Gross Domestic Product (GDP)

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Meaning of GDP (Gross Domestic Product)

GDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period. It depicts the economic production, activity, and standard of living of the nation in question for a particular year. Furthermore, it serves as an indicator defining the size, growth, or decline of an economy.

It is an acronym for gross domestic product. Its annual calculation allows businesses, investors, and policymakers to assess, forecast, and plan future economic decisions. It only considers finished products and services while excluding their processing and operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more. Countries measure it in their native currencies and based on factors, including production, income, and expenditure.

GDP

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Gross Domestic Product (GDP) (wallstreetmojo.com)

Key Takeaways

  • GDP is a monetary measure of the total market worth of a country’s final output across time. Production, income, and spending are three criteria that nations use to calculate it in their currencies.
  • It acts as a metric for measuring the total domestic production, standard of living, and foreign trade balance of an economy.
  • It aids in determining the size, growth, expansion, contraction or decline, and prospects of an economy and plays a crucial part in regulating and planning the economy.
  • Public and private consumption, corporate investments, government spending, and net exports are its primary components. Nominal, real, per capita, growth rate, PPP, and potential are its four common types.

GDP Explanation

GDP or gross domestic product is the total value of goods and services generated inside a country over an accounting period. In simpler words, it reflects a nation’s total domestic production and foreign balance of tradeBalance Of TradeThe balance of trade (BOT) is the country’s exports minus its imports. BOT is one of the significant components for any current economic asset as it measures a country’s net income earned on global investments.read more. It considers factors like demand and supply, inflation, and per capita income in the calculation.

What GDP Indicates

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Gross Domestic Product (GDP) (wallstreetmojo.com)

English economist William Petty (1654-1676) was the first to suggest the concept, further improved by English politician Charles Davenant (1695) and modified by American economist Simon Kuznets (1934).

The two common ways to calculate gross domestic product are nominal (not adjusted for inflation) and real (adjusted for inflation/deflation). Since factoring the former with the inflation gives the latter, it is relatively higher than the latter.

In other words, an economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more is in good shape or trade surplus if the market value of its goods and services, including net exports, is more than imports. On the other hand, if the total value of domestic product and service production is less than imports, the economy is in a trade deficitTrade DeficitWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.read more and must be regulated. Significantly, the higher the difference between the nominal and real gross domestic product, the greater the risk of inflation or deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more.

The gross domestic product is a crucial aspect in establishing the gross national income. It aids economists, businesses, and the government in determining the current and future state of the economy. Furthermore, it depicts a nation’s economic, production, employment, and per capita incomePer Capita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc.read more positions.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

GDP vs GNP Explanation in Video

Gross Domestic Product Characteristics

1. The four main components of the gross domestic product are:

components of GDP

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Gross Domestic Product (GDP) (wallstreetmojo.com)

  • Public and Private Consumption, i.e., retail sales
  • Investments From Business, i.e., construction and storage
  • Government Expenditures, i.e., social security benefits, Medicare, defense, education, etc
  • Net Exports, i.e., export trade – import trade

2. It relies on the monetary worth of goods and services and their consumption, and hence it is subject to inflation and population.

3. Rise and fall in the real gross domestic product represent growth or expansion and decline or contraction of the economy.

4. It is an excellent method for comparing the output of two or more economies.

5. Gross domestic product is not the same as the gross national product (GNP), which refers to all the final production from the resources owned by the residents of a country.

6. Countries worldwide follow the international standard set by the European Commission, International Monetary Fund, the Organization for Economic Cooperation and Development, the World Bank, and the United Nations to compute their gross domestic product.

7. A country with a higher gross domestic product will have a higher living standard.

Types of Gross Domestic Product

Gross domestic product has four categories, each revealing a unique feature of an economy and its gross national income:

Gross Domestic Product Types

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Gross Domestic Product (GDP) (wallstreetmojo.com)

#1 – Nominal GDP

Nominal GDPNominal GDPNominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country's population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more evaluates a country’s overall economic output without taking inflation into account. Instead, it assesses all domestically produced goods and services based on current market pricesMarket PricesMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price.read more. Furthermore, it is an excellent tool for comparing economic output from different quarters of the same year.

#2 – Real GDP

Real GDPReal GDPReal GDP can be described as an inflation-adjusted measure that reflects the value of services and goods produced in a single year by an economy, expressed in the prices of the base year, and is also known as "constant dollar GDP" or "inflation corrected GDP."read more is the most precise indicator of a country’s economic activitIndicator Of A Country's Economic ActivitSome economic indicators are GDP, Exchange Rate Stability, Risk Premiums, Crude Oil Prices etc. read morey, such as growth or decline and production of goods and services in a particular year. The calculation of actual gross domestic product uses the GDP deflatorGDP DeflatorThe GDP deflator measures the change in the annual domestic production due to changes in price rates in the economy. Hence, it measures the change in nominal GDP and real GDP during a particular year calculated by dividing the nominal GDP with the real GDP and multiplying the resultant with 100.read more, i.e., measuring the difference in the values of all products and services between the current and the base year. It helps compare the gross domestic product of several years by adjusting changes in market prices for inflation or deflation.

#3 – Potential GDP

It is a benchmark set for a country’s economic output that it can achieve in perfect conditions when everything is under control. Examples include low inflation, steady or increased purchasing power of the currency, full employment, optimal resource utilization, and so on.

