Gross domestic product

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This article is about GDP in the context of economics. For other uses, see GDP (disambiguation).
Image:GDP nominal per capita world map IMF figures for year 2006.png
Nominal GDP per person (capita) in 2006.
Image:Gdp nominal and ppp 2005 world map single colour.png
IMF 2005 figures of total nominal GDP (top) compared to PPP-adjusted GDP (bottom).

A region's gross domestic product, or GDP, is one of the ways of measuring the size of its economy. The GDP of a country is defined as the total market value of all final goods and services produced within a country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time.

The most common approach to measuring and understanding GDP is the expenditure method:

GDP = consumption + investment + (government spending) + (exports − imports), or, GDP = C + I + G + (X-M)

"Gross" means depreciation of capital stock is not included. With depreciation, with net investment instead of gross investment, it is the net domestic product. Consumption and investment in this equation are the expenditure on final goods and services. The exports minus imports part of the equation (often called cumulative exports) then adjusts this by subtracting the part of this expenditure not produced domestically (the imports), and adding back in domestic area (the exports).

Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending. Two advantages of dividing total consumption this way in theoretical macroeconomics are:

  • Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption.
  • If separated from endogenous private consumption, government consumption can be treated as exogenous, so that different government spending levels can be considered within a meaningful macroeconomic framework.

Contents

[edit] GDP vs GNP

GDP can be contrasted with GNP or gross national product, which the United States used in its national accounts until 1992. The two terms GDP and GNP are almost identical - and yet entirely different; GDP (or GDI - Gross Domestic Income) being concerned with the region in which income is generated. That is, what is the market value of all the output produced in a nation, the United States, for example, in one year. GDP concerns itself with where the output is produced and not who produced it. Meanwhile, GNP (or GNI - Gross National Income) is a measure of the accrual of income or the value of the output, produced by the "nationals" of a region. GNP concerns itself with who "owns" the production. If we take the USA as an example again, GNP measures the value of output produced by American firms, regardless of where the firms are located. This compares to GDP which is concerned with where the production takes place and not if the company is an American firm or not (assuming that a firm can be defined as American in an economic world where most large firms are actually global groups).

[edit] Measuring GDP

[edit] The components of GDP

Each of the variables C, I, G and NX (where GDP = C + I + G + (X-M) as above):

(Note: * GDP is sometimes also referred to as Y in reference to a GDP graph)

  • C is private consumption in the economy. This includes most personal expenditures of households such as food, rent, medical expenses and so on but does not include new housing.
  • I is defined as business investments in capital. Examples of investment by a business include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households on new houses is also included in Investment. Unlike general meaning, 'Investment' in GDP is meant very specifically as non-financial product purchases. Buying financial products is classed as 'saving', as opposed to investment. The distinction is (in theory) clear: if money is converted into goods or services, it is investment; but, if you buy a bond or a share of stock, this transfer payment is excluded from the GDP sum. Although such purchases would be called investments in normal speech, from the total-economy point of view, this is simply swapping of deeds, and not part of the real economy or the GDP formula.
  • G is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.
  • X is gross exports. GDP captures the amount a country produces, including goods and services produced for overseas consumption, therefore exports are added.
  • M is gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.

It is important to understand the meaning of each variable precisely in order to:

[edit] Examples of GDP component variables

Examples of C, I, G, & NX: If you spend money to renovate your hotel so that occupancy rates increase, that is private investment, but if you buy shares in a consortium to do the same thing it is saving. The former is included when measuring GDP (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP.

If the hotel is your private home your renovation spending would be measured as Consumption, but if a government agency is converting the hotel into an office for civil servants the renovation spending would be measured as part of public sector spending (G).

If the renovation involves the purchase of a chandelier from abroad, that spending would also be counted as an increase in imports, so that NX would fall and the total GDP is unaffected by the purchase. (This highlights the fact that GDP is intended to measure domestic production rather than total consumption or spending. Spending is really a convenient means of estimating production.)

