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What is Gross Domestic Product?

Level:
AS, A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 26 Jul 2023

Gross Domestic Product (GDP) is a fundamental economic indicator that measures the total monetary value of all finished goods and services produced within a country's borders during a specific period, typically measured on a quarterly or annual basis. It is used as a measure of a country's economic performance and overall economic health.

GDP can be calculated using three different approaches:

  • Production Approach: This method calculates GDP by summing up the value-added at each stage of production across all industries in the country. It includes the value of goods and services produced minus the value of intermediate inputs used in the production process.
  • Expenditure Approach: This method calculates GDP by summing up the total expenditures made in the economy during a specific period. It includes four main components: consumer spending (C), business investment (I), government spending (G), and net exports (X - M), which represents the difference between exports and imports.
  • GDP = C + I + G + (X - M)

  • Income Approach: This method calculates GDP by summing up all the factor income earned within a country's borders during a specific period. This includes wages, salaries, profits, rents, and other income earned by individuals and businesses.

GDP provides a comprehensive view of a country's economic output and is widely used by policymakers, economists, and investors to assess economic growth, compare the economic performance of different countries, and make informed decisions regarding fiscal and monetary policies.

However, it's important to note that GDP has its limitations and may not fully capture the overall well-being or quality of life of a population as it doesn't consider factors like income distribution, environmental sustainability, and social aspects.

How does nominal GDP differ from real GDP?

Nominal GDP and real GDP are both measures of a country's economic output, but they differ in the way they account for inflation. The main distinction lies in how they consider changes in the general price level over time.

Nominal GDP

Nominal GDP is the raw GDP figure calculated using current market prices of goods and services produced during a specific period. It represents the total value of goods and services produced in the economy without adjusting for inflation. As a result, it reflects changes in both the quantity of goods and services produced and changes in their prices.

Formula for calculating Nominal GDP: Nominal GDP = Σ (Price of Goods and Services) x (Quantity of Goods and Services)

Real GDP

Real GDP adjusts nominal GDP for inflation, which means it accounts for changes in the general price level over time. Real GDP is calculated by valuing the output of goods and services using a fixed base year's prices, thereby eliminating the impact of price changes and providing a more accurate measure of economic growth or contraction.

Formula for calculating Real GDP: Real GDP = Σ (Price of Goods and Services in Base Year) x (Quantity of Goods and Services)

By using a constant price level from a chosen base year, real GDP isolates the changes in output (quantity) and filters out the influence of inflation or deflation, allowing for a more accurate comparison of economic performance between different time periods.

The difference between nominal GDP and real GDP can be used to estimate the extent of inflation or deflation during a given period.

If nominal GDP exceeds real GDP, it suggests that prices have increased (inflation).

Conversely, if real GDP exceeds nominal GDP, it indicates that prices have decreased (deflation).

What is GDP per capita?

GDP per capita is a metric that measures the average economic output, or Gross Domestic Product (GDP), of a country per person. It is calculated by dividing the total GDP of a country by its population. This indicator provides an estimation of the average economic well-being or income of the individuals in a specific country.

The formula to calculate GDP per capita is:

GDP per capita = Total GDP of the country / Total population of the country

For example, let's consider a hypothetical country with a GDP of $1 trillion and a population of 200 million people. The GDP per capita for this country would be:

GDP per capita = $1,000,000,000,000 / 200,000,000 GDP per capita = $5,000

In this example, the GDP per capita is $5,000, which means, on average, each person in the country produces or contributes to $5,000 worth of goods and services annually.

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