WHAT IS GROSS DOMESTIC PRODUCT (GDP) AND ITS IMPORTANCE

Gross domestic product (abbreviated GDP) is the market value of all final goods and services produced within a country during a given period.

Definitions are of critical definition to the economist, so, let analyze every component of this definition.

"GDP is the market value..."

By this, we mean GDP adds together the production of millions of different goods and services produced in a current year into a value of the economic activity.

To do this, it simply takes the quantity of everything produced within a country's border and multiplies it by the price at which each product is sold.

"....of all......"

As a measure of market value, GDP tries to be comprehensive enough. It consists of all goods and services produced and sold within a country.

It involves counting the production of millions of items in a country. It does not just count the bananas and orange produce in a country, but it also counts smartphones, teaching services, books, and every other item produced in a country

"......Final goods....."

Final goods are goods that are at their furthest stage of production.

To understand this phrase, let's consider tires. If manufacturers make tires and automobile manufactures then use these tires to produce automobiles, Then, the tire is an intermediate good while the automobile is a final good.

GDP only counts finals goods. It does not count intermediate goods.

The reason for this is that the value of the intermediate goods (in this case, tires) is included in the market value of the final goods (automobile).

Separately including the market value of tire and the market value of the automobile to GDP would be double-counting( which will overstate the GDP )

Therefore, Only finals goods are included in GDP.

"......services....."

GDP does not just include the market value of goods produced in a country. It also includes the market value of intangible services.

As Wikipedia put it, service is a transaction in which no physical goods are transferred from the seller to the buyer.

For example, when you paid a teacher to teach you, you are buying services, and the fees paid are included in GDP.

"......produced........."

GDP includes only items produced. It does not include any non-production activities in a country. 

This explains why goods resold are not counted in GDP because they do not involve the production of goods.

"...... within a country......"

By this, we mean GDP measures the market value of all goods and services produced within a country, regardless of the nationality of the producer.

What this means is that if a British citizen produced cars in Nigeria, his production will be recorded in the GDP of Nigeria even though he is British.

Similarly, the production of French men in Nigeria is not part of France's GDP (but is part of Nigeria's GDP).

Therefore, GDP includes all items produced in a country. It does not matter who produces them.

".....In a given period....."

Like every other statistic, GDP measures the market value of items for a specific period.

This period is usually a year, although many countries are now releasing quarterly GDP statistics.

Having defined GDP, let now turn our attention to the main approach of measuring GDP

How do we measure GDP

There are two ways of calculating GDP: The expenditure approach and the income approach.

1. Expenditure approach: This measures GDP by evaluating the sum of final goods and services purchased in a country. That is, it measures the aggregate expenditure(demand)for goods and services in a country. 

It is the most widely used method of calculating GDP. The expenditure approach asserts that the total spending by household (consumption), business (investment), government, and net export must add up to the total market of all final goods and services produced in a country.

These four components: consumption (C), investment (I), government spending (G), and net exports (X-M)) makes up the GDP

These four major components give us the single-most-important formula for G.D.P

$Y=C+I+G+(X-M)$

 Where $Y$ is GDP

               $C$ is consumption or household demand

               $I$ is investments

               $G$ is government spending

               $X-M$ is net export.

You will learn about these four major components of GDP in this next post.

2. Income approach: This is the less-known method of calculating GDP. The income approach of calculating GDP says that the GDP of an economy is the sum of its total national income (wages, rent, interest, profit), sales taxes, depreciation.

If we were to express this statement mathematically, it will be:

$GDP=TNI+T+D-S$

    Where TNI is the total national income 

                   T is the Indirect tax

                   D is depreciation

                   S is subsidy

We discussed the income component of GDP here.

Having looked at the approaches of calculating GDP, Let's now distinguish between real GDP and nominal GDP.

Real GDP is GDP measured at constant prices while Nominal GDP is GDP measured at current prices. Because real GDP is measured at constant prices, it accounts for changes in average prices (inflation and deflation).

For this reason, Real GDP is considered a better measure of economic growth than nominal GDP. You can read more about real GDP and nominal GDP here.

Why Is Gdp Important To Economists?

GDP is one of the most widely used measures of national income (or expenditure). GDP shows the income (or expenditures) that everyone in an economy is earning/making.

GDP is the single most important measurement of the health of an economy. It is often used to measure the size of an economy. GDP should not be confused with GNP, which is the market value of all goods and services produced by a country's citizens.

GDP tracks some of the important data that we need to know from consumer spending to business spending to government spending.

GDP is also used to show the economic growth rate. That is, when compared to previous years, it tells us whether a country is expanding (producing more) or contracting (producing less)

This economic growth rate is usually measured in real GDP which is GDP adjusted for inflation.

Voila! We just learned GDP. If you enjoy this post and feel it was valuable in teaching you GDP, share it with your friends that might benefit from this information. 

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