Gross domestic product

Gross domestic product

Overview



Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP per capita
Per capita
Per capita is a Latin prepositional phrase: per and capita . The phrase thus means "by heads" or "for each head", i.e. per individual or per person...

 is often considered an indicator of a country's standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

.

Gross domestic product is related to national accounts
National accounts
National accounts or national account systems are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry accounting...

, a subject in macroeconomics
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

.

GDP was first developed by Simon Kuznets
Simon Kuznets
Simon Smith Kuznets was a Russian American economist at the Wharton School of the University of Pennsylvania who won the 1971 Nobel Memorial Prize in Economic Sciences "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and...

 for a US Congress report in 1934, who immediately said not to use it as a measure for welfare (see below under limitations).

GDP can be determined in three ways, all of which should, in principle, give the same result.
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Encyclopedia



Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP per capita
Per capita
Per capita is a Latin prepositional phrase: per and capita . The phrase thus means "by heads" or "for each head", i.e. per individual or per person...

 is often considered an indicator of a country's standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

.

Gross domestic product is related to national accounts
National accounts
National accounts or national account systems are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry accounting...

, a subject in macroeconomics
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

.

History


GDP was first developed by Simon Kuznets
Simon Kuznets
Simon Smith Kuznets was a Russian American economist at the Wharton School of the University of Pennsylvania who won the 1971 Nobel Memorial Prize in Economic Sciences "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and...

 for a US Congress report in 1934, who immediately said not to use it as a measure for welfare (see below under limitations).

Determining GDP


GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.

The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

Example: the expenditure method:
GDP = private consumption
Consumption (economics)
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...

 + gross investment
Gross private domestic investment
Gross private domestic investment is the measure of investment used to compute GDP. This is an important component of GDP because it provides an indicator of the future productive capacity of the economy. It includes replacement purchases plus net additions to capital assets plus investments in...

 + government spending
Government spending
Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...

 + (export
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...

s − import
Import
The term import is derived from the conceptual meaning as to bring in the goods and services into the port of a country. The buyer of such goods and services is referred to an "importer" who is based in the country of import whereas the overseas based seller is referred to as an "exporter". Thus...

s)
, or




Note: "Gross" means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets.
"Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).


Economists (since Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...

) have preferred to split the general consumption term into two parts; private consumption, and public sector
Public sector
The public sector, sometimes referred to as the state sector, is a part of the state that deals with either the production, delivery and allocation of goods and services by and for the government or its citizens, whether national, regional or local/municipal.Examples of public sector activity range...

 (or government) spending. Two advantages of dividing total consumption this way in theoretical macroeconomics
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

 are:
  • Private consumption is a central concern of welfare economics
    Welfare economics
    Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...

    . 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
    Endogeneity (economics)
    In an econometric model, a parameter or variable is said to be endogenous when there is a correlation between the parameter or variable and the error term. Endogeneity can arise as a result of measurement error, autoregression with autocorrelated errors, simultaneity, omitted variables, and sample...

     private consumption, government consumption can be treated as exogenous, so that different government spending levels can be considered within a meaningful macroeconomic framework.

Production approach


The production approach is also called as Net Product or Value added method. This method consists of three stages:
  1. Estimating the Gross Value of domestic Output in various economic activities;
  2. Determining the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services; and finally
  3. Deducting intermediate consumption from Gross Value to obtain the Net Value of Domestic Output.


Symbolically,

Gross Value Added = Value of output – Value of Intermediate Consumption.

Value of Output = Value of the total sales of goods and services + Value of changes in the inventories.

The sum of Gross Value Added in various economic activities is known as GDP at factor cost.

GDP at factor cost plus indirect taxes less subsidies on products is GDP at Producer Price.

For measuring gross output of domestic product, economic activities (i.e. industries) are classified into various sectors. After classifying economic activities, the gross output of each sector is calculated by any of the following two methods:
  1. By multiplying the output of each sector by their respective market price and adding them together and
  2. By collecting data on gross sales and inventories from the records of companies and adding them together.


