Gross Domestic Product (GDP)

What is Gross Domestic Product (GDP)?

Gross domestic product (GDP) is the total value of all the consumer goods and services that a country produces domestically within a given time period. This includes both native and foreign companies operating within a country’s borders.

GDP is measured monthly, quarterly, and annually. It is one of the most important statistics of economic growth and health. It signals which stage of the economic cycle a country is in, for example, expansion, peak, recession, or trough. Thus, GDP figures are crucial for most key economic policy decisions.

Types of Gross Domestic Product

There can be several types of GDP, which all convey different information, as highlighted below:

Real GDP

Real GDP excludes the effect of inflation or deflation from the goods and services produced in an economy in a year. For the purposes of real GDP, it is as if prices have stayed constant throughout the year considered.

This is because inflation or deflation highly influences GDP, as the monetary value of goods is being considered. In several cases of inflation, GDP figures may rise because prices are rising. However, that does not translate into any real increase in production or quality and can be quite misleading.

Real GDP takes a base year’s prices into account while calculating the GDP output for the current year. Using a GDP deflator eliminates the impact of inflation in the current year to keep prices level with the base year.

This makes real GDP the most valuable measure of how an economy is actually doing. It also points out whether there are any factors affecting production.

Nominal GDP

Nominal GDP, in a way, does the opposite of what real GDP does. It does not cancel out the impact of rising prices from its calculation. It takes the current year’s prices, as they are, into account without adjusting them with a base year’s.

This means that nominal GDP is often quite a bit higher than real GDP. Hence, policymakers can’t always take it at face value to assess economic activity or production. Countries value nominal GDP in either US dollars for better international comparability or in the domestic country’s own currency.

Nominal GDP looks at quarters rather than years. This can help mitigate the impact of inflation somewhat, even if no active measures are taken to eliminate it. It is usually useful in comparisons with any other macroeconomic statistic that is also not inflation-adjusted, such as national debt.

GDP Per Capita

GDP per capita measures the amount of gross domestic product per person in a country in order to glean insight into the average standard of living and production. It can easily be taken as a measure of prosperity, and the higher it is, the wealthier a country usually is. GDP per capita can use both real and nominal gross domestic product.

Since GDP per capita takes both GDP and population into account, it can better analyze how each affects output and the economy.

Sometimes, smaller and wealthier countries such as Luxembourg or Switzerland may also have a very high GDP per capita. This is despite them having a relatively small population. This can be due to them being quite self-sufficient or having very advanced technology and other resources.

Similarly, if a country’s population remains more or less the same, but GDP per capita rises, it can be due to technological improvements increasing production levels.

GDP Growth Rate

The GDP growth rate is the rate at which a country’s economy is growing quarter-on-quarter or year-on-year.?The real GDP growth rate adjusts for inflation or deflation, giving a more accurate measure of actual economic growth by considering both changes in the quantity of goods and services produced and their prices.

The GDP growth rate is one of the most important types of GDPs considered for economic reports, monetary policy, and more. This is because of its simplicity yet impact in economic terms.

The real GDP growth rate can be calculated as below:

GDP Growth Rate = {(Current year’s real GDP-Previous year’s real GDP)/Previous year’s real GDP} x 100.

It can also be calculated like this:

(Nominal GDP/GDP Deflator) x 100.

When GDP is accelerating at a substantially fast pace, the economy may be headed towards a boom period. This usually happens when demand grows at an unprecedented pace and supply becomes unable to fulfill it.

This leads to higher inflation, amongst other factors, and can cause an economy to “overheat”. As a result, central banks may decide to further tighten monetary policy to curb inflation.

On the other hand, if GDP is reducing, it may spur governments and central banks to think about stimulus measures and laxer monetary policies.

GDP Purchasing Power Parity (PPP)

Gross domestic product purchasing power parity serves primarily as a comparative instrument rather than a distinct GDP category. It is mostly used to compare one country’s GDP with another’s.

Essentially, this approach seeks to assess the value of a country’s GDP in relation to the US dollar on the global stage. The choice of the US dollar as the benchmark is rooted in its widespread use as the predominant currency in international trade.

