Welcome to our beginner-friendly guide on Gross Domestic Product (GDP), a crucial measure used to understand how well a country’s economy is doing. In this blog, we’ll explain what GDP is, how it’s calculated, and why it’s so important.
GDP tells us how much all the stuff produced in a country is worth. This stuff includes everything from cars and books to services like teaching and driving taxis. But there are some things GDP doesn’t count, like work people do at home or in the “black” economy, where things aren’t always recorded.
We’ll break down the different types of GDP, like the regular GDP, which doesn’t account for inflation, and real GDP, which does. We’ll also look at GDP per person and adjusted GDP, which helps compare economies in different countries.
Next, we’ll explore how economists figure out GDP. There are three main ways: by looking at how much people spend, how much value is added at each step of making things, and how much money people and businesses make.
Finally, we’ll discuss what GDP growth or shrinkage means for a country. When GDP grows, it usually means more jobs, more spending, and a happier economy. But when GDP shrinks, it’s often a sign of trouble, like fewer jobs and less money for businesses.
So, if you’re curious about how countries measure their economies and what it all means, you’re in the right place. Let’s dive into the world of GDP together!
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What is GDP?
The gross domestic product (GDP) is an economic indicator that reflects the monetary value of all final goods and services generated by a country during a specific period. It is used to measure the wealth that a country generates. It is also known as GDP in short.
The GDP is a metric used to quantify the economic output of a country. To calculate it, we add the value of everything that has been created in the country, whether goods or services. This includes, from the production of apples, books and cars for example, to services offered by taxi drivers, dentists, lawyers, banks or teachers, among many others. Not all things are measurable in GDP. Some operations are excluded because they are hard to measure. Some activities, such as what people produce for their consumption or what is known as the ‘black economy’, are left out because it is difficult to measure them.
Certain statistics cannot be incorporated into the GDP computation due to their extreme difficulty in measurement. People’s consumption of goods and the so-called “black economy” are two instances of this. All of this adds up to a measurement of a country’s overall economic prosperity, or its size of economy. A country’s ability to create jobs and attract investment increases with GDP since it indicates that it has a stronger economy. It is usually calculated quarterly, although the data that is usually used to measure the size of an economy is the annual GDP, that is, everything produced in that country during a year.
Types of GDP:-
Let’s examine the many types of GDP:
Nominal GDP:
The Gross Domestic Product (GDP) as measured without accounting for inflation is referred to as nominal GDP. It expresses the total value of all goods and services generated in an economy at the moment of measurement, or at current prices. This suggests that variations in the cost of products and services have a direct impact on the nominal GDP value. Thus, even in the absence of an increase in the volume of real output, nominal GDP tends to rise when prices generally rise. This indicator helps determine the size of an economy and for establishing direct comparisons between particular periods. Nevertheless, it does not give a precise indication of real economic growth or purchasing power because it ignores inflation. Real GDP is used to account for the impacts of inflation and provide a more realistic picture of economic growth.
Real GDP:
 Real GDP is a measure of GDP that has been adjusted for the effects of inflation, thus providing a more realistic result of a country’s economic growth. Constant prices are used in this type of GDP to exclude the inflationary effect. To calculate real GDP, nominal GDP values are adjusted to prices in a base year using a price index, known as the Consumer Price Index, or CPI. This makes it possible to quantify changes in the amount of economic output in real terms. This rate is also used to compare different periods, just like nominal GDP. However, the ability to assess economic growth free from the distortion caused by fluctuations in price levels is provided by real GDP. In conclusion, prices can be used to estimate GDP both with and without discounting inflation. In conclusion, there are differences in the outcomes when estimating GDP using prices that discount inflation against those that do not. As we have previously shown, using the real GDP value usually makes sense because it provides a more realistic picture of a country’s economic activities.
GDP per capita:Â
GDP per capita is a metric used to calculate a country’s average standard of living or degree of wealth among its citizens. It is computed by taking the GDP of a country and dividing it by the entire population. This division yields a value that roughly represents the quantity of economic production that is available to each individual. It is crucial to remember that, because GDP per capita does not account for income disparities, it may not accurately represent the distribution of wealth within a country. This measure is employed to assess the degree of economic and social development of various countries and to draw comparisons between them.
PPP GDP:
GDP by purchasing power parity, or PPP GDP, is a metric that makes it possible to estimate a territory’s GDP by removing price discrepancies between countries. Because it reflects the purchasing power of the populace, adjusting the GDP by purchasing power parity yields a more accurate assessment of the state of the economy and of people’s well-being. This makes cross-national comparisons more fair and realistic.
How do we know if a country’s GDP is increasing?
It is said that a country grows economically when the rate of change of GDP increases, that is, the GDP of the calculated year is greater than that of the previous year. The formula used to see the percentage of variation is:
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GDP variation rate = (GDP Final – GDP Initial)/GDP INitial * 100%
In summary, if the rate of change is greater than 0, there is economic growth. Otherwise, below zero, there is economic growth.
What happens if GDP increases or decreases?
A rising GDP is indicative of a strong economy and benefits almost the whole population of the country. Conversely, when it falls, it is not a good sign. We could compare it to the income of a family or a company; If income increases it is usually a good sign. On the other hand, if income is reduced it is a bad sign for the economy.
An increase in GDP indicates a general increase in consumption, investment, and investment in the country. Together with imports and exports, these are the exact variables that makeup GDP.
An increase in GDP, or spending, consumption, and investment, usually has a positive impact on the economy because it raises the income of businesses, households, and governments, giving them more money to invest and create jobs. This, since more individuals have the means to consume, leads to a rise in spending and consumption. For this reason, employment and wages tend to rise in tandem with GDP growth. Conversely, a decrease in GDP or an economic recession results in a decline in overall corporate earnings and consumption, which in turn reduces investment and employment.
That is why it is such an important indicator and so followed by investors and journalists.
How is gross domestic product (GDP) calculated?
We will now examine the process of calculating GDP. Three approaches can be used to measure this:
1. Expenditure Method:Â It represents the total amount of money locals spend overtime on finished goods and services. Therefore,
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GDP = C + I + G + X – M
C: Consumption
I: Investment
G: Public spending
X: Exports
M: Imports
2. Value Added Method:Â It is the total amount of added value (gross) produced within a specific period in a country during the production of products and services. The gross domestic product formula is:
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GDP = GVA + taxes – subsidies
GVA is Gross value added)
3. Income Method: It is equal to the total amount of money made during a given period by the proprietors of the productive factors (labour and capital).
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GDP = RA + EBE + taxes – subsidies
RA: Remuneration of employees, or the total of all the salaries that residents of a region earn.
EBE: Gross operating surplus.
GDP Comparisons
When we compare the gross domestic product of a quarter with the previous quarter, we obtain the quarter-on-quarter variation rate, that is, the economic growth that the country is experiencing from quarter to quarter. If we compare the GDP of a quarter with the same quarter of the previous year, we obtain the year-on-year rate.
When we compare the gross domestic product of a quarter with the previous quarter, we obtain the quarter-on-quarter variation rate, that is, the economic growth that the country is experiencing from quarter to quarter.
If we compare the GDP of a quarter with the same quarter of the previous year, we obtain the year-on-year rate. When comparing the GDP of countries internationally, the annual GDP data is usually used, measured in United States dollars.