Measuring GDP

Gross domestic product, GDP, is defined as the total value of all goods and services produced within that territory during a given year. GDP is designed to measure the market value of production that flows through the economy.

• Includes only goods and services purchased by their final users, so GDP measures final production.
• Counts only the goods and services produced within the country's borders during the year, whether by citizens or foreigners.
• Excludes financial transactions and transfer payments since they do not represent current production.
• Measures both output and income, which are equal.

Distinguish between GDP and Gross National product GNP

GDP differs from Gross National Product (GNP), in excluding inter-country income transfers, in effect attributing to a territory the product generated within it rather than the incomes received in it. Essentially, GDP = GNP - NFP (net factor payments).

Real GDP and Nominal GDP

Nominal GDP measures the value of output during a given year using the prices prevailing during that year. Over time, the general level of prices rise due to inflation, leading to an increase in nominal GDP even if the volume of goods and services produced is unchanged.

Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation. For example, if both the "nominal GDP" and price level doubled between 1995 and 2005, the "real GDP " would remain the same. For year over year GDP growth, "real GDP" is usually used as it gives a more accurate view of the economy.

Relation between Real GDP and Nominal GDP

Real GDP is calculated using constant prices whereas nominal GDP uses current prices.[1] The difference between the nominal GDP and real GDP is due to the inflation rate in market.

A simple example:

Our simplistic economy only produces apples and pears. The price for an apple is $2 in 2000, whereas the price for a pear is $3. Same year we produce 100 apples and 50 pears. In 2005, because of the inflation the price for an apple goes up to $3, whereas the price for a pear is $4 at the same production levels.

The nominal GDP in 2000 is ($200 + $150)= $350 and the nominal GDP in 2005 is ($300 + $200) = $500. However real GDP did not change, because real GDP only changes with the changing production level and therefore is a better size measure for economy.

Three Approaches to Measuring GDP

1. Expenditures Approach:

The total spending on all final goods and services (Consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) - Imports (M))

GDP = C + I + G + (X-M)

2. Income approach (NY = National Income)

Using the Income Approach GDP is calculated by adding up the factor incomes to the factors of production in the society. These include

National Income (NY) + Indirect Business Taxes (IBT) + Capital Consumption Allowance and Depreciation (CCA) + Net Factor Payments to the rest of the world (NFP)

In this approach,

NY = Employee compensation + Corporate profits + Proprietor's Income + Rental income + Net Interest

CCA = Igross + Inet (I= Investment)

NFP = Payments of factor income to the ROW minus the receipt of factor income from the rest of the world.

Thus,

GDP - NFP = GNP （GROSS NATIONAL PRODUCT)

GNP - CCA = NNP ( NET NATIONAL PRODUCT)

NNP - IBT = NY (NATIONAL INCOME)

3. Value added Approach:

The value of sales of goods - purchase of intermediate goods to produce the goods sold.

Distinguish between the GDP deflator and the consumer price index

1. The GDP deflator measures a changing basket of commodities while CPI always indicates the price of a fixed representative basket.

2. GDP deflator frequently changes weights while CPI is revised very infrequently.

3. CPI will consider imported goods because they are still considered as consumer goods while GDP deflator will only contain prices of domestic goods.

Read more: Difference Between CPI and GDP Deflator | Difference Between | CPI vs GDP Deflator http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-gdp-deflator/#ixzz15VVahfFH

The major limitations of GDP

The GDP fails to measure or express changes in a nation's:

• Quality of life

• Unpaid labour

• Intangible valuables (e.g. feeling secure)

• Real Savings

• Standard of Living

• Uneven inflationary price changes (e.g. a housing bubble)

• Transactions on the Blackmarket

Alternative measures of domestic output and income

• Gross Happiness Index
• Genuine Progress Index
• Human Development Index

See also

• measures of national income and output
• GDP deflator
• Gross value added
• Measures of national income
• Natural gross domestic product
• Green gross domestic product
• Uneconomic growth
• Value added