Question

Gross Domestic Product (GDP)

• Definition

•   Calculation – Expenditure and income approaches

•   Final goods versus intermediate goods

•   Are used goods counted in GDP?

•   Are stocks and bonds (financial assets) counted in GDP?

•   How are inventories treated in GDP?

•   Calculation of real GDP & current GDP

•   Definition of the standard of living

•    Limitations of GDP per person as a measure of the standard of living – e.g., is household production included in GDP? What about underground economic activity? What about leisure and environmental quality?

Answer 1

Definition: -

Gross Domestic Product or GDP is defined as the "market value of all goods and services which are produced in a country within a specific time period". It is rapidly used across the globe, as a measure of the amount of success in a country respectively

Calculation: -

The two most popular methods of calculating GDP are the Income approach and the Expenditure approach the calculation of the same is as explained.

Expenditure Approach: -

In the expenditure approach, we take into account the sum of expenses done by everyone in the country. The areas where this is focussed is Consumer Spending, Business Investments, Government Spending and the overall net exports of the country.

The formula for calculating GDP through this approach is as follows: -

GDP=C+I+G+(X-M)

C= Consumer Spending on final goods and services

I= Investment in Capital Goods and Services by Business owners

G= Government Spending on Public Goods and Services

X= Government Exports

M= Government Imports

Note- Net imports is calculated by deducting the value of imports.

The income approach on the other hand is designed to say that the worth of the GDP is defined as the total income generated from the production of all final goods and services in the economy. It is important to note that both Income and Expenditure approach should ideally give you an equal value.

It is calculated using the following formulae: -

TNI= Sales Tax+ Depreciation + NFFI

Where TNI= Total National Income, NFFI = Net Foreign Factor Income

Final Goods VS Intermediate Goods: -

Final Goods are those goods, that are used for final consumption by households or by industries as capital goods. Intermediate goods include all those parts which are used up in the production of the final goods. To avoid double counting, Intermediate goods are avoided in the final estimation of GDP.

Used Goods: -

Used goods and their sale is not counted in calculation of GDP as they have already been counted once when they were produced.

Stocks and Bonds: -

Shares and Bonds are token money and even when you can earn from them there is no production or value addition to the economy. These are thus avoided in calculation of GDP.

Inventories Treated in GDP: -

Increase in inventory that is produced goods which are not sold in a financial year are included in the GDP in the year in which it is produced. Therefore, they form an important part of the GDP of a nation respectively.

Real GDP and Current GDP

The key difference between Real GDP and Current GDP is the inflation rate of the country. Real GDP accounts for inflation related adjustment whereas Current GDP does not.

Standard of Living & Limitation of GDP: -

Standard of Living refers to the level of wealth and total social welfare within a country at any given point of time. The limitation of GDP is the fact that underground activity which refers to illegal income and household production which is the production done at a very small scale by households themselves is not included in the calculation of the Final GDP of a country.

Further, other elements such as Leisure and environmental activity are also excluded.

Please feel free to ask your doubts in the comments section.