What is GDP?

GDP is computed as the total final value of goods and services produced within the boundaries of a specific region (e.g. a country) in a given period of time (e.g. a year). It is measured in terms of final value of the product after deducting the costs of intermediary goods (e.g. raw materials) used to produce the final product, so as to avoid double counting.

GDP is also referred as the size of the economy and is widely used to gauge the health of a country’s economic situation, as it gives a picture of consumption capacity of the country and also affects the level of employment.

How is GDP determined?

The calculation of GDP is a complicated process as recording every transaction in the economy is difficult to do, but there are three basic approaches to estimate it, namely the Product (output) Approach, the Income Approach and the Expenditure Approach. Logically, all these methods should have same result, as expense borne by one is an income for the other.

Production Approach GDP: In this method, GDP is calculated as,

[Gross Value of Output = Value of final output – Value of intermediary products]

The aggregate value of all the gross outputs in the country is called as GDP at Factor Cost. When indirect taxes (e.g. excise duty) on the product are added and subsidies are subtracted, we get GDP at Market Price.

Income Approach GDP: Income approach comprises of the income generated within the domestic economy. It is measured as,

[GDP (I) = Salaries and wages to employees + other benefits to employees + Surplus Profits of firms + Indirect Taxes – Subsides + Interest on Capital + rent on land + depreciation]

This is called GDP at Market Price. If you remove Indirect Taxes and add back subsides than we can get GDP at Factor Cost.

Expenditure Approach GDP: This is the most widely used approach to estimate GDP and is measured as,

[GDP = Consumption + Investments + Govt. Spending + Exports – Imports]

Where,

Consumption comprises of total final value of the goods and services consumed (expensed) by domestic household in the given period of time. It includes durable and non‐ durables products such as food, clothing, computers, fuel, internet, movie tickets, purchase of house, etc. But, it does not include used items. Investments comprises of investment done by private businesses. It comprises of investments done in fixed assets like machinery & equipment, land, etc. but does not include investments in financial products like equity, debenture or fixed deposits. When the firm in which one has bought equity or debenture, invests in a fixed asset, that time it will be counted as an investments and will get added up in the GDP.

Govt. Spending includes expenditure done on salaries to public servants (e.g. MPs), on infrastructure, on subsidies, on purchase of military equipment, etc. but it does not include interest payments or grants given by Govt. Net Exports is Exports minus Imports and comprises of all the goods and services traded with other countries.

The relevance of this break‐up of GDP is that, it helps in understanding the structure of an economy. Private Consumption forms the largest part of the GDP and it also shows the amount of disposable income lying in the economy. Increasing the Private Consumption is always the target for policy makers of welfare economy. Analysis of Investment (Capital Formation) will help in knowing the growth of the economy as today’s investment helps to meet future consumption. Govt. spending on constructive items too helps to boost the GDP. Net Exports, if positive, reflects good productivity of the people living in the country which can produce more than the domestic needs and the surplus can be exported to other countries, thus it adds to the GDP. While, Net Exports if negative, shows higher imports and dependency on other countries for domestic consumption.