GDP is a term which is a short form of ‘gross domestic product’ and it is a way to measure the strength of an economy. Every country calculates the GDP annually using different formulas and procedures to know the progress or downfall of the economy. If the GDP rises every year, it is said that the economy is progressing but if it is falling, it gives warning to the government to work for the improvement of GDP.
GDP is basically the valuation of the amount of goods and services produced in the country domestically in monetary terms. It is a very important term of economics, and a positive, or negative change in GDP has a direct impact on the economy. If the GDP of the country is rising, it means the domestic production is increasing which means more employment, increased spending and increase in economic growth. On the other hand, falling GDP means low domestic production, increased unemployment and reduced spending in the economy. Therefore, every government works hard to improve the GDP of the country as it indicates how well the country is performing. There are two forms of GDP namely nominal GDP and real GDP. Nominal GDP measures the value of goods and services at current market prices whereas real GDP measures the value using the base year price (Fleurbaey, 2013). Real GDP gives the clearer picture to the economy compared to nominal GDP as it evaluates the effect of inflation.
There are three ways to measure the GDP of the country namely Expenditure method, Income method and Production method. In expenditure method, as the name suggests; the market value of all the domestic expenditure that is made on the goods and services is added to get the final figure. These include net exports of the country, net investments on the production of goods and services, the expenditure made by government and the consumption expenditure.
In the income method, the incomes of all the people are summed up who have earned from the production of domestic goods and services (Slavin, 2008). These include the firms which are involved in the production and the employees of the firm. The figures in the income method are wages of the employees, profits earned by stockholders and owner of the firm and rents. Income earned through interests is also added to get an accurate figure of GDP.
In the production method, value added method is most preferred for the calculation as there is a chance of double counting in the production method. To avoid adding the value of product twice, once in the intermediate stage and again in the final stage; economist add the total market value of all goods and services to measure GDP.
Although all three methods are correct ways to measure GDP, but the most known and used method to calculate GDP is expenditure method. Roughly, the answer from three evaluations is the same but the most accurate GDP figure derives from the expenditure method.
Whichever method the country uses to measure its GDP, the fact is it holds great significance in the economy mainly because it tells the worth of the country. It helps the economy realize whether it is prospering or declining and if it is going on the darker side; immediate measures are taken for its rectification. Moreover, GDP also acts as a tool to set the monthly interest rate for all the banks.
Fleurbaey, M., & Blanchet, D. (2013). Beyond GDP: Measuring welfare and assessing sustainability. Oxford: Oxford University Press.
Slavin, S. (2008). Economics (8th ed.). Boston, Mass.: McGraw-Hill.