Subtracting each sector's intermediate consumption from gross output, we get sectoral Gross Value Added (GVA) at factor cost. We, then add gross value of all sectors to get GDP at factor cost. Adding indirect tax less subsidies in GDP at factor cost, we get GDP at Producer Prices.

Income approach


Another way of measuring GDP is to measure total income. If GDP is calculated this way it is sometimes called Gross Domestic Income (GDI), or GDP(I).
GDI should provide the same amount 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.)

This method measures GDP by adding incomes that firms pay households for factors of production they hire- wages for labour, interest for capital, rent for land and profits for entrepreneurship.

The US "National Income and Expenditure Accounts" divide incomes into five categories:
  1. Wages, salaries, and supplementary labour income
  2. Corporate profits
  3. Interest and miscellaneous investment income
  4. Farmers’ income
  5. Income from non-farm unincorporated businesses

These five income components sum to net domestic income at factor cost.

Two adjustments must be made to get GDP:
  1. Indirect taxes minus subsidies are added to get from factor cost to market prices.
  2. Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product.


Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is:
GDP = compensation of employees
Compensation of employees
Compensation of employees is a statistical term used in national accounts, balance of payments statistics and sometimes in corporate accounts as well...

 + gross operating surplus
Gross operating surplus
In the national accounts, is the portion of income derived from production by incorporated enterprises that is earned by the capital factor. It is calculated as a balancing item in the of the national accounts....

 + gross mixed income + taxes less subsidies on production and imports
GDP = COE + GOS + GMI + TP & MSP & M
  • 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
    Social security
    Social security is primarily a social insurance program providing social protection or protection against socially recognized conditions, including poverty, old age, disability, unemployment and others. Social security may refer to:...

     and other such programs.
  • Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits
    Profit (accounting)
    In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...

    , although only a subset of total costs are subtracted from gross output
    Gross Output
    Gross output is an economic concept used in national accounts such as the United Nations System of National Accounts and the US National Income and Product Accounts...

     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; it is the income of all of the factors of production in society. It 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
Factor cost
Factor cost has the following uses in economics:*Factor cost or national income by type of income is a measure of national income or output based on the cost of factors of production, instead of market prices...

 to GDP(I).

Total factor income is also sometimes expressed as:
Total factor income = Employee compensation + Corporate profits + Proprieter's income + Rental income + Net interest


Yet another formula for GDP by the income method is:


where R : rents
I : interests
P : profits
SA : statistical adjustments (corporate income taxes, dividends, undistributed corporate profits)
W : wages
Note the mnemonic, "ripsaw".

Expenditure approach


In economics, most things produced are produced for sale, and sold. Therefore, measuring the total expenditure of money used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP. Note that if you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Sweater-knitting is a small part of the economy, but if one counts some major activities such as child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of production. Similarly, if there is a long term shift from non-market provision of services (for example cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then this trend toward increased
market provision of services may mask a dramatic decrease in actual domestic production, resulting in overly optimistic
and inflated reported GDP. This is particularly a problem for economies which have shifted from production economies to
service economies
Service economy
Service economy can refer to one or both of two recent economic developments. One is the increased importance of the service sector in industrialized economies. Services account for a higher percentage of US GDP than 20 years ago...

.

Components of GDP by expenditure


GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M).
Y = C + I + G + (X − M)


Here is a description of each GDP component:
  • C (consumption) is normally the largest GDP component in the economy, consisting of private (household final consumption expenditure
    Household final consumption expenditure
    is a transaction of the national account's use of income account representing consumer spending. It consists of the expenditure incurred by households on individual consumption goods and services, including those sold at prices that are not economically significant...

    ) in the economy. These personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses but does not include the purchase of new housing.
  • I (investment) includes business investment in equipments for example and does not include exchanges of existing assets. Examples include construction of a new mine
    Mining
    Mining is the extraction of valuable minerals or other geological materials from the earth, from an ore body, vein or seam. The term also includes the removal of soil. Materials recovered by mining include base metals, precious metals, iron, uranium, coal, diamonds, limestone, oil shale, rock...

    , purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment. In contrast to its colloquial meaning, 'Investment' in GDP does not mean purchases of financial products
    Financial market
    In economics, a financial market is a mechanism that allows people and entities to buy and sell financial securities , commodities , and other fungible items of value at low transaction costs and at prices that reflect supply and demand.Both general markets and...

    . Buying financial products is classed as 'saving', as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds
    Bond (finance)
    In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

     or stock
    Stock
    The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

    s is a swapping of deed
    Deed
    A deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...

    s, a transfer of claims on future production, not directly an expenditure on products.
  • G (government spending) is the sum of government expenditures
    Government spending
    Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...

     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 payment
    Transfer payment
    In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...

    s, such as social security
    Social security
    Social security is primarily a social insurance program providing social protection or protection against socially recognized conditions, including poverty, old age, disability, unemployment and others. Social security may refer to:...

     or unemployment benefits.
  • X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.
  • M (imports) represents 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
    Supply and demand
    Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

     as domestic.


A fully equivalent definition is that GDP (Y) is the sum of final consumption expenditure
Final consumption expenditure
In the national accounts expenditure on goods and services that are used for the direct satisfaction of individual needs or collective needs of members of the community is recorded in the use of income account under the transaction final consumption expenditure .The most important part of final...

 (FCE)
, gross capital formation
Gross fixed capital formation
Gross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...

 (GCF)
, and net exports (X – M).
Y = FCE + GCF+ (X − M)

FCE can then be further broken down by three sectors (households, governments and non-profit institutions serving households) and GCF by five sectors (non-financial corporations, financial corporations, households, governments and non-profit institutions serving households). The advantage of this second definition is that expenditure is systematically broken down, firstly, by type of final use (final consumption or capital formation) and, secondly, by sectors making the expenditure, whereas the first definition partly follows a mixed delimitation concept by type of final use and sector.

Note that C, G, and I are expenditures on final goods and services; expenditures on intermediate goods and services do not count. (Intermediate goods and services are those used by businesses to produce other goods and services within the accounting year.
)

According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, "In general, the source data for the expenditures components are considered more reliable than those for the income components [see income method, below]."

Examples of GDP component variables


C, I, G, and NX(net exports): If a person spends money to renovate a hotel to increase occupancy rates, the spending represents private investment, but if he buys shares in a consortium to execute the renovation, it is saving. The former is included when measuring GDP
Measuring GDP
Gross domestic product, GDP, is defined as the total value of all goods and services produced within that territory during a given year. GDP is designed to measure the market value of production that flows through the economy....

 (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP.

If a hotel is a private home, spending for renovation would be measured as consumption, but if a government agency converts the hotel into an office for civil servants, the spending would be included in the public sector spending, or G.

If the renovation involves the purchase of a chandelier
Chandelier
A chandelier is a branched decorative ceiling-mounted light fixture with two or more arms bearing lights. Chandeliers are often ornate, containing dozens of lamps and complex arrays of glass or crystal prisms to illuminate a room with refracted light...

 from abroad, that spending would be
counted as C, G, or I (depending on whether a private individual, the government, or a business is doing the renovation), but then counted again as an import and subtracted from the GDP so that GDP counts only goods produced within the country.

If a domestic producer is paid to make the chandelier for a foreign hotel, the payment would not be counted as C, G, or I, but would be counted as an export.

A "production boundary" that delimits what will be counted as GDP.


"One of the fundamental questions that must be addressed in preparing the national economic accounts is how to define the production boundary–that is, what parts of the myriad human activities are to be included in or excluded from the measure of the economic production."

All output for market is at least in theory included within the boundary. Market output is defined as that which is sold for "economically significant" prices; economically significant
prices are "prices which have a significant influence on the amounts producers are willing to supply and purchasers wish to buy."
An exception is that illegal goods and services are often excluded even if they are sold at economically significant prices (Australia and the United States exclude them).

