Gross domestic product (GDP) is a money related measure of the market price of all the products and services produced in a year. GCP is the overall measurement of a country’s economic condition. Along with the market value of goods and services it also includes the personal utilization, purchases made by the government, cost of the private warehouses, and the manufacturing costs. It also includes the foreign trading balance sheets from where the exports are added and the imports are removed.
The GDP of any country comprises of the total worth of the country’s production. It consists of the goods and services produced by various individuals, business concerns and the government within the country. GDP is generally presented on the basis of yearly percents.
Types of GDP measurements
There are various types of GDP measurements. They are:
- Nominal GDP which is the calculation of the unprocessed data.
- Real GDP which counts the effects of inflation and calls for the comparison for the economic output of a year to another year and other comparisons over a certain period of time.
- GDP growth rate is the increase in GDP from one quarter to the following quarter.
- GDP per capita which is the measurement of GDP per person. This is a very effective way to compare the GDP of one country with another.
How is GDP important for the investors?
Every investor keeps a constant eye on the growth of the GDP. This helps them a lot in making their decisions on asset assignment. They even compare the growth in GDP of various countries and take decisions about assigning their resources to stocks in the fast economically growing countries.
The Federal Reserve considers these economic growth rates and several other GDP statistics while deciding the type of monetary policies they should implement. If they find out that there is a slower rate of growth in the economy then they apply an expanded monetary policy to help the economic condition grow faster. If they find that there is a vigorous growth in the economic condition then they implement certain economic policies to slow down things so that there is no harmful effect of inflation.
Real GDP indicates the maximum about the condition of the economy of a country and if the statistics are released beforehand then they will be able to move the market. All the investors, economists, and the policymakers keep a constant watch on the current GDP.
The profits made by various corporate organizations and the inventory data in a GDP report are very helpful statistics for equity investors. Both of these attributes are very helpful in finding out the total growth of a country in a definite period of time. The profit data of various corporate organizations also shows the pre-tax profits made by them, the flow of cash in the organization and the proper break-ups of the various important sectors of the economy.
One of the major drawbacks of this data is that it does not maintain a proper time frame. The investors get the knowledge of the data in every quarter. The revisions are large enough to show the remarkable change in the percentage in GDP.
The Advantages of GDP
GDP is the widest measure of the economic growth and output of a country. Real GDP is very important for accounting inflation. It helps to take proper precautions so that inflation can be warded off. The GDP data of a country helps to fight inflation in comparison to various methods used in past incidents.
The Bureau of Economic Analysis releases various documents of analysis after every GDP release. This helps the investors to analyze the economic figures and market trends. This also helps them to extract the important data from the very big release on GDP.
Demerits of GDP
GDP is helpful in accounting and asset assignment but it has got some major demerits. The GDP data is not timely and is released in every quarter. Also, the revision of the data can remarkably change the historical figures.
The GDP figure does not include the underlying economy of a nation. The GDP calculation is entirely based on the official data of various organizations. Therefore there is no accounting of the underlying economy which can be relatively high in any nation.
In some cases, the value of GDP can also be far from perfection. In many cases, GNP (Gross National Product) is considered to be a more appropriate measure of calculation than GDP. GDP does not count the profit earned by a country from its foreign companies. Therefore this restrains from calculating the appropriate GDP.
How is GDP important for a country?
The GDP data can give a general idea of the economic condition of a country. The GDP is very beneficial for the policymakers and the various national banks in deciding whether the economic condition of the country is getting better or worse. It helps in deciding whether the economy needs to be uplifted or needs to be subdued. It also provides a clear signal that whether inflation is near the corner and if any precautions are needed to be taken.
The National Income and Product Accounts (NIPA) is behind the accounting of the GDP. The GDP data is always very helpful for the economists, policy makers and businessmen to take major decisions on various economic matters and tax-related issues. It also helps them to take feasible decisions during sudden bloom in the price of any essentials. Proper knowledge of the GDP figure and being well informed about the economic condition of the country has always been helpful in saving a business from perishing.
How can GDP be calculated?
GDP can be calculated employing two approaches; one is from the approach of the total expenses and the other is from the approach of the earnings. The expenditure approach implies the total money that is spent by a nation in a particular time span.