If you are paid to manufacture the chandelier to hang in a foreign hotel the situation would be reversed, and the payment you receive would be counted in NX (positively, as an export). Again, we see that GDP is attempting to measure production through the means of expenditure; if the chandelier you produced had been bought domestically it would have been included in the GDP figures (in C or I) when purchased by a consumer or a business, but because it was exported it is necessary to 'correct' the amount consumed domestically to give the amount produced domestically. (As in Gross Domestic Product.)

[edit] Types of GDP and GDP growth

1) Current GDP is GDP expressed in the current prices of the period being measured

2) Nominal GDP growth is GDP growth in nominal prices (unadjusted for price changes).

3) Real GDP growth is GDP growth adjusted for price changes. Calculating real prices allows economists to determine if production increased or decreased, regardless of changes in the purchasing power of the currency.

[edit] The GDP income account

Another way of measuring GDP is to measure the total income payable in the GDP income accounts. In this situation, one will sometimes hear of Gross Domestic Income (GDI), rather than Gross Domestic Product. This should provide the same figure as the expenditure method described above. (By definition, GDI=GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.)

The formula for GDP measured using the income approach, called GDP(I), is:

GDP = Compensation of employees + Gross operating surplus + Gross mixed income + Taxes less subsidies on production and imports
  • Compensation of employees (COE) measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.
  • Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.
  • Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.

The sum of COE, GOS and GMI is called total factor income, and measures the value of GDP at factor (basic) prices.The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the Government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I).

Another formula can be written as this:

GDP = R + I + P + SA + W

where R = rents
I = interests
P = profits
SA = statistical adjustments (corporate income taxes, dividends, undistributed corporate profits)
W = wages

[edit] Measurement

[edit] International standards

The international standard for measuring GDP is contained in the book System of National Accounts (1993), which was prepared by representatives of the International Monetary Fund, European Union, Organization for Economic Co-operation and Development, United Nations and World Bank. The publication is normally referred to as SNA93, to distinguish it from the previous edition published in 1968 (called SNA68).

SNA93 provides a set of rules and procedures for the measurement of national accounts. The standards are designed to be flexible, to allow for differences in local statistical needs and conditions.

[edit] National measurement

All or part of this article may be confusing or unclear.
Please help clarify the article. Suggestions may be on the talk page. (September 2007)

Within each country GDP is normally measured by a national government statistical agency, as private sector organizations normally do not have access to the information required (especially information on expenditure and production by governments).

GDP can measure spending on all goods and services. GDP can also measure all income earned.

[edit] Interest rates

Net interest expense is a transfer payment in all sectors except the financial sector. Net interest expenses in the financial sector is seen as production and value added and is added to GDP. Perú: Instituto de Estadísticas e Informática - INEI [4]

[edit] Cross-border comparison

The level of GDP in different countries may be compared by converting their value in national currency according to either

The relative ranking of countries may differ dramatically between the two approaches.

  • The current exchange rate method converts the value of goods and services using global currency exchange rates. This can offer better indications of a country's international purchasing power and relative economic strength. For instance, if 10% of GDP is being spent on buying hi-tech foreign arms, the number of weapons purchased is entirely governed by current exchange rates, since arms are a traded product bought on the international market (there is no meaningful 'local' price distinct from the international price for high technology goods).
  • The purchasing power parity method accounts for the relative effective domestic purchasing power of the average producer or consumer within an economy. This can be a better indicator of the living standards of less-developed countries because it compensates for the weakness of local currencies in world markets. (For example, India ranks 13th by GDP but 4th by PPP.)The PPP method of GDP conversion is most relevant to non-traded goods and services.

There is a clear pattern of the purchasing power parity method decreasing the disparity in GDP between high and low income (GDP) countries, as compared to the current exchange rate method. This finding is called the Penn effect.

For more information see Measures of national income and output.

[edit] GDP and the health of an economy

[edit] GDP and standard of living

Image:World GDP Capita 1-2003 A.D.png
World GDP per capita changed very little for most of human history before the industrial revolution. (Note the empty areas mean no data, not very low levels. There are data for the years 1, 1000, 1500, 1600, 1700, 1820, 1900, and 2003.)

GDP per capita is often used as an indicator of standard of living in an economy. While this approach has advantages, many criticisms of GDP focus on its use as a sole indicator of standard of living.