This leaves non-market output. It is partly excluded and partly included. First, "natural processes without human involvement or direction" are excluded.
Also, there must be a person or institution that owns or is entitled to compensation for the product. An example of what is included and excluded by these criteria is given by the United States' national accounts agency: "the growth of trees in an uncultivated forest is not included in production, but the harvesting of the trees from that forest is included."

Within the limits so far described, the boundary is further constricted by "functional considerations."
The Australian Bureau for Statistics explains this:
"The national accounts are primarily constructed to assist governments and others to make market-based macroeconomic policy decisions, including analysis of markets and factors affecting market performance, such as inflation and unemployment."
Consequently, production that is, according to them, "relatively independent and isolated from markets," or "difficult to value in an economically meaningful way" [i.e., difficult to put a price on] is excluded.
Thus excluded are services provided by people to members of their own families free of charge, such as child rearing, meal preparation, cleaning, transportation, entertainment of family members, emotional support, care of the elderly.
Most other production for own (or one's family's) use is also excluded, with two notable exceptions which are given in the list later in this section.

Nonmarket outputs that are included within the boundary are listed below. Since, by definition, they do not have a market price, the compilers of GDP must impute a value to them, usually either the cost of the goods and services used to produce them, or the value of a similar item that is sold on the market.
  • Goods and services provided by governments and non-profit organisations free of charge or for economically insignificant prices are included. The value of these goods and services is estimated as equal to their cost of production. This ignores the consumer surplus generated by an efficient and effective government supplied infrastructure. For example, government-provided clean water confers substantial benefits above its cost. Ironically, lack of such infrastructure which would result in higher water prices (and probably higher hospital and medication expenditures) would be reflected as a higher GDP. This may also cause a bias that mistakenly favors inefficient privatizations since some of the consumer surplus from privatized entities' sale of goods and services are indeed reflected in GDP.
  • Goods and services produced for own-use by businesses are attempted to be included. An example of this kind of production would be a machine constructed by an engineering firm for use in its own plant.
  • Renovations and upkeep by an individual to a home that she owns and occupies are included. The value of the upkeep is estimated as the rent that she could charge for the home if she did not occupy it herself. This is the largest item of production for own use by an individual (as opposed to a business) that the compilers include in GDP. If the measure uses historical or book prices for real estate, this will grossly underestimate the value of the rent in real estate markets which have experienced significant price increases (or economies with general inflation). Furthermore, depreciation schedules for houses often accelerate the accounted depreciation relative to actual depreciation (a well built house can be lived in for several hundred years – a very long time after it has been fully depreciated). In summary, this is likely to grossly underestimate the value of existing housing stock on consumers' actual consumption or income.
  • Agricultural production for consumption by oneself or one's household is included.
  • Services (such as chequeing-account maintenance and services to borrowers) provided by banks and other financial institutions without charge or for a fee that does not reflect their full value have a value imputed to them by the compilers and are included. The financial institutions provide these services by giving the customer a less advantageous interest rate than they would if the services were absent; the value imputed to these services by the compilers is the difference between the interest rate of the account with the services and the interest rate of a similar account that does not have the services. According to the United States Bureau for Economic Analysis, this is one of the largest imputed items in the GDP.

GDP vs GNP


GDP can be contrasted with gross national product (GNP) or gross national income
Gross National Income
The GNI consists of: the personal consumption expenditures, the gross private investment, the government consumption expenditures, the net income from assets abroad , and the gross exports of goods and services, after deducting two components: the gross imports of goods and services, and the...

 (GNI). The difference is that GDP defines its scope according to location, while GNP defines its scope according to ownership. In a global context, world GDP and world GNP
Gross world product
Gross world product is the total gross national product of all the countries in the world. This also equals the total gross domestic product. See measures of national income and output for more details...

 are, therefore, equivalent terms.

GDP is product produced within a country's borders; GNP is product produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNP non-identical. Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNP; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNP but not its GDP.

To take the United States as an example, the U.S.'s GNP is the value of output produced by American-owned firms, regardless of where the firms are located. Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the
use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.

Gross national income (GNI) equals GDP plus income receipts from the rest of the world minus income payments to the rest of the world.

