Gross domestic product (GDP)

SUMMARY: Gross domestic product is a figure used frequently in economics to discuss a country’s complete economic output.

Until the Industrial Revolution, population size was a dominant factor in economic output. With the coming of technology, notions of productivity changed. The gross domestic product (GDP) is the most widely accepted and broadest indicator of aggregate economic activity.

The GDP represents a country’s overall economic output, the dollar value of all final goods and services produced over a period of time within a nation’s domestic boundaries. Many assert that the concept of quantifying a nation’s economic output can be traced back to newspaper articles written in 1939 by British economist John Maynard Keynes, who was concerned about how Britain would manage its very limited resources at the start of World War II. The Keynesian formula for GDP was the sum of a country’s consumption, investment, government spending, and exports, minus its imports.

In the United States, the GDP is calculated and released quarterly by the Department of Commerce. In general, the GDP is used to define emerging economic trends, devise appropriate policies, and gauge the effectiveness of current economic policies. More specifically, corporations use the data to forecast sales and adjust production and investment accordingly. Social scientists monitor the GDP as an indicator of well-being and as a proxy for individuals’ voting and investment decisions. In 2003, economists Sir Clive Granger and Robert Engle won a Nobel Prize for their innovative, sophisticated methods of statistical time series analyses that enhance the understanding of market movements and economic trends. In 2010, mathematicians developed an objective quality of life index that uses linear functions and dimensionality reduction to combine four well-studied and widely used indices, including per capita GDP, to produce a relative ranking of countries.

Economists have devised three distinct methods of calculating a nation’s GDP. While these approaches derive the same value, each views the GDP differently. The “product method” represents the market value of final goods and services newly produced within a nation during a particular time frame. The “expenditure method” is the national expenditure on goods and services within a specific time frame. The “income method” is the total of wages, rents, dividends, interest, and profits received by producers during a specified time frame. Regardless which method is used, the outcome is referred to as the “nominal” gross domestic product. When the nominal GDP is adjusted for inflation, it is called the “real” gross domestic product. The real GDP is used to measure the growth of a country’s economy and real GDP per capita is often used as an indicator of aggregate standard of living.

The Product Approach to Measuring the GDP

The simplest and most direct way to calculate the GDP is the product approach. The product approach calculates the GDP as the market value of final goods and services newly produced within a specific nation. Goods and services produced throughout the year may be classified as either intermediate or final goods. Intermediate goods and services are those that are consumed during the production of other goods and services and are not counted when calculating the GDP; only the final value of a good or service is included in total output. This avoids an issue often called “double counting,” in which the total value of a good is included multiple times in national output. The following equation is used to solve for the GDP using the product approach:

GDP = P − C

where P is the market price of final goods and services and C is intermediate consumption.

The Expenditure Approach to Measuring the GDP

The expenditure approach works on the principle that all of the products must be consumed, therefore the value of the total product must equal the people’s total expenditures. The four main components in calculating the GDP via the expenditure method are consumption expenditures by households (C), gross private investment spending (I), government purchases of goods and services (G), and net exports (exports minus imports, EX - IM).

The expenditure approach can be represented in the following equation:

GDP = C + I + G + (EX − IM).

The Income Approach to Measuring the GDP

The income approach to measuring the GDP assumes that expenditures on final goods and services are eventually received by households and corporations as income. A key to calculating the GDP using this method is a concept known as “national income.” The national income consists of five types of income: compensation of employees (W), proprietor’s income (P), rental income (R), corporate profits (C), and net interest (I). Thus, national income = W + R + I + P + C.

Once the national income is calculated, several adjustments must be made before arriving at the GDP. The first is an adjustment for the taxes paid by businesses to the government (indirect business taxes). Next, depreciation, or the consumption of fixed capital, is taken into account. Finally, the net foreign factor income (NFI) is included as an adjustment. The NFI is the difference between payments received from the foreign sector and payments made to the foreign sector for domestic production. The NFI represents the key difference between gross domestic product and gross national product. The following equation is used to solve for the GDP using the income approach:

GDP = Compensation of Employees + Rent + Interest + Proprietor’s Income + Corporate Profits + Indirect business taxes + Depreciation + NFI.

Nominal Versus Real GDP

If using GDP to examine production over time, the effects of price increases and inflation must be taken into account. The real GDP is the total value of all goods and services adjusted to eliminate the effects of changing prices. The nominal GDP is calculated by using current market prices. Hence, the real GDP is the value of all goods and services produced by an economy in a given year in dollars of constant purchasing power.

Figure 1. Top 10 Countries by Nominal GDP in 2020 (**International Monetary Fund, World Economic Outlook Database).

CountryYearUnitsScaleGDPUnited States2020US $Billions20,933China2020US $Billions14,723Japan2020US $Billions5,049Germany2020US $Billions3,803United Kingdom2020US $Billions2,711India2020US $Billions2,709France2020US $Billions2,599Italy2020US $Billions1,885Canada2020US $Billions1,643South Korea2020US $Billions1,631

Mathematics concepts have also been used to debate related economic concepts, such as the principle of comparative advantage. Taken in its simplest form, this principle states that if two or more countries have already expanded their respective GDPs as far as possible under some set of international trade restraints, they can expand them further by relaxing those restraints. This has been formulated and proven mathematically, using techniques like convex analysis. However, some researchers have questioned the conventional wisdom that GDP growth is always beneficial.

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