The major advantages to using GDP per capita as an indicator of standard of living are that it is measured frequently, widely and consistently; frequently in that most countries provide information on GDP on a quarterly basis (which allows a user to spot trends more quickly), widely in that some measure of GDP is available for practically every country in the world (allowing crude comparisons between the standard of living in different countries), and consistently in that the technical definitions used within GDP are relatively consistent between countries, and so there can be confidence that the same thing is being measured in each country.

The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living. GDP is intended to be a measure of particular types of economic activity within a country. Nothing about the definition of GDP suggests that it is necessarily a measure of standard of living. For instance, in an extreme example, a country which exported 100 per cent of its production and imported nothing would still have a high GDP, but a very poor standard of living.

The argument in favour of using GDP is not that it is a good indicator of standard of living, but rather that (all other things being equal) standard of living tends to increase when GDP per capita increases. This makes GDP a proxy for standard of living, rather than a direct measure of it. GDP per capita can also be seen as a proxy of labor productivity. As the productivity of the workers increases, employers must compete for them by paying higher wages. Conversely, if productivity is low, then wages must be low or the businesses will not be able to make a profit.

There are a number of controversies about this use of GDP.

[edit] Criticisms and limitations

All or part of this article may be confusing or unclear.
Please help clarify the article. Suggestions may be on the talk page. (September 2007)

GDP is widely used by economists to gauge the health of an economy, as its variations are relatively quickly identified. However, its value as an indicator for the standard of living is considered to be limited. An alternative for this purpose is the United Nations' Human Development Index in which the GDP is a contributing factor in its calculation. Criticisms of how the GDP is used include:

The limits of GDP (or GNP, a slightly different notion) can be summed up in the words of two critics. Robert Kennedy said[3]:
The gross national product includes air pollution and advertising for cigarettes and ambulances to clear our highways of carnage. It counts special locks for our doors and jails for the people who break them. GNP includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm, and missiles and nuclear warheads... it does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. It does not include the beauty of our poetry or the strength of our marriages, or the intelligence of our public debate or the integrity of our public officials. It measures everything, in short, except that which makes life worthwhile.
The second critic, Simon Kuznets the inventor of the GDP, in his very first report to the US Congress in 1934 said[4]:
...the welfare of a nation [can] scarcely be inferred from a measure of national income...
In 1962, Kuznets stated[5]:
Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

Some economists have attempted to create a replacement for GDP called the Genuine Progress Indicator (GPI), which attempts to address many of the above criticisms. Many nations calculate a national wealth, a sum of all assets in a nation, but this again does not account for future obligations such as environmental degradation, asset bubbles, and debt. Other nations such as Bhutan have advocated gross national happiness as a standard of living. (Bhutan claims to be the world's happiest nation.)

[edit] Lists of countries by their GDP

[edit] See also

v • d • e
Economic classification of countries
Developed country · Developing country · Least developed country · High income country · Newly industrialized country
Worlds TheoryFirst World · Second World · Third World · Fourth World
Lists of countries
GDP per capita List of countries by GDP (nominal), (per capita) · List of countries by GDP (PPP), (per capita), (per hour)
Human Development Index List of countries by Human Development Index
Human Poverty Index List of countries by percentage of population living in poverty
Literacy rate List of countries by literacy rate

[edit] References

  1. ^ Column on US national net worth.
  2. ^ National net worth per person for different countries.
  3. ^ Measuring Progress: Annex 1-What's wrong with the GDP?, Friends of the Earth. March 13, 2003. [1]
  4. ^ Simon Kuznets, 1934. "National Income, 1929-1932". 73rd US Congress, 2d session, Senate document no. 124, page 7. http://library.bea.gov/u?/NI_reports,539
  5. ^ Simon Kuznets. "How To Judge Quality". The New Republic, October 20, 1962

[edit] External links

[edit] Global

[edit] Data

[edit] Articles and books


It has been suggested that Real GDP be merged into this article or section. (Discuss)
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Please discuss this issue on the talk page. This article has been tagged since September 2007 .
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