In 1991, the United States switched from using GNP to using GDP as its primary measure of production.
The relationship between United States GDP and GNP is shown in table 1.7.5 of the National Income and Product Accounts
National Income and Product Accounts
The National Income and Product Accounts are part of the national accounts of the United States. They are produced by the Bureau of Economic Analysis of the Department of Commerce...

.

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
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...

, European Union
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...

, Organization for Economic Co-operation and Development, United Nations
United Nations
The United Nations is an international organization whose stated aims are facilitating cooperation in international law, international security, economic development, social progress, human rights, and achievement of world peace...

 and World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...

. 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.

National measurement


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).

Interest rates


Net interest expense is a transfer payment
Transfer payment
In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...

 in all sectors except the financial sector. Net interest expenses in the financial sector are seen as production
Mass production
Mass production is the production of large amounts of standardized products, including and especially on assembly lines...

 and value added
Value added
In economics, the difference between the sale price and the production cost of a product is the value added per unit. Summing value added per unit over all units sold is total value added. Total value added is equivalent to Revenue less Outside Purchases...

 and are added to GDP.

Nominal GDP and Adjustments to GDP


The raw GDP figure as given by the equations above is called the Nominal, or Historical, or Current, GDP. When comparing GDP figures from one year to another, it is desirable to compensate for changes in the value of money – i.e., for the effects of inflation or deflation. To make it more meaningful for year-to-year comparisons, it may be multiplied by the ratio between the value of money in the year the GDP was measured and the value of money in some base year. For example, suppose a country's GDP in 1990 was $100 million and its GDP in 2000 was $300 million; but suppose that inflation had halved the value of its currency over that period. To meaningfully compare its 2000 GDP to its 1990 GDP we could multiply the 2000 GDP by one-half, to make it relative to 1990 as a base year. The result would be that the 2000 GDP equals $300 million × one-half = $150 million, in 1990 monetary terms. We would see that the country's GDP had, realistically, increased 50 percent over that period, not 200 percent, as it might appear from the raw GDP data. The GDP adjusted for changes in money-value in this way is called the Real, or Constant, GDP.

The factor used to convert GDP from current to constant values in this way is called the GDP deflator
GDP deflator
In economics, the GDP deflator is a measure of the level of prices of all new, domestically produced, final goods and services in an economy...

. Unlike the Consumer price index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...

, which measures inflation or deflation in the price of household consumer goods, the GDP deflator measures changes in the prices of all domestically produced goods and services in an economy–including investment goods and government services, as well as household consumption goods.

Constant-GDP figures allow us to calculate a GDP growth rate, which tells us how much a country's production has increased (or decreased, if the growth rate is negative) compared to the previous year.
Real GDP growth rate for year n = [(Real GDP in year n) − (Real GDP in year n − 1)] / (Real GDP in year n − 1)


Another thing that it may be desirable to compensate for is population growth. If a country's GDP doubled over some period but its population tripled, the increase in GDP may not be deemed such a great accomplishment: the average person in the country is producing less than they were before. Per-capita GDP is the measure compensated for population growth.

Cross-border comparison


The level of GDP in different countries may be compared by converting their value in national currency according to either the current currency exchange rate, or the purchase power parity exchange rate.
  • Current currency exchange rate is the exchange rate in the international currency market.
  • Purchasing power parity exchange rate is the exchange rate based on the purchasing power parity
    Purchasing power parity
    In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...

     (PPP) of a currency relative to a selected standard (usually the United States dollar
    United States dollar
    The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....

    ). This is a comparative (and theoretical) exchange rate, the only way to directly realize this rate is to sell an entire CPI
    CPI
    A consumer price index is a measure of the average price of consumer goods and services purchased by householdsCPI may also stand for:*Central Port Injection, see fuel injection...

     basket in one country, convert the cash at the currency market rate & then rebuy that same basket of goods in the other country (with the converted cash). Going from country to country, the distribution of prices within the basket will vary; typically, non-tradable purchases will consume a greater proportion of the basket's total cost in the higher GDP country, per the Balassa-Samuelson effect
    Balassa-Samuelson effect
    The Balassa–Samuelson effect, also known as Harrod–Balassa–Samuelson effect , the Ricardo–Viner–Harrod–Balassa–Samuelson–Penn–Bhagwati effect , productivity biased purchasing power parity and the rule of five eights is either of two related things:#The observation that consumer price levels...

