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Gross Domestic Product (GDP)

What is Gross Domestic Product (GDP)?

Gross domestic product (GDP) is the total valuation of final goods and services produced within the geographical borders of a country during a specified period (usually a year).

The GDP is a statistical indicator that defines the economic progress and development of a country. Percentage growth in the GDP during a quarter is considered as the standard of economic growth.

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Top 5 Countries in the world based on GDP

RankCountryNominal GDP (trillion)
1United States$21.4
2China$14.14
3Japan$5.15
4Germany$3.86
5India$2.94

Not only a nation but states and cities in addition to industries and different sectors can also have their own GDP, which helps a nation examine the impact of growing industries or states on the growth rate of a country.

Types of GDP Measurements

  • Real GDP

Real GDP is the gross domestic product, and measured with respect to a base year. It is adjusted to inflation and hence is also known as inflation-corrected GDP or current price.

For example, since 2015, the current base year for determination of India’s real GDP is 2011-12. Earlier, it was 2004-05.

The Advisory Committee on National Accounts Statistics (ACNAS) had suggested changing the base year to 2017-18. Later, in a meeting held in November 2019, the committee recommended the same to be changed to 2020-21.

Real GDP is considered to be a more accurate representation of a nation’s economic growth, as it takes into account actual income earned by resident individuals after adjusting the same at the prevailing price level.

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  • Nominal GDP

Nominal GDP is measured based on prevailing current market prices, without taking into account the effects of inflation or deflation. It depicts the monetary value of goods and services produced in a country in one financial year.

  • GDP per capita

GDP per capita is gross domestic product per person. It is the ratio between a country’s real GDP to its population.

For instance, as per the International Monetary Fund (IMF), the current nominal per capita GDP of India as of October 2019 is $2,172.

  • GDP growth rate 

GDP growth rate, as the name suggests, is an increase in the gross domestic product of a country per quarter.

For instance, the current Indian GDP growth rate of India during the 2nd quarter (July to September) of FY 2019-20 was 4.5%. During FY2020-21, the World Bank predicts India’s GDP growth rate to be 5%.

As per the National Statistical Office (NSO), the 5% growth rate of India is the slowest in last 11 years.

Calculation Methodologies of GDP

GDP can be calculated based on three approaches, all of which deliver the same results –

  • Income 

Income approach for determining GDP is a summation of all incomes that companies pay to hire the workforce. When GDP is determined based on this approach, it is referred to as gross domestic income (GDI) or GDP (I).

As per the Reserve Bank of India, the GDI calculation takes into account the following factors –

  • Compensation to employees or compensation of employees (CE)

It is the total wages before tax that are paid to employees by employers during a specific period.

  • Net production and product taxes

Production taxes or subsidies are levied on a firm engaged in manufacturing a product or products. Product taxes or subsidies are charged on the volume of total output.

  • Consumption of fixed capital (CFC)

Consumption of fixed capital (CFC) is the depreciation of fixed assets (plant, machinery, etc.), owned by a firm, during a financial period.

  • Gross operating surplus (GOS) or gross mixed income (GMI)

Gross operating surplus (GOS) is the surplus income generated by a firm minus the payroll to the workforce. Gross mixed income is the GOS earned by sole proprietorships, unincorporated enterprises, farming enterprises, and professionals (doctors, lawyers, CAs, etc.).

GDP = Total income (from salary, profits, etc.) + tax + depreciation + gross operating surplus.

  • Expenditure Method

Expenditure approach or spending approach calculates GDP by adding all expenditures made by all individuals in an economy.

As per RBI, the expenditure approach is the summation of the following –

  • Consumption expenditure (Private and government)

Consumption expenditure is the cumulative final consumption spending of private households and the government.

The consumption expenditure of both private households and the government is considered when determining nominal GDP.

  • Investments

Investments are the expenditures that businesses and households spend on assets. For households, these usually include purchasing/constructing a new home. For businesses, it includes plants, machinery, equipment, etc.

  • Government expenditure 

This includes all expenses incurred by the government for the development of a country, such as education, infrastructure, medication, etc.

  • Net exports (exports minus imports)

Net exports include the goods and services produced by a country, which are exported overseas minus the imports.

The formula for calculation of GDP basis expenditure approach is –

GDP = C + I + G+ NX.

Where C is the consumption expenditure, G is government expenditure, I is the investment, and NX is the net exports.

  • Production or Value Added Method

The production output for determining GDP takes into account the total output produced by a country minus the goods consumed in the process. Only the final value of goods and services is considered to avoid double counting. Double counting involves counting output during several stages of production.

GDP vs NDP 

Net domestic product (NDP) is the total amount of final goods and services produced by a country, minus depreciation. Thus, the NDP can be achieved by subtracting depreciation from the gross domestic product.

On the other hand, net national product (NNP) is the total valuation of final goods and services produced by a nation’s citizens domestically and internationally, minus depreciation. Thus, NNP can be found by subtracting depreciation from GNP.

Importance of GDP

Gross Domestic Product is the most popular measure used by individuals all over the world to determine the size and production capacity of an economy. It also reflects the growth potential of a country, as it takes into account the total amount of resources available in a country.

GDP growth rate is a major indicator of the development rate of an economy and is one of the major parameters considered while analysing the overall health and performance of the country.

Limitations of GDP

Some of the limitations of GDP include –

  • Exclusions of non-market transactions 

Non-market transactions like voluntary, domestic, or other work that has a positive impact on the productivity of workers are excluded from GDP. Additionally, goods that are produced for private consumption are also not included when GDP is calculated.

  • Does not account for the standard of living

The standard of living of a country cannot be determined by considering its GDP. India is one of the best examples of a country with a high GDP but relatively low standard of living.

To get a more realistic assessment of a country’s standard of living, Pakistani economist Mahbub ul Haq conceived the Human Development Index (HDI) in 1990 in accordance with Indian economist Amartya Sen. This takes into account the life expectancy, mean schooling years, and GDP of an economy adjusted for purchasing power parity (PPP) to develop a more holistic measure of the growth rate of a country.

  • Does not account for externalities 

GDP does not consider the impact of industries on the environment and social welfare. Environmental experts have argued for the inclusion of such damage to the GDP.

While several developed countries impose several fines and penalties on industries violating environmental laws, some developing ones ignore the same to promote the growth of their economy.

For determining the effects of environmental damage on GDP, green gross domestic product or GGNP was devised. GGNP is an index for economic progress factoring the harms done environment for the same.

  • Does not account for income inequality 

Similar to standards of living, GDP is not also a determinant of income inequality. India is also a prime example here owing to high unequal income distribution. To counter this, the value of Gini coefficient can be determined, which measures a nation’s income to its wealth distribution rate. The top 5 fastest growing economies of the world include Rwanda – 7.7%, Bangladesh – 7.5%, Senegal – 7.3%, Ethiopia – 7.0% and Myanmar – 6.8%.