Definition: The total market value of the services and final goods formed within a nation’s boundaries in a financial year is known as a Gross Domestic Product (GDP). Gross Domestic Product is used to measure the comprehensive achievement of an economy.
Content: Gross Domestic Product (GDP)
- Factors of Gross Domestic Product
- Ways to calculate Gross Domestic Product
- Parts of Gross Domestic Product
- Explanatory Chart of Calculating Real and Nominal GDP
- Gross Domestic Product Deflator
- What is Inflation?
- Drawbacks of Gross Domestic Product
- Points to Remember
Factors of Gross Domestic Product
- Nominal GDP: Nominal GDP part the Gross Domestic Product based on the unadjusted price or valued on current prices, which means it takes into account the Inflationary/Deflationary effect. And therefore, it is not a better measure of economic growth.
- Real GDP: Real GDP is valued at a constant price; thus, it shows the Gross Domestic Product that adjusts for Inflation or Deflation.
Real GDP is a better indicator of economic growth or production because it does not take into account price effect but shows genuine production.
Ways to calculate Gross Domestic Product
- Income Approach
In this approach, we calculate the income earned by all the factors of production (Inputs which goes into producing final products).
Majorly there are four factors of production-
- Labour (includes wages earned by them)
- Land (Rent earned by the land)
- Capital (Return on capital in the form of interest)
- Management (Business profit earned by the management)
In India from 2015, we refer GDP market cost as India’s GDP, before that GDP factor cost was considered as GDP of India. The formula for Both the factors are as follows-
NFFI = Income earned by the rest of the world in this country minus(-) income earned by this country in the rest of the world.
- Expenditure Approach
The Sum of money spent on goods and services comes under the expenditure approach.
The formula for finding GDP with the following method is as follows-
C = Monetary value of consumption
I = Gross Investment
G = Acquisition of goods and services by the government.
X = Net exports produced within a nation during the year.
Parts of Gross Domestic Product
The flow of final products or evidently, as a flow of earning or incomes are the systematic ways to find GDP. It can be understood easily with the help of the above diagrammatical representation.
- In the upper curve, customers buy goods and services, and the total flow of money which they spend every year is one measure of GDP.
- The lower curve, shows the annual flow of output cost, the revenue that business pay-off in interest, wages, dividends, rent, profit.
Explanatory Chart of Calculating Real and Nominal GDP
|Production||20000 tonnes||24000 tonnes|
|Nominal GDP=||Current year production*Current year price=||24000*150=36,00,000|
|Real GDP=||Current year production*Base year price=||24000*100=24,00,000|
Calculation of percentage (%) increase in Real and Nominal GDP in the current year
- Last year production value = 20000 tones*100 rupees = 20,00,000
- Real GDP = 24000 tones*100rupees = 24,00,000 (% Increase (+) 20%)
- Nominal GDP = 24000*150 rupees = 36,00,000 (% Increase (+) 80%)
Gross Domestic Product Deflator
- The GDP deflator is also termed as the implicit deflator and is a measurement deflator of Inflation in the economy.
- It can be used to compare the performance of the two economies, and various investment decisions are taken with the help of GDP deflator.
- The government also uses it to draft their policies.
- The GDP deflator is a ratio from real to nominal GDP or visa-versa.
GDPN = GDP at Nominal price
GDPR = GDP at Real price
To understand it properly it is important to know
What is Inflation?
Inflation means the persistent rise in the prices of commodities in the market, and it can be of two types-
- Demand-Pull Inflation: It is an Inflation that usually happens because of aggregate demand,
i.e. when aggregate demand is higher than aggregate supply in the economy their will a deficit of commodities (Demand > supply), and it will be treated as demand-pull Inflation.
- Cost-Pull Inflation: Cost pull Inflation arises because of an increase or push in the cost of production, it increases Inflation because of which commodities in the market also become expensive and their market prices increase.
Drawbacks of Gross Domestic Product
- It does not include underground money; i.e. Black money floating in the market does not include in the calculation of the nation’s GDP.
- Non- Market production not measured as goods and services produced but not exchanged for money does not include in GDP calculation.
For Example: If you grow your food, its value will not include in GDP, but when you purchase or buy it from the market, it will include in GDP calculation.
- Calculation complexities and different ways of GDP calculations as the concept of GDP was introduced when the market was manufacturing-driven. But now- a- days majorly services driven expenditure calculating GDP has become a complex mechanism.
- Changes in quality may not be included in GDP because it is difficult to attribute the change in price to change in quality.
Points to Remember
- GDP comprises of two-factors, Nominal GDP and Real GDP.
- GDP can be calculated with two approaches one is the income approach, and the other is the expenditure approach.
- GDP only includes finished goods prices and not intermediate goods prices.
- Capital goods will be included in calculating GDP, irrespective of being intermediate goods.
GDP of a country includes a product and services produced within its boundaries; thus, the products manufactured in India and exported to other countries will be considered in calculating the nation’s GDP for the year.
Whereas; items imported from outside India will not be included in GDP calculations.