The GDP is the monetary value of final goods and services produced by an economy in a given period of time.
The word gross means that certain values are not calculated; these values are: variation in inventories and capital depreciations or appreciations.
The word domestic indicates production within the geographical boundaries of a given economy and
The word product refers to an added value.
How is the GDP calculated?
Three equivalent theoretical methods are used to calculate GDP: (1) Expenditure Method, (2) Income Method, and (3) Added Value Method.
The GDP is the sum of all expenditures made for the acquisition of end product goods or services produced within a given economy; this means that the acquisition of intermediate goods and services is excluded, as are imported goods or services.
Added Value Method
The GDP is the sum of the added values in the different production stages in every sector of the economy. The added value created by a business in the production process is equal to the value of its production minus the value of the intermediate goods.
The GDP is the sum of: the earnings of salaried employees, profits made by businesses, and taxes minus any grants. The difference between the value of a company’s outputs and the intermediate goods ends up in one of the three following categories: workers; in the form of labor income, businesses; in the form of benefits, or the State; in the form of indirect taxes, such as the VAT (Value Added Tax).
Nominal GDP versus real GDP
It must be kept in mind that production is measured in monetary terms; because of this, inflation can cause the nominal measurement of the GDP to be bigger from one year to the next, while at the same time the real GDP is unchanged. To solve this problem, the real GDP is calculated by deflating the nominal GDP through a price index, or, to be more exact, a GDP deflator is applied. A GDP deflator is an price index that includes every produced good.
To make international comparisons, the GDP can be expressed in US dollars. Since exchange rates tend to be very unstable, this measurement is affected by the exchange rate fluctuations. To solve this problem, economists use another method to conduct international comparisons, which consists of deflating the GDP by using the purchasing power parity (better known as PPP).
Domestic Product versus National Product
In the case of the Gross Domestic Product (GDP), the added value within a country is calculated. In the case of the Gross National Product (GNP), the value added by the nationally owned production factors is calculated.
Gross Product versus Net Product
The difference between the gross product and national product is the depreciation of the capital. Gross Product does not consider the depreciation of the capital, while the Net Product does in fact use it for calculating the total.
Product Per Capita
The GDP per capita is the average amount of Gross Product per person. It is calculated by dividing the total GDP by the amount of people living in a given economy.
What is wrong with the GDP?
The use of the GDP per capita as a measurement of well being is generalized. These figures should be carefully considered, due to the following reasons:
- The GDP does not take capital depreciation into account (this includes machinery, factories, etc. as well as natural resources; and “human capital” could also be included). For instance, a country can increase its GDP by intensively exploiting its natural resources, but the countries´ capital will diminish, leaving decreased capital for future generations.
- It does not consider the negative externalities generated by some production activities, for instance: environmental pollution.
- The distribution of income is not taken into account. The inhabitants of a country with the same per capita GDP as another country but with a more equitable distribution of its income will enjoy an increased level of well being.
- The GDP measurement does not take into consideration productive activities that affect well being but do not generate transactions, for instance, volunteer work or stay-home parents.
- Some activities that negatively affect well being can actually increase the GDP, for instance, divorces, crimes and war.
- The GDP ignores external debt. The GDP of a country will increase if the government or the businesses within its boundaries take on loans from foreign entities. Obviously, this would cause a diminished GDP in future periods.