It also takes into account the economic and labor resources of each country, as well as the local prices, regulations, and more. This is in order to evaluate the economic and production efficiency between countries.

Thus, it’s possible to gain insights into their living standards and the strength of their own currencies.

GDP Calculation

Essentially, there are three different methods to calculate GDP:

• Expenditure method
• Production or output method
• Income method.

Expenditure Method

Out of the methods above, the expenditure method is the most common.

Gross domestic product = Consumption + Government spending + Investment + Net exports.

This can also be shortened to G = C+G+I+NX.

Consumption takes into account private consumer expenditures, whereas government spending can be infrastructure, equipment, payroll, healthcare, and more. Investments can be capital expenditures or private domestic expenditures. Net exports are the difference between total exports and total imports.

Production Method

The production method of calculating GDP is basically the opposite of the expenditure approach. Instead of taking the input costs into account, it takes the output value into consideration and minuses the intermediate goods cost.

Income Method

The income approach considers the income generated by land, labor, capital, and entrepreneurship, otherwise known as the factors of production. However, it deducts indirect taxes such as property and sales taxes as well as depreciation.

How GDP Data is Used

Governments and banks mostly use gross domestic product data to know how an economy is doing at regular intervals. It is the most relevant while deciding on economic policies, such as monetary policies and labor laws.

In times of high inflation, central banks consult GDP figures for guidance on how to proceed with monetary policy. Banks also refer to other factors, such as retail sales and unemployment. This influences whether interest rates continue to increase, take a pause, or even come down. Economies usually use real GDP figures the most.

When it comes to quarterly GDP, most countries release an advance statement four weeks following the end of the quarter. However, a full report comes out three months after the quarter.

This contains mostly exhaustive details about production and economic factors. Policymakers, businesses, and even individuals use these reports to make key decisions.

GDP estimates, especially the advance reports, can considerably impact stock and bond markets. Due to this, investors keep an eye on GDP too. Sometimes, economists make other adjustments to gross domestic product figures.

This is in order to make them more useful or tailored to a particular issue. For example, tax-to-GDP looks at how a country’s tax revenue affects its economy.

Sources for GDP Data

GDP data can usually be found in a number of national and international databases. These include the Organization for Economic Cooperation and Development (OECD), the World Bank, and the International Monetary Fund (IMF).

Out of these, the World Bank and the OECD are most preferred for the range and depth of their data. They are also fairly easy and accessible to use.

GDP databases not only provide current GDP data for a number of countries but also historical data. They can also help predict GDP growth. They also have a number of other statistical and analytical tools to help draw out more insights from the data and compare countries.

In the US, the Federal Reserve plays a crucial role in gathering and sharing GDP data, sourcing information from a diverse array of international economic agencies. The Bureau of Economic Analysis (BEA) also helps support it by providing further in-depth analysis to bolster GDP reports.

The Office for National Statistics (ONS) is responsible for delivering comprehensive GDP data, ensuring a reliable portrayal of the economic landscape.

Other Measures of Economic Growth

Apart from gross domestic product, there are also a few other measures of economic growth, as highlighted below:

Gross National Product (GNP)

Gross national product refers to the total production of goods and services all over the world by individuals or companies that are native to a country.

In turn, GNP excludes domestic production by foreign companies or individuals. This differs from GDP, which considers all production within its physical boundaries.

GNP takes into account private domestic investments, net exports, personal consumption expenditures, government expenditures, and any income earned from foreign investments. It then deducts the income foreign residents in the domestic country earn.

In some ways, GNP is a more reliable measure of a country’s economic activity, as it does not take physical location into account.

Gross National Income (GNI)

Gross national income refers to the total income earned by all individuals and businesses native to a country. This is regardless of where they earn income, so like GNP, GNI does not take location into account either.

However, it does deduct the income earned by foreign nationals or companies domestically. GNI is calculated by taking a country’s GDP and adding the income earned by native individuals and businesses abroad.

In cases of a country having a lot of foreign companies operating domestically, significant foreign aid and foreign direct investment, GDP, and GNI figures can be vastly different. However, for other nations, they may be quite similar.

Drawbacks of GDP

Although GDP is widely used and is still considered a key macroeconomic statistic, it also has its fair share of drawbacks, as highlighted below: