calculating GDP
3. Types: GDP Per Capita, GDP PPP, Growth Rate, etc.
4. Measurement Methods

What is GDP?

GDP is an aggregate measure of product that is equal to the sum of gross values of units engaged in production and services. It provides a complete score of the economy. Let us now understand the definition in-depth

1. Gross indicates the total amount before deductions.
2. Domestic refers to the products and services that have been produced within the country. 
3. Product indicates the production of goods and services to sell them in the market. Following are the products that are not included: 

• Voluntary work
• Non-monetary compensated work
• Bartered goods and services
• Products sold in black market
• Used goods

Calculating GDP

GDP increases whenever domestic sellers are able to sell more than foreign traders. This is the situation of trade surplus. On the other hand, when foreign traders are able to sell more within the country, it is a trade deficit.

Types of Gross Domestic Product

There are different types of GDP including the following:

1. Nominal GDP

Nominal GDP helps in assessing economic production that includes the current prices. You calculate it in either the local currency or in the U.S. dollars at currency market exchange rates. 

It is used while comparing output within different quarters of the same year. It is not an accurate calculation of GDP since prices may have increased due to inflation rather. than increased production

When comparing the gross domestic product of two or more years, experts use real GDP. This is because, in effect, the removal of the influence of inflation allows the comparison of the different years to focus solely on volume.

2. Real GDP

This method helps in calculating gross domestic product for two or more years. It is an inflation-adjusted measure. This means that it would give an accurate calculation of GDP due to production. You can calculate real GDP by the following method:

Here:

The GDP deflator is the measure of inflation. In mathematical terms, it is the ratio of annual production in an economy to the prices during the base year. You would be able to identify the increase in GDP due to increased prices instead of increased output. 

3. GDP Per Capita

GDP per capita is the measurement of per person GDP within the country’s population. This indicates that the per-person output or income indicates average productivity or living standards. You can state it in nominal, real and purchasing power parity (PPP) terms. It also reflects how much economic production value can be attributed to every individual citizen. 

4. Per-capita GDP 

It measures the average income earned per person in the given area for a specific year. To calculate per capita income, you would divide the total income of the area by the total population. You can assess a country’s standard of living through per capita income. 

Some countries might have high per-capita GDP but a small population. This happens when the country has a self-sufficient economy that is based on the abundance of special resources.

5. GDP Growth Rate

It provides a comparison for year-over-year changes in the country’s economic output. You can measure how fast an economy is growing using the growth rate.

When this rate increases, this signals that the economy is “overheating” and the central bank might raise interest rates. A negative growth rate signals that we should work towards lowering this rate and there is a need for stimulus.

6. GDP Purchasing Power Parity (PPP)

It is not a direct measure of Gross Domestic Product. Experts use this method to compare economic productivity and the standards of living between countries. This is a useful metric for making inter-country comparisons in terms of gross domestic product and component expenditure. 

You can calculate PPT in three stages. The first stage is at the product level. Here, you measure price relatives for the individual goods and services. The second stage is at the product group level, where price relatives that are calculated for products are averaged. This is done for obtaining unweighted PPPs for the group. 

The third stage is at aggregation levels, where PPPs for the product groups are weighted. These are then averaged for obtaining weighted PPPs for the aggregation level up to Gross Domestic Product

Measurement of Gross Domestic Product

In the previous section, you have learnt about the types of gross domestic product. This section will help you in learning about measurement methods for it:

1. Output/Production Method

This measures the market value of domestic goods and services. This approach estimates the value of total economic output while deducting the cost of intermediate goods consumed. 

Here, GDP = Real GDP (at constant prices) – Taxes + Subsidies.

2. Expenditure Method

It is the reverse of the production approach which is also known as the spending approach. It indicates the individual consumption of products and services within the country’s border. Here, you will be able to calculate the expenditure of different groups. You can calculate the expenditure approach using this formula:

GDP = C + G + I + NX

where:

C=consumption;

G=government spending;

I=investment; and

NX=net exports

3. Income Method

It is an approach that lies in between the production and expenditure approach. It helps in calculating income through each factor of production within the economy. This may include wages, rent, return on capital among other sources. You can calculate this approach by:

GDP = GDP at factor cost + Taxes – Subsidies.

The gross domestic product indicates the size of the economy and helps in tracking its performance. Authorities can take appropriate actions based on the rate. Policymakers and businesses can assess the impact of variables such as fiscal policy, taxation and economic shocks. Organizations can evaluate markets based on GDP  before investing or stepping into that market. 

You need to know that Gross Domestic Product is one of the several financial metrics to measure how the economy is performing. It is important to consider other parameters as well before reporting the progress.