Gross domestic product (abbreviated GDP) is the main macroeconomic indicator. It is by him that they judge the development of the country, its impact on world economy and investment attractiveness. Gross domestic product shows the size of the national economy, and its structure - the ratio of industries and their productivity. That is why it is so important to understand the methods of calculating GDP. Three main of them we will consider.
The term and its definition
Before we move on to what methods of calculating GDP exist, it is logical to dwell on what this indicator is. Gross domestic product is an aggregate indicator of production equal to the sum of value added created by all residents and institutional units engaged in economic activities (plus taxes and minus subsidies). This definition gives Organization for Economic Co-operation and Development (OECD for short). She unites the developed countries with representative democracy and a free market economy. It was originally created as part of the Marshall Plan to coordinate various US projects for the post-war reconstruction of Europe.
General information
Methods of calculating GDP are usually used in order to assess the economic productivity of an entire country or a particular region. It can also be used to measure the relative contribution to the national economy of the industry in question. This is possible because the sum of all added values is GDP. The formula for calculating the indicator is not based on sales. It takes into account the difference between the cost of factors of production and finished products. For example, a company buys steel and produces a car. If the methods for calculating GDP were based on market prices, then double counting would arise. Since the gross domestic product is the sum of the added values, it also increases when the enterprise reduces the consumption of materials and other resources (the so-called intermediate consumption), while continuing to produce the same volume of output.
The most common use of GDP is to calculate economic growth from year to year (more recently and on a quarterly basis). The gross domestic product graph shows the successes and failures of the national government. Moreover, one can always say from it at what stage of the cycle the economy is: growth, peak, recession, depression.
Determination methods
GDP can be determined by three methods. Each of them should give the same result. Allocate the production method of calculating GDP (value added), income and expenses. The easiest is the first way. It follows logically from the definition. But its application is associated with data collection problems, which we will dwell on later. The calculation of GDP by expenditure is based on the fact that all products released must be bought by someone. This means that the sum of the added values should be equal to the waste of the subjects. The calculation of GDP by income works on the principle that each factor contributes to the creation of finished goods. Net imports should also be taken into account. Therefore, GDP should be equal to the sum of the incomes of all producers.
By value added
The second name of this method is the production method for calculating GDP. This approach reflects the definition of the term given by the OECD.Since the sum of value added created by all residents and institutional units in the country is GDP, the calculation formula is as follows: the difference between the total cost of output and intermediate consumption. To measure gross domestic product economic activity classified by various sectors. After that, the performance of each of them is evaluated using one of the methods:
- Multiplying output in each sector by market prices in it and adding up the results.
- Collection of statistics on total sales and stocks from the balance sheets of enterprises and their summation.
The deduction of intermediate consumption gives GDP at a factor value. In this case, you need to take into account each sector. Value added plus taxes and minus subsidies is GDP at producer prices.
Expenditure GDP calculation
In economics, most things are made for sale. Therefore, the amount of money spent on the purchase of goods and services can serve to estimate GDP. The formula in this case includes the following components:
- Consumption.
- Investment.
- Government spending.
- Export.
- Import.
GDP is equal to the sum of the first four components minus the last. An alternative formula includes final consumption expenditures, gross fixed capital formation and net exports.
GDP calculation by income
The number obtained using this method should be equal to the previous one. However, in practice, statistical errors often arise that lead to slight differences. Revenues are usually divided into five categories:
- Salaries, additional labor money.
- Corporate income.
- Percentage and return on investment.
- The income of farmers.
- Profit unincorporated business.
GDP equals the sum of these five categories minus depreciation.
History reference
William Petty came up with the basic concept of GDP in order to protect landowners from dishonest taxation during the Anglo-Dutch wars of 1652-1674. The method was developed by the mercantilist Charles Davenant. The modern gross domestic product concept was first developed by Simon Kuznets to report to the US Congress in 1934. An American economist of Ukrainian descent and a Nobel laureate already warned of the problems of using this indicator to measure well-being.
However, after the Bretton Woods Conference in 1944, GDP turned into the main means of assessing the economies of states. At that time, the most common indicator was gross national product (GNP for short). Its main difference from GDP is that it measures production not of enterprises and resident individuals, but of citizens and national firms, regardless of their place of business. The ubiquity of gross domestic product began in the 1980s. British economist Angus Maddison, a specialist in the field of quantitative macroeconomic history, calculated the GDP of countries until 1830.
Real and nominal indicators
Both market prices and basic prices can be used to calculate GDP. The nominal gross domestic product is the value of the final goods and services produced in the state. As a result, it depends on inflation. Its presence leads to an inevitable increase in the indicator. Deflation, by contrast, causes a decrease in GDP. The calculation of real GDP involves taking into account exclusively real production growth. It can be expressed both in prices of the previous year, and any other that you decide to take as a basis. The ratio of nominal and real GDP is called a deflator.
Data Collection Issues
The calculation of GDP indicators is based on statistical data for the country.If the added value created by firms is easy enough to take into account, then with the public sector, the financial sectors that deal with the production of intangible assets, it is much more complicated. Nevertheless, it is the activity of these sectors that plays a significant role in the national economy of developed countries. International conventions which guides organizations and statistical offices, must constantly change so that the calculation of GDP keeps up with the times. The gross domestic product measure is the result of an analysis of extensive statistics that are embedded in the conceptual framework of measurement.
