Posted in Finance Articles, Total Reads: 5629
, Published on 30 October 2010
Gross Domestic Product is the total market value of all goods and services produced in the country in a particular year. It is equal to total consumer, investment and government spending, plus the value of exports and minus the value of imports.
GDP can be measured in mainly two ways
In this approach it is assumed that most of the things that are produced are for sale and hence are sold. Therefore if we measure the total expenditure of money in buying things, it can be equated to a way of measuring production. This is known as the expenditure method of calculation of GDP.
It is calculated as follows
GDP = Consumption + Investment + Government Spending + (Exports – Imports)
Consumption: It forms the largest component and is the private household final expenditure. E.g., personal expenditure could be categorized into durable, non durable goods and services such as food, rent, jewellery etc.
Investment: It includes business investments involving the acquisition of assets but not exchange of assets. E.g., construction of new factory, purchase of software, purchase of equipment for the factory etc.
Government Spending: It is the sum of government expenditure on goods and services. e.g., salaries to government employees, defence expenditure etc.
Exports & Imports: represent the gross exports and imports.
In this method, the GDP is the measure of the total income. It is usually referred to as GDP(I). However the GDP calculated from both the income as well as the expenditure approach should be the same.
It is calculated as follows
GDP = Compensation of Employees + gross operating surplus + gross mixed income + taxes less subsidies on production and imports
Compensation of Employees is the total remuneration to the employees for performing a work.
Gross Operating surplus is the surplus due to the owners of incorporated business
Gross Mixed income is same as gross operating surplus but it takes into consideration unincorporated business.
The sum of the above three is called the factor income i.e., income of all the factors of production in the society.
Limitations of GDP
•GDP does not take into account the disparity in the income of the rich and the poor.
•GDP omits the underground economy and thereby causing the GDP to be underestimated
•GDP does not consider activities that are not provided through the market such as household production, volunteer and thereby causing the GDP to be understated.
•GDP would be understated in economies where money does into play at all. This is usually seen in economies where major transactions take place informally or where there is existence of barter system.
•GDP ignores externalities or damage done to the environment. So in a way we are counting goods produced but not considering negative effects of higher production and thereby overstating the GDP.
•GDP ignores subsistence production
Alternatives to GDP
•Human Development Index: which takes into account other factors such as life expectancy and education levels
•Gini Coefficient: which measures the disparity of income within a country
•Gross National Happiness: which measures the quality of life or social progress in a more holistic manner than the GDP
•Wealth Estimates: method of combining monetary wealth with intangible wealth and environmental capital
Top 10 countries in terms of GDP as per IMF (for year 2009)
India is 11th largest in the world in terms of GDP numbers.
Importance of GDP
GDP which represents economic production and growth has an impact on everyone in the economy. A healthy economy will mean lower unemployment and wage increases because business need labour to fulfil the needs of the economy. On the other hand a bad economy would be typically lower profits and low stock prices. Investors usually keep track of the GDP and worry about the negative GDP growth because this is one of the measures used in determining whether a economy is in recession or not.
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