Gross domestic product


Gross domestic product is a monetary measure of the total market value of all of the final goods and services which are produced and rendered during a specific period of time by a country or countries. GDP is often used to measure the economic activity of a country or region. The major components of GDP are consumption, government spending, net exports, and investment. Changing any of these factors can increase the size of the economy. For example, population growth through mass immigration can raise consumption and demand for public services, thereby contributing to GDP growth. However, GDP is not a measure of overall standard of living or well-being, as it does not account for how income is distributed among the population. A country may rank high in GDP but still experience jobless growth depending on its planned economic structure and strategies. Dividing total GDP by the population gives an idealized rough measure of GDP per capita. Several national and international economic organizations, such as the OECD and the International Monetary Fund, maintain their own definitions of GDP.
GDP is often used as a metric for international comparisons as well as a broad measure of economic progress. It serves as a statistical indicator of national development and progress. Total GDP can also be broken down into the contribution of each industry or sector of the economy. Nominal GDP is useful when comparing national economies on the international market using current exchange rate. To compare economies over time inflation can be adjusted by comparing real instead of nominal values. For cross-country comparisons, GDP figures are often adjusted for differences in the cost of living using purchasing power parity. GDP per capita at purchasing power parity can be useful for comparing living standards between nations.
GDP has been criticized for leaving out key externalities, such as resource extraction, environmental impact and unpaid domestic work. Alternative economic indicators such as doughnut economics use other measures, such as the Human Development Index or Better Life Index, as better approaches to measuring the effect of the economy on human development and well-being.

History

Sir William Petty came up with a concept of GDP, to calculate the tax burden, and argue landlords were unfairly taxed during warfare between the Dutch and the English between 1652 and 1674. Charles Davenant developed the method further in 1695.
The modern concept of GDP was first developed by Simon Kuznets for a 1934 U.S. Congress report, where he warned against its use as a measure of welfare. After the Bretton Woods Conference in 1944, GDP became the main tool for measuring a country's economy. At that time gross national product was the preferred estimate, which differed from GDP in that it measured production by a country's citizens at home and abroad rather than its "resident institutional units". The switch from GNP to GDP in the United States occurred in 1991. The role that measurements of GDP played in World War II was crucial to the subsequent political acceptance of GDP values as indicators of national development and progress. A crucial role was played here by the U.S. Department of Commerce under Milton Gilbert where ideas from Kuznets were embedded into institutions.
The history of the concept of GDP should be distinguished from the history of changes in many ways of estimating it. The value added by firms is relatively easy to calculate from their accounts, but the value added by the public sector, by financial industries, and by intangible asset creation is more complex. These activities are increasingly important in developed economies, and the international conventions governing their estimation and their inclusion or exclusion in GDP regularly change in an attempt to keep up with industrial advances. In the words of one academic economist, "The actual number for GDP is, therefore, the product of a vast patchwork of statistics and a complicated set of processes carried out on the raw data to fit them to the conceptual framework."
China officially adopted GDP in 1993 as its indicator of economic performance. Previously, China had relied on a Marxist-inspired national accounting system.

Determining gross domestic product (GDP)

GDP can be determined in three ways, all of which should, theoretically, give the same result. They are the production approach, the income approach, and the speculated expenditure approach. It is representative of the total output and income within an economy.
The most direct of the three is the production approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the products must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

Production approach

Also known as the Value Added Approach, it calculates how much value is contributed at each stage of production.
This approach mirrors the OECD definition given above.
  1. Estimate the gross value of domestic output out of the many various economic activities;
  2. Determine the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services.
  3. Deduct intermediate consumption from gross value to obtain the gross value added.
Gross value added = gross value of output – value of intermediate consumption.
Value of output = value of the total sales of goods and services plus the value of changes in the inventory.
The sum of the gross value added in the various economic activities is known as "GDP at factor cost".
GDP at factor cost plus indirect taxes less subsidies on products = "GDP at producer price".
For measuring the output of domestic product, economic activities are classified into various sectors. After classifying economic activities, the output of each sector is calculated by any of the following two methods:
  1. By multiplying the output of each sector by their respective market price and adding them together
  2. By collecting data on gross sales and inventories from the records of companies and adding them together
The value of output of all sectors is then added to get the gross value of output at factor cost. Subtracting each sector's intermediate consumption from gross output value gives the GVA at factor cost. Adding indirect tax minus subsidies to GVA at factor cost gives the "GVA at producer prices".

Income approach

The second way of estimating GDP is to use "the sum of primary incomes distributed by resident producer units".
If GDP is calculated this way it is sometimes called gross domestic income, or GDP. GDI should provide the same amount as the expenditure method described later. By definition, GDI is equal to GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.
This method measures GDP by adding incomes that firms pay households for factors of production they hire – wages for labour, interest for capital, rent for land and profits for entrepreneurship.
The US "National Income and Product Accounts" divide incomes into five categories:
  1. Wages, salaries, and supplementary labor income
  2. Corporate profits
  3. Interest and miscellaneous investment income
  4. Income earned by sole proprietors and from the Housing subsector
  5. Net income from transfer payments from businesses
These five income components sum to net domestic income at factor cost.
Two adjustments must be made to get GDP:
  1. Taxes on production and imports minus subsidies are added to get from factor cost to market prices.
  2. Depreciation is added to get from net domestic product to gross domestic product.
Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is:
  • Compensation of employees measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.
  • Gross operating surplus is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.
  • Gross mixed income is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.
The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor prices. The difference between basic prices and final prices is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP at final prices.
Total factor income is also sometimes expressed as:

Expenditure approach

The third way to estimate GDP is to calculate the sum of the final uses of goods and services measured in purchasers' prices.
Market goods that are produced are purchased by someone. In the case where a good is produced and unsold, the standard accounting convention is that the producer has bought the good from themselves. Therefore, measuring the total expenditure used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP.

Components of GDP by expenditure

GDP is the sum of consumption , investment , government expenditures and net exports .
Here is a description of each GDP component:
  • C is normally the largest GDP component in the economy, consisting of private expenditures in the economy. These personal expenditures fall under one of the following categories: durable goods, nondurable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses, but not the purchase of new housing.
  • I includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include the construction of a new mine, the purchase of software, or the purchase of machinery and equipment for a factory. Spending by households on new houses is also included in investment. In contrast to its colloquial meaning, "investment" in GDP does not mean purchases related to financial investments. Buying financial products is classed as 'saving', as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to build a plant, purchase equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or companies' equity shares is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products; buying an existing building will involve a positive investment by the buyer and a negative investment by the seller, netting to zero overall investment.
  • G is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchases of weapons for the military and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits. Analyses outside the US will often treat government investment as part of investment rather than government spending.
  • X represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.
  • M represents gross imports. Imports are subtracted since imported goods will be included in the terms C, I, and G, and must be deducted to avoid counting foreign supply as domestic.
C, I, and G are expenditures on final goods and services; expenditures on intermediate goods and services do not count. So for example if a car manufacturer buys auto parts, assembles the car and sells it, only the final car sold is counted towards the GDP. Meanwhile, if a person buys replacement auto parts to install them on their car, those are counted towards the GDP.
According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, "In general, the source data for the expenditures components are considered more reliable than those for the income components ."
Encyclopedia Britannica records an alternate way of measuring exports minus imports: notating it as the single variable NX.