    .


The ranking of countries may differ significantly based on which method is used.
  • The current exchange rate method converts the value of goods and services using global currency exchange rates. The method 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
    Weapon
    A weapon, arm, or armament is a tool or instrument used with the aim of causing damage or harm to living beings or artificial structures or systems...

    , 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. The method can provide a better indicator of the living standards of less developed countries, because it compensates for the weakness of local currencies in the international markets. For example, India ranks 11th by nominal GDP, but fourth by PPP. The PPP method of GDP conversion is more 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
Penn effect
The Penn effect is the economic finding associated with what became the Penn World Table that real income ratios between high and low income countries are systematically exaggerated by gross domestic product conversion at market exchange rates...

.

For more information, see Measures of national income and output
Measures of national income and output
A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product , gross national product , and net national income . All are specially concerned with counting the total amount of goods and...

.

Per unit GDP


GDP is an aggregate figure which does not consider differing sizes of nations. Therefore, GDP can be stated as GDP per capita (per person) in which total GDP is divided by the resident population on a given date, GDP per citizen where total GDP is divided by the numbers of citizens residing in the country on a given date, and less commonly GDP per unit of a resource input, such as GDP per GJ of energy or Gross domestic product per barrel
Gross domestic product per barrel
Energy efficiency as it relates to oil usage can be described by the gross domestic product per barrel of oil used . The original data for this is taken from two sources, the and the List of countries by GDP article from Wikipedia...

.
GDP per citizen in the above case is pretty similar to GDP per capita in most nations, however, in nations with very high proportions of temporary foreign workers like in Persian Gulf nations, the two figures can be vastly different.

Standard of living and GDP


GDP per capita is not a measurement of the standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

 in an economy
Economic system
An economic system is the combination of the various agencies, entities that provide the economic structure that defines the social community. These agencies are joined by lines of trade and exchange along which goods, money etc. are continuously flowing. An example of such a system for a closed...

. However, it is often used as such an indicator, on the rationale that all citizens would benefit from their country's increased economic production. Similarly, GDP per capita is not a measure of personal income. GDP may increase while real income
Real income
Real income is the income of individuals or nations after adjusting for inflation. It is calculated by subtracting inflation from the nominal income...

s for the majority decline. The major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely, and consistently. It is measured frequently in that most countries provide information on GDP on a quarterly basis, allowing trends to be seen quickly. It is measured widely in that some measure of GDP is available for almost every country
Country
A country is a region legally identified as a distinct entity in political geography. A country may be an independent sovereign state or one that is occupied by another state, as a non-sovereign or formerly sovereign political division, or a geographic region associated with a previously...

 in the world
World
World is a common name for the whole of human civilization, specifically human experience, history, or the human condition in general, worldwide, i.e. anywhere on Earth....

, allowing inter-country comparisons. It is measured consistently in that the technical definition of GDP is relatively consistent among countries.

The major disadvantage is that it is not a measure of standard of living. GDP is intended to be a measure of total national economic activity— a separate concept.

The argument for using GDP as a standard-of-living proxy
Proxy (statistics)
In statistics, a proxy variable is something that is probably not in itself of any great interest, but from which a variable of interest can be obtained...

 is not that it is a good indicator of the absolute level of standard of living, but that living standards tend to move with per-capita GDP, so that changes in living standards are readily detected through changes in GDP.

Proponents of GDP as a metric of social well being argue that it is a value neutral measure and expresses what we can do, not what we should do. This is compatible with the fact that different people have different preferences and different opinions on what well-being is. Competing measures like GPI define well-being to mean things that the definers ideologically support. Therefore, they cannot function as the goals of a plural society. Moreover, they are more vulnerable to political manipulation.