#4 – GDP Per Capita

It measures a nation’s total economic output by dividing its nominal gross domestic product for a specific period by its total population. As a result, it shows the average per capita income, living standards, and worker productivity.

#5 – GDP Growth Rate

It measures changes in a country’s overall economic production on a quarterly or annual basis to aid in managing issues such as unemployment and inflation. A negative real-gross domestic product growth rate suggests economic contraction, recessionRecessionEconomic recession is defined as the phase in which economic activities of a country become stagnant, leading to a disturbance in the business cycle and affecting the overall demand-supply balance. read more, or depression, whereas an overly positive growth rate indicates inflation.

#6 – GDP Purchasing Power Parity (PPP)

It determines a country’s gross domestic product based on the purchasing power parityPurchasing Power ParityPurchasing power parity formula depicts the variation in the exchange rate between the currencies of two different nations. It is evaluated as the fraction of a particular goods' cost in one country to that in the second country.read more (PPP) of numerous nations’ economic production, market prices of goods and services, incomes, living costs, and living standards.

Calculate GDP

The following are the three most common methods for calculating gross domestic productCalculating Gross Domestic ProductGDP or gross domestic product refers to the sum of the total monetary value of all finished goods and services produced within the border limits of any country. GDP determines the economic health of a nation. GDP = C + I + G + NXread more that provides comparable results:

Gross Domestic Product Calculation

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Gross Domestic Product (GDP) (wallstreetmojo.com)

  • Production (Output or Value Added) Approach: Subtracting total sales from the value of intermediate inputs used in the manufacturing process, i.e., the total of the “value-added” at each step of production.
  • Income Approach: Summing up incomes earned from production factors.
  • Expenditure (Speculated or Spending) Approach: Totaling the amounts spent by end-users on goods and services.

The expenditure approach estimates GDPExpenditure Approach Estimates GDPThe Expenditure Approach is one of the methods for calculating a country's Gross Domestic Product (GDP) by adding all of the economy's spending, including consumer spending on goods and services, investment spending, government spending on infrastructure, and net exports.read more by summing all the money citizens spend on goods and services over a year. It also considers spending by other economic participants, including businesses and the government. It uses the following formula for calculation:

GDP = C + I + G + NX

Where,

The nominal value obtained from this GDP formula is then calibrated with the inflation rate to arrive at the real figure.

Examples of GDP

The following examples will help understand the GDP much better:

Example #1

External variables can have a significant impact on a country’s total economic output. For instance, the COVID-19 pandemic has wreaked havoc on the world economy, putting it in a near-recessionary state. As a result, the International Monetary Fund expects global economic growth in 2021 to be significantly lower than its July prediction of 6%.

Many negative economic trends have resulted from the pandemic, including increasing global debt burdens and interest rates, inflation and rising food costs, and vaccine shortages, particularly in emerging and developing economies. It does, however, recommend debt restructuringDebt RestructuringDebt restructuring is a refinancing process whereby the company facing cash flow issues arranges with lenders to renegotiate favourable or flexible terms, saving themselves from bankruptcy. The lenders may choose to lower the business rate or increase the time limit for paying the interest and principal amount.read more, trade liberalizationTrade LiberalizationTrade liberalization refers to eliminating or easing trade barriers between countries to promote free trade of goods and services.read more, incentives for COVID-19 immunization, and a shift to renewable energy to boost global GDP.

Example #2

On the contrary, developed economiesDeveloped EconomiesA developed economy is the one that has a high per capita income or per capita GDP, a high degree of industrialization, developed infrastructure, technical advances, and a relatively high rank in human development, health, and education.read more, are seeing an economic resurgence due to their aggressive measures to manage the coronavirus and its negative implications. According to the business group Confindustria, Italy’s overall domestic production might expand by 6.1% in 2021 and 4.1% in 2022, which would be much higher than pre-pandemic levels.

The group states it is feasible because the COVID-19 Delta variation has less influence in Italy, and economic indicators have been greater than projected. This growth estimate is notable in light of the nation’s economy contracting by 8.9% in 2020 due to the COVID-19 pandemic, resulting in its deepest postwar recession.

Frequently Asked Questions (FAQs)

What GDP means?

GDP or gross domestic product is the total worth of products and services produced within a country over a given accounting period. It only takes into account final goods and services, ignoring processing and running costs. Demand and supply, inflation, and per capita income are all elements that go into its computation.

How is GDP calculated?

Nominal (not adjusted for inflation) and real (adjusted for inflation/deflation) are the two most popular methods of calculating GDP. Other commonly used approaches for estimating gross domestic product that yield similar results are:

Production Approach – Adds together the outputs of all types of businesses.
Income Approach – Sums incomes from productive components, equaling the value of goods and services produced.
Expenditure Approach – The overall product’s worth must equal the sum of consumers’ purchases. The formula for this is:

Gross domestic product = Consumption + Investment + Government + Net exports

Why is GDP important?

The annual calculation of GDP enables firms, investors, and policymakers to evaluate, forecast, regulate, and plan for future economic decisions. It also assists in assessing the growth, expansion, contraction, or decline of an economy. Furthermore, it helps determine an economy’s total domestic production, living standard, and international trade balance.

This has been a Guide to what is Gross Domestic Product (GDP) and its Meaning. Here we discuss its types, characteristics, and examples. You may also have a look at the following articles –