GDP or Gross Domestic Product is one of the most overused term we come across while understanding the economy of a nation. As a basic definition, GDP is the final market value of all the goods and services produced in the nation during a given period of time usually a year. It is also referred to the size of the economy.
For GDP, “gross” means that a product which is made and is included in the GDP of a country can be used for different purposes like consumption now, saving and investment for future or for replacement of assets. Further, by domestic we mean that measurement is only limited to a nation’s borders.
If we go deeper into the generic definitions, some key characteristics come to light. The word “final” is a very important term in that sense. GDP only includes products which are completed and are sold to others and are not used as intermediate material for producing other goods. This is to avoid double counting as the value of the final good includes the value of all its intermediate goods. Further, the word “market” describes the value derived after selling the product in the market. Finally, it is calculated for a given period of time, a year or a quarter. This way the number obtained can be compared to other quarters to gauge the growth. If we combine all these values of all products made in a country, we get a fair idea of the health of the economy of the country.
Difference between GDP and GNP
GNP or Gross national product is similar concept as that of GDP albeit with one very important difference. It measures the level of production of a country but without the geographic limitation as imposed by the GDP. This means that while GDP measures production of goods within the physical borders of the country, GNP can refer to anyone who is citizen or an incorporated company of a nation to produce goods anywhere in the world. For example, an Indian citizen or an Indian-owned entity can produce goods both at home and abroad and this will still be counted as a part of India’s GNP but will only be included in the GDP if the production is taking place within India. This way GNP defines the economy in terms of citizenships.
GNP can be greater or lower than GDP depending upon the ratio of the country’s domestic to foreign manufacturers. India’s GNP is less than GDP due to large number of foreign companies manufacturing the goods in the country which form a part of GDP (goods produced in the country) but not of GNP (foreign manufacturers). Similarly, China’s GDP is also significantly larger than their GNP. On the other hand, however, USA’s GNP is higher than their GDP due to large amounts of productions that takes place outside the country.
Although it is important to refer both GDP and GNP while discussing the state of the economy, GDP over the years has become more relevant and reliable measure. Due to world becoming more interconnected today, it is easy for a person to sell to multiple countries via the internet. This creates accounting issues while calculating GNP.
Given the definition, can the GDP figure only be interpreted as a count of all goods produced in the country? Not necessarily so. At this point it is important to know the difference between Nominal and Real GDP and what the respective term means.
Nominal GDP takes into account both the price and quantity produced during a year. So, if in one particular year the prices increase, the GDP will show growth even if the quantity remains the same. On the other hand, GDP in real terms takes into account the inflation or the increases in prices and adjusts it to provide the final number. This adjustment makes sure that the GDP thus calculated only reflects the increase in the quantity of goods produced. This way economists can compare real growth on a year-on-year basis keeping the price level same as previous reference year also known as the base year. In most cases, the real GDP is regarded as the true measure of the purchasing power of the nation. Nominal GDP, on the other hand, will be a larger number (due to inflation being positive in most cases) and is not a true reflection of the economy as a higher figure could be due to high prices and not higher quantity.
For example, India ranks 6th in terms of nominal GDP and 3rd in terms on purchasing power or real GDP. A GDP deflator can also be used to calculate the price inflation in a country. The figure is arrived at by dividing the nominal GDP with real GDP and multiplying by 100. This will give us a measure of price inflation/ deflation with respect to a specific base year. Further, the best way to compare the GDPs of two nations is to divide the GDP figure by the respective populations of the nation. The resulting figure arrived at is known as GDP per capita and is a heavily relied upon number while making comparisons between countries.
GDP is an important figure or the business in the country which gives them a fair idea of how much to produce and when to limit the production. Similarly, investors keep a close watch on GDP figures and the accompanying data on profits of businesses as well as inventory figures. A rapidly decreasing inventory and increasing profits can be interpreted a sign of good growth as consumer demand is on the rise. Consumer spending in fact is the largest component of the economy. Hence, a rise in quantity of goods sold is a sign of boosting confidence as the consumers have enough money and are willing to spend. Business investment is another important component of GDP. Higher investment is sign of investor confidence and helps increase productivity and boosts employment. Government spending and investment on infrastructure, also has a direct impact on the nation’s economy.
GDP Calculations
There are primarily two approaches to calculating the GDP: The income approach and the expenditure approach. The income approach, also referred to as GDP (I), is calculated by adding up the compensations or incomes earned by the employees, the profits earned by business and the government’s income in the form of taxes less any subsidies given to businesses. This is also known as GDP at factor cost as the value of the good produced is based on the costs of the factors of production or inputs such as Land (wages), Labor (Rent) and Capital (profits).
The expenditure approach is the more common one and is often used to explain to people. It essentially divides the GDP into 4 components namely, Consumer spending (C), private investment (I), government expenditure (G) and net exports (exports - Imports) (X-M). The figure arrived at after adding all these components is regarded as the GDP of the nation. The following equation is often used to calculate the GDP:
GDP = C + I + G + (X – M)
How is GDP calculated in India?
Most nations release GDP figures every month or quarter. In India, the gathering of data and record keeping responsibilities rest with The Central Statistics Office (CSO). Their other responsibilities entail conducting survey of various industries and compiling indices such as the consumer price index. For this they coordinate with various state and central agencies specially to gather data points. Once the data, is collected, GDP is calculated using two methods. The first method uses factor cost (the cost of inputs of production) and second is based on the market price (or the selling price). Further calculations are made to provide figures on nominal and real GDP as well. Among these, the GDP figure, based on factor cost is the most relied upon in the country. The figures are available every quarter and the final figures are given at May 31 with lag of two months.
Conclusion
GDP to this day remains an important number to gauge the health of the nation even though it fails to account a number of factors such as health, distribution of wealth, discrimination and other constituent factors of public welfare. Other criticism of GDP points towards not accounting for unpaid services such as child care as well as ignoring the associated environmental costs. Some believe that despite these shortcomings there is a direct correlation between higher GDP and a rise in employment. It is no doubt that an increasing GDP gives a boost of confidence in the nation, hence the specific campaigns such as ‘Make in India’ and policies to attract FDI are encouraged in our country. GDP can have an impact on your personal lives as well. A period of slow growth often leads to unemployment as there are layoffs due to lesser profits. Further, it is often advised to look for jobs in the rapidly growing sectors. Therefore, it comes as no surprise that increasing efforts are made to improve the GDP accuracy and specificity and its importance will only grow in the near future.
- Kartik Kukreja
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