Gross Domestic Product (GDP)

<Last updated 14.04.2020>

Dear reader,

Hi! If you are interested in Economics, I’ve prepared the below to help your understanding abut economic indicators. You should take a look at this short article in which I explain what is Gross Domestic Product (GDP), one of the most important economic indicators.

The gross domestic product (GDP) is one of the primary indicators used to understand the health of a country’s economy. It represents the total value (i.e. in EUR) of all final goods and services produced over a specific time period. If we add all products produced from the 3 main production sectors of the economy, we can calculate the total  GDP value of the economy.

To calculate total production/output we have to add the quantity of all products. The problem is that adding quantity/number of i.e. “oranges” and “apples” has no meaning (10+10 =20 what is 20?)

GDP takes into consideration the market value of the products instead taking into consideration both price and quantity.

i.e. Quantities: 10 apples + 10 oranges       Prices: 1 apple price: 0.10 EUR, 1 orange price: 0.20 EUR

> GDP = (10 x 0.10 EUR) + (10 x 0.20 EUR) = 1 EUR + 2 EUR = 3 EUR = The total market value of 10 apples and 10 oranges.

GDP also takes into consideration the market value of the Final Goods and not the Intermediary Goods. Final goods are the goods and services bought by the end user and does not require any further processing. i.e. oranges (intermediate good) used to produce juice (final good).

While Intermediary Goods are the ones produced by a business and another business is buying them to use them as part of a final product or service.

Already used goods (resold) are not included (they were included in a previous period’s GDP).

Let’s see a comparison of GDP between countries just to get an idea of how big is an economy in terms of domestic production.

This economic indicator measures the market value of final goods produced within the geographical borders of a country for a specific period of time. This means that these goods and services were provided/sold within the country so people’s needs of that country were satisfied.

There are three approaches to GDP calculation: 1) Output approach 2) Income approach 3) Expenditures approach.

It does not matter which approach we use. We will get the same result.

a) Output Method: Sum of the value of all final goods and services produced/provided during a period. The sum is called domestic product.

i. The final value method: To calculate GDP we include only the vale of all final goods and services produced. The inventory (i.e. raw materials kept, final products) must be included in the value of final goods.

ii. Value added method: Difficult to implement, we need more data than just the ones from sales of final products.

Added Value =  Sales – (Inventory at start + Purchases – Inventory at the end of period)

b) Income Method: Sum of the income of all factors of production that are used in the production process for a period of time. The sum is called Domestic Income.

With the Income method we add up all income/payments for factors of production, that the owners of those factors earn for providing them to the production process (the data are taken from tax related documents).

This is net because dos not take into account depreciation, taxes and subsidies.

> To have equal amounts of output measure and income measure, we must add: > Depreciation + Indirect Tax – Subsidies

c) Expenditure Method: Sum of the expenditure used for acquiring all final goods and services produced produced/provided during a period. The sum is called domestic expenditure.

With the Expenditure Method we add up the expenditure done by households, businesses and the government for buying goods and services for a specific period of time.

Categories of Expenditure: a) Public Consumption (Government purchases) b) Private Consumption (households/consumer purchases for consumption)

GDP is of course related with Standard of Living but is not a good measure of it. There is household production not included in this metric and also the Underground Economy, both affecting people and the way they live their lives. Think about the  illegal economic activity for example, (includes drug dealing, trade in stolen goods, smuggling, illegal gambling etc.), not measured and affects lives, the standard of living > Any produced goods or provision of services resulting from these activities are not reported.

Quality of the Environment : the better the quality, the higher the standard of living. It is not included in GDP.

Life Expectancy and Good Health: These increase standard of living but they are not included in GDP measure.

“I hope I am clear on this one. If not, contact us on social media and we will do our best to help you.

Thank you for reading my articles and watching my videos.”

Marios Kyriakou