Gross Domestic Product (GDP) is the value of all final goods and services produced within a country’s border in a specific period of time, usually a year. Value is represented in the form of American Dollars. If it was to be measured by the raw number of things produced, a country producing 500,000 cups would be doing just as well as a country producing 500,000 tables. So, now that we understand why GDP is measured in dollar terms, we have a problem. If every country reflected their GDP through dollar terms, data would not be consistent because every country’s currency has a different value against the American dollar. Inflation is the problem. If two countries produce the same amount of cars, but one has higher prices then that country is going to have a higher nominal GDP.

 

Nominal GDP

Nominal GDP is not adjusted for inflation. Inflation causes a rise in market prices that do not correctly reflect the true value of the goods or services that are produced. Thus, this is an unreliable representation of the health of the economy.

 

Real GDP

Economists refer to real GDP for a more accurate idea of the health of the economy. Real GDP is GDP adjusted for inflation! Real GDP is calculated through the GDP deflator, and Nominal GDP must be known for the calculation to be correct.

 

GDP Deflator

The GDP Deflator measures the prices of all goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in GDP Deflator. “Deflates the nominal GDP”

3.7 Gross Domestic Product (GDP) | Economics

GDP Per Capita

GDP per capita is a measure of the total output of a country that takes GDP and divides it by the population. This reveals the average output each person contributes to the country’s GDP. GDP per capita is also used as an indicator of standard of living, with higher GDP per capita equating to a higher standard of living.

 

Changes in GDP

Can be calculated through this formula:

3.7 Gross Domestic Product (GDP) | Economics

Calculating GDP

There are two ways to calculating a country’s GDP:

 

  1. Expenditures approach
    Sum of all expenditure on final goods and services produced in a given year.

GDP = C + I + G + (X – M)

  1. Income approach
    Sum of all income derived from selling all final goods and services produced in a given year.

GDP = Rent + Wages + Interest + Profit

 

GDP does NOT include every transaction within an economy.

For example:  

  • Purchase of used domestic car does not count towards GDP because nothing was produced or created.
  • Financial assets such as stock or purchases of another company because no new goods or services was produced.
  • If a plumber charges $150 to fix someone’s plumbing system, it is counted towards GDP. However, f a plumber was to fix his own plumbing system from home it is not counted towards GDP
  • Intermediate goods. We only consider the final product such as the laptop as a whole and not the microchips that were bought from another company.
  • Non-market goods such as illegal goods like drugs.

 

Check out our other blogs below!

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