Measuring GDP
From Wikipedia, the free encyclopedia
Gross domestic product, GDP, is defined as the total value of all goods and services produced within that territory during a given year. GDP is designed to measure the market value of production that flows through the economy.
- Includes only goods and services purchased by their final users, so GDP measures final production.
- Counts only the goods and services produced within the country's borders during the year, whether by citizens or foreigners.
- Excludes financial transactions and transfer payments since they do not represent current production.
- Measures both output and income, which are equal.
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[edit] Distinguish between GDP and Gross National product GNP
GDP differs from Gross National Product (GNP), in excludng inter-country income transfers, in effect attributing to a territory the product generated within it rather than the incomes received in it. Essentially, GDP = GNP - NFP (net factor payments).
[edit] Real GDP and Nominal GDP
Nominal GDP measures the value of output during a given year using the prices prevailing during that year. Over time, the general level of prices rise due to inflation, leading to an increase in nominal GDP even if the volume of goods and services produced is unchanged.
Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation. For example, if both the "nominal GDP" and price level doubled between 1995 and 2005, the "real GDP " would remain the same. For year over year GDP growth, "real GDP" is usually used as it gives a more accurate view of the economy.
[edit] Relation between Real GDP and Nominal GDP
Nominal GDP is calculated using current prices whereas real GDP uses constant prices. The difference between the nominal GDP and real GDP is due to the inflation rate in market. The relationship between inflation, real GDP and nominal GDP is explained by Fisher Equation.
Real GDP = Nominal GDP - Inflation
A simple example:
Our simplistic economy only produces apples and pears. The price for an apple is $2 in 2000, whereas the price for a pear is $3. Same year we produce 100 apples and 50 pears. In 2005, because of the inflation the price for an apple goes up to $3, whereas the price for a pear is $4 at the same production levels.
The nominal GDP in 2000 is $350 and the nominal GDP in 2005 is $500. However real GDP did not change, because real GDP only changes with the changing production level and therefore is a better size measure for economy.
[edit] 2 approaches to measuring GDP
1. Adding up total expenditures. (Consumption goods and services + Investments + Government Purchases + Exports - Imports)
2. Adding up total income The GDP is calculated this way by adding up the factor incomes to the factors of production in the society. These include
Wages and Salaries (factor - labour) +Interest Payments (factor - capital) +Business profits (factor - enterprise - the payoffs for taking on business risk) +Rent (factor - land) +Taxes less subsidies (since if there were no taxes, the amounts would be counted at income (for labour) or profits (for enterprises/businesses).
There is a comprehensive explanation at the main GDP site
[edit] Distinguish between the GDP deflator and the consumer price index
You have a third approach, which is Output approach: GDP = Total Value Added of all
[edit] The major limitations of GDP
- Doesn't measure quality of life.
- Doesn't measure standard of living.
- Price changes.
