GDP is the universal measure of income among different countries. We’ve heard of the term GDP multiple times, but what exactly is GDP, and how do we measure an entire country’s income?
Definition of GDP
GDP, Gross Domestic Product, measures the total value of all final goods and services produced in the economy of a country during a given year. Important points that need special attention in the definition of GDP are ‘total,’ ‘final,’ ‘country,’ and ‘a given year.’
Let’s start with ‘total.’ There are multiple ways of measuring GDP, and the most common way is the expenditure approach. Basically, in order to calculate the gross domestic product, one must add up all the spendings that occurred in the given period. Why do we add expenditures when we’re looking for the total value of production? This is because when an economy produces goods and services, the products are always purchased by either the consumers, businesses, or the government. Therefore, it is safe to say that the expenditures will equal production.
Calculating the total value of expenditures is typically done through a simple equation: GDP = C + I + G + X – M. C stands for consumption, I for investment, G for government spending, X for exports, and M for imports. An example of consumption would be anything ranging from purchasing fruits at the grocery store to getting a new car—in essence, consumption is consumer spending. Consumption is typically the largest component in GDP. Investment is expenditures on plants and equipments by businesses, not consumers. This would include companies purchasing new machines to facilitate their production process. Government spending comprises the government’s expenditures on goods and services, such as purchasing weapons for the military. Lastly, exports and imports are how much a country sells its products to foreign markets and how much a country purchases products from foreign markets.
The next step in understanding GDP is the ‘final‘ part of its definition. When calculating the GDP, one must make sure that only the final products are taken into account. In other words, intermediate goods or services are not included. For example, when a cell phone company purchases steel for its production process, the expenditures on steel would not be calculated into GDP as the final product of the cell phone company is the cell phones, not steel. Intermediate goods or services are not included because the price of the final product incorporates all the intermediate prices.
Furthermore, as the name suggests, GDP measures only the domestic aspect of all expenditures—it is restricted into the production process within a particular country’s border. Let’s say an American company has its factories in China. Despite the company being the United States’ possession, because the factory’s production process takes place in China, the goods and services produced from the factory are not taken into account when calculating the U.S.’s GDP. On the other hand, it will be calculated into China’s GDP.
What GDP Measures
The final step is to understand how GDP measures the value of goods and services produced in only a given year. This indicates that secondhand sales will not be included in GDP. For example, when an art piece by Picasso gets sold in an auction, the purchase will not be calculated because the actual production of the piece was taken place years ago. There are exceptions, however. Rents, despite the actual house being produced years before, are included in the calculation of GDP. This is intended to prevent the GDP from discriminating tenant-occupied housing against owner-occupied housing.
So now we know what the GDP represents and how to find the GDP. The advantage of GDP is that we can assume the entire country’s income in just a few numbers. The disadvantage, however, is also the fact that the GDP only measures a country’s income in terms of numbers. Other than the financial facet, there are various other important values that must be taken into consideration when looking at a country. One of the most typical criticisms of GDP is that it doesn’t take pollution into consideration. In a time where global warming is getting more and more intense, noting the environmental costs of a country is also getting more and more important. This is why many economists often deny the fact that the GDP measures the ‘well-being’ of a country—it just isn’t enough. In short, although understanding the GDP and methods of measuring it is important, it is also crucial to realize the various flaws it holds and that the GDP does not always represent a holistic view of a country.
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Chappelow, Jim. “Gross Domestic Product—GDP.” Investopedia, 29 Apr. 2020, http://www.investopedia.com/terms/g/gdp.asp. Accessed 25 May 2020.
“Defining GDP.” Lumen, courses.lumenlearning.com/boundless-economics/chapter/measuring-output-using-gdp/. Accessed 25 May 2020.
“What is GDP?” Worldometer, http://www.worldometers.info/gdp/what-is-gdp/. Accessed 25 May 2020.
“Why Does GDP Include Imputations?” Bureau of Economic Analysis, 23 Apr. 2008, http://www.bea.gov/help/faq/488. Accessed 25 May 2020.
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