The earning approach is all about the total earning of the people of a nation in a specific time period. GDP calculated by this process is also called GDI (Gross Domestic Income). Income can be further categorized into five categories; they are salary and other additional income, profits of the corporate organizations, income from various interests, revenues and other miscellaneous income, the earning of the farmers, income from several other organizations. Both of the above procedures should yield the same output.
There is also a third method for calculating GDP. It is called the value-added process. It is used by the industries to calculate GDP.
The GDP calculated by expense approach gives the real and official value by adjusting the inflation if any. But on the other hand, the GDP calculated from the earning approach gives only the nominal value. Here the inflation cannot be determined. The expense based approach is more common in use and gives a relatively clearer idea.
The expense based GDP is calculated by adding the total utilization of resources with government expenditure, investments, and total exports.
It can be also explained as:
GDP= C+ I+ G+ (X-M)
Here, C stands for the total spending of the consumers,
I stand for the total business expenditure,
G stands for the expenses of the government,
X stands for the exports figure and
M stands for total imports.
Why does GDP vary?
No nation can maintain a constant GDP throughout. The GDP will sure vary from time to time. The GDP varies due to the business and its cycles. When there is a rise in the economy of the country, it also sees an increase in the figure of the GDP. In this situation there often comes a point when there builds the pressure of inflation. The labor capacity and the productivity limit gets almost full. At this point, the central bank has to invade by taking a rigid economic policy to reduce the over-rising economy and save the nation from major inflation which can lead to recession.
As the rate of interest gets high on various loans, the industries, and the consumers lower their rate of expenditure. This helps in slowing down the fast-growing economy of the nation. This slowing down process leads to the dismissal of employees which leads to the disturbance in the consumer’s demands. This is a very brutal cycle and needs to be addressed with maximum care.
The central bank lays some easier economic policies to encourage the economic growth of the nation. This is done until there is the repetition of the same situation once again. Hence the cycle is continued again and again.
The consumptions of the consumers contribute the maximum in the economic condition of a country. Therefore it is very important that these consumers’ confidence should be maintained as it has a lot to do with the economic rising of a country. If the consumers have a good amount of confidence in the economic condition then they will be more likely to spend a good amount of money. But if they lack in confidence then they will not be doing the same as they have no surety about the future.
The investment in businesses contributes to a major part of GDP calculation. The business investments increase the production volume and also raise employment. The expenditure of the government has also got some importance when the consumer expenditure and business investments see a sharp downfall. A perfect example of this situation is the after effects of a recession.
The use of GDP
Most of the countries issue the GDP figure monthly and quarterly. In the United States, the Bureau of Economic Analysis (BEA) releases an advance figure of the quarterly calculated GDP after 4 weeks from the end of a quarter. They issue the final figure of GDP after three months from the end of a quarter.
The effect of the GDP figure has got certain limitations as it is released much later from the end of a quarter. But it has a larger effect on the economic condition of the nation if there is a huge difference between the actual GDP figure and the expectation of the investors.
Tips to overcome drawbacks of GDP
Using of capability approach can be beneficial. It emphasizes on the functional abilities of the people residing in the country and not on the average wealth that is present within a nation.
Using the Human Development Index (HDI). It is a hint to the expectation of life on the birth of a child, literacy rate of adults, and the standard of living of the people. This can give a clear idea of the purchasing capacity of the people.
Using the method Index of Sustainable Economic Welfare (ISEW). Here several factors like the utilization of non-renewable resources, and the rate of degradation of the environment is taken into account.
There are various other methods that have been suggested by the famous economists of the world that can prove as a very important tool for calculating GDP. All these methods are effective and have been employed for a long time. All of them can be very helpful in maintaining the proper GDP figure of a county and protecting the country from any economic threat.
The GDP of a country also denotes its advancement in terms of economy. It denotes the clear economic size of the country. A country with a good GDP number is surely counted amongst the developing nations. It also motivates the investors to make good investments which can prove beneficial for the economic condition of the whole nation.
Professor Michelle Johnson has penned down this article which contains all necessary information about GDP. She has a degree in MBA and has been working with Harvard University for the past six years. She has profound knowledge in various subjects and her suggestions have always proved beneficial for students. She is a very proficient online tutor and provides good assistance to her students. If you need any kind of help then you can approach her anytime.