Externalities


GDP is widely used by economists to gauge economic recession and recovery and an economies general monetary ability address externalites. Its not meant to measure externalities. Its serves as a general metric for a nominal monetary standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

 and is not adjusted for costs of living within a region. GDP is a neutral measure which merely shows an economy's general ability to pay for externalities such as social and environmental concerns. Examples of externalities include:
  • Wealth distribution – GDP does not account for variances in incomes of various demographic groups. See income inequality metrics
    Income inequality metrics
    The concept of inequality is distinct from that of poverty and fairness. Income inequality metrics or income distribution metrics are used by social scientists to measure the distribution of income, and economic inequality among the participants in a particular economy, such as that of a specific...

     for discussion of a variety of inequality-based economic measures.
  • Non-market transactions–GDP excludes activities that are not provided through the market, such as household production and volunteer or unpaid services. As a result, GDP is understated. Unpaid work conducted on Free and Open Source Software
    Foss
    Foss may refer toPeople*Foss , people with the last name Foss*Foss Shanahan , New Zealand diplomat*Foss Westcott , English bishop...

     (such as Linux
    Linux
    Linux is a Unix-like computer operating system assembled under the model of free and open source software development and distribution. The defining component of any Linux system is the Linux kernel, an operating system kernel first released October 5, 1991 by Linus Torvalds...

    ) contribute nothing to GDP, but it was estimated that it would have cost more than a billion US dollars for a commercial company to develop. Also, if Free and Open Source Software became identical to its proprietary software
    Proprietary software
    Proprietary software is computer software licensed under exclusive legal right of the copyright holder. The licensee is given the right to use the software under certain conditions, while restricted from other uses, such as modification, further distribution, or reverse engineering.Complementary...

     counterparts, and the nation producing the propriety software stops buying proprietary software and switches to Free and Open Source Software, then the GDP of this nation would reduce, however there would be no reduction in economic production or standard of living. The work of New Zealand economist Marilyn Waring
    Marilyn Waring
    Marilyn Waring, CNZM, D.Phil., D.Litt. is a New Zealand feminist, a politician, an activist for female human rights and environmental issues, an author and an academic, known for her contributions to feminist economics....

     has highlighted that if a concerted attempt to factor in unpaid work were made, then it would in part undo the injustices of unpaid (and in some cases, slave) labour, and also provide the political transparency and accountability necessary for democracy. Shedding some doubt on this claim, however, is the theory that won economist Douglass North
    Douglass North
    Douglass Cecil North is an American economist known for his work in economic history. He is the co-recipient of the 1993 Nobel Memorial Prize in Economic Sciences...

     the Nobel Memorial Prize in Economic Sciences in 1993. North argued that the encouragement of private invention and enterprise due to the creation and strengthening of the patent system became the fundamental catalyst behind the Industrial Revolution in England.
  • Underground economy–Official GDP estimates may not take into account the underground economy
    Underground economy
    A black market or underground economy is a market in goods or services which operates outside the formal one supported by established state power. Typically the totality of such activity is referred to with the definite article as a complement to the official economies, by market for such goods and...

    , in which transactions contributing to production, such as illegal trade and tax-avoiding activities, are unreported, causing GDP to be underestimated.
  • Asset Value–GDP does not take into account the value of all assets in an economy. This is akin to ignoring a company's balance sheet
    Balance sheet
    In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

    , and judging it solely on the basis of its income statement
    Income statement
    Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...

    .
  • Non-monetary economy–GDP omits economies where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures. For example, in countries with major business transactions occurring informally, portions of local economy are not easily registered. Bartering may be more prominent than the use of money, even extending to services (I helped you build your house ten years ago, so now you help me).
  • GDP also ignores subsistence production.
  • Quality improvements and inclusion of new products–By not adjusting for quality improvements and new products, GDP understates true economic growth
    Economic growth
    In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...

    . For instance, although computers today are less expensive and more powerful than computers from the past, GDP treats them as the same products by only accounting for the monetary value. The introduction of new products is also difