Gross Domestic Product, its importance, calculation and other basics
Gross Domestic Product, its importance, calculation and other basics
Gross domestic product is a term used in macroeconomics to measure the total of finished goods and services produced in a country during a period usually a year. Those things which are produced in the country are counted in GDP. Things like remittance and other things which are earned from other countries are not taken into consideration while calculating GDP. It is the most important indicator which tells about the economy of a country. It incorporates several other indicators as well like retail sales, personal consumptions, etc. II. Body A.
Four parts that make up Gross Domestic Product The main components of GDP are consumption, investment accounts, spending and net exports. GDP can be calculated in three different approaches, product approach, expenditure approach and income approach. Product approach is considered to be the most direct approach in which all outputs are summed up. While the expenditure approach follows this equation: GDP = C+I+S+NE. The assumption made in this equation is that all organizations produce things or services which can be consumed by the users and is a source of investment for the organization.
This equation also implies that the organization follow the supply and demand trends in the market. The income approach implies the principle that the income of the producers must be equal to that of their products. • Consumption Consumption is the purchase of goods or services by the consumers. Consumption can be of three types, durable goods, non durable goods and services. Durable goods are those good which last for a long time. They are also considered as consumer investments even. Those goods which come under the head of durable goods are automobiles, refrigerator, etc.
These types of goods are bought with the intention of retaining them for a long time thus are known as durable goods. Non durable goods are those goods which have a comparatively short life time than that of durable goods. They could be newspapers, grocery, etc. Services are intangible things. Things which can be classified as a service are medical treatment, teaching, etc. • Investment accounts Investment is the purchase of purchase of things which are used in the production. They can also be classified into three group, business investment, residential construction and inventories.
Anything that helps in the process of production comes under business investment. For example, machinery, office, plant, etc. It is the gross amount of investment that counts. Basically it subtracts the depreciation value from the value of the asset. Those assets which are replaced with the new ones, if they don’t produce any improvement in the outputs then they contribute nothing in addition to the country’s economy. Residential construction relates to the building of new houses in a period (year). Those houses which are already been constructed and are held for resale have already contributed in the GDP thus they won’t be included again.
Inventories are stocked in anticipation of future sales. Changes in inventories contribute or affect the economy of a country. They are considered to be a small part that contributes to the GDP but changes in them can have great changes in the economy. For example when the inventory level increases the desired level then there may be a slowdown and producers might reduce their outputs. • Government spending The government spending relates to all the items the government spends on with exception of interest paid on the debts and government transfers.
Government spending mostly includes those items which are rarely sold in the market like space shuttles, aircrafts, etc. These items bear a large price that is why government pays for them (Kaplan). • Net exports A net export is the difference between the total exports and imports of a country. When the exports exceed the imports, it is known as surplus export. While export deficit occurs when the imports increase from the export and when both export and import are equal it is a trade balance (Barnaby). B. Cross-border comparison
As different countries have different currencies it is difficult to compare the GDPs in the respective countries currencies. For example comparing GDP of US in dollars with the GDP of India in Rupees would give a false reflection and therefore in order to have a correct comparison they are converted into national currency through current exchange rate or by purchasing power parity. • Current currency exchange rates Current exchange rates are the international rates of the currency. It gives a better indication of the country’s international purchasing power and its growth.
• Purchasing power parity exchange rates Purchasing power parity exchange rates are those in which currency is purchasing power parity compared with that of a standard one which is usually US dollars. Non traded goods usually make use of this method rather than current currency exchange rate. It relates to prices of particular goods in the country and abroad. Therefore it can be misleading while considering the comparison of GDPs of countries due to different inflation rates, depreciation rate, etc. Mostly those countries which are less developed make use of this method to compare their GDPs.
Therefore it differentiates between the high and low income countries and doesn’t forms a just comparison. C. Standards of living and GDP Standard of living can be calculated through a per capita GDP approach. There are advantages and disadvantages of calculating standard of living this way. As most of the countries on quarterly basis provide information to the authorities for calculating GDP, trends can be spotted through them on a regular basis. Most of the indicators used in GDP are widely used by other countries even therefore comparison becomes easy.
The calculation of GDP is done on yearly basis that means it gives a consistent way. GDP per capita is not a very good way of calculating standard of living as it varies due to several reasons which GDP per capita might not take into account. For example a country with high exports and almost no imports would have a high GDP but a poor standard of living. Therefore GDP per capita should not be considered as the main indicator of standard of living, but just a way to it. As the standard of living increase, GDP per capita also increases. III. Conclusion To assess the effectiveness of a country’s economy GDP is widely used.
But using GDP to calculate the standard of living proved a limited result. GDP does not take the wealth distribution into account which might mislead while judging the economy of a country. It doesn’t account for the inequality of the wealth. All those activities which do not occur through a market are excluded by GDP. All those activities which are free or as a volunteer are counted amongst those activities. Not counting these activities would be an understatement in the GDP. Even if the services are provided for free but there must have been a cost to provide the services.
Therefore if they don’t contribute toward the GDP most of the organization would move towards free services rather than providing them on money. Another form of understatement of GDP is when those transactions which are illegal or tax avoiding activities are not taken into account. Barter system is also ignored in the calculation of GDP. Barter system is a very common system followed nowadays even through which people might exchange goods or services without any dealing of money. The improvement in products and quality are even those amongst the ignored items in GDP which does not reflect the real economic growth of a country.
Computers have become more advanced but less expensive GDP will treat them as the old computers used in the past, rather than considering its worth. GDP rakes into account few things which should not be taken like the cost of rebuilding after an earthquake which might boost the GDP but would provide an unrealistic way to judge the country’s economic growth. Only those things which are economically ‘good’ are reflected in the calculation of GDP while the bad ones are excluded. All those negative effects to the environment which might be due to the production are ignored which is a bias way.
Some of the things are sometimes included in GDP like cleaning up of oil spills and etc. GDP does not project the economy of a country but it just measures the economic activity. Therefore it cannot calculate the sustainable growth of a country. There are several ways a country can achieve a high GDP for a time being, for example by excessive use of natural resources, etc. But it can be very costly to pay back after if the natural resources are used badly (mistreated). As value of money changes with time comparing or determining the growth in different sorts of goods can be a difficult task to perform.
While comparison of a country’s economy is done by other countries they can give inaccurate results as they might not take the local differences like change in quality, content, etc not into account which might not be a just form of judgment. There are many other limitations of using GDP to judge the economy of a country (Jackson,p63). Although GDP is a way to measure the market value of a country’s finished goods and services it should not be the key indicator to provide information about a country’s economy. It gives a rather flawed and biased way to compare things domestically as well as internationally.
A country’s economy should be judged on its ability to provide the people of the country with what they need and what their basic necessities are, some of the basic necessities might include food, shelter, clothing, better place to live in, etc. Therefore things which are not included in the judging the standard of living should be considered. With a combination of indicators which can judge the conditions of the country environmentally as well as in terms of living and financial ways should be used as a way to judge the effectiveness of a country should be taken into consideration rather than just the use of GDP.
Word Cited Page Barnaby, Meins. How the GDP is calculated and what it does not count. 2010, 5 May 2010, < http://www. helium. com/items/1284362-the-gdp-how-the-gdp-is-calculated-and-what-it-does-not-count> Jackson, Tim. Prosperity without Growth: Economics for a Finite Planet, Earthscan Publications Ltd. 1 edition, 2009 Kaplan, Jay, Components of GDP. 1999, 5 May 2010, < http://www. colorado. edu/Economics/courses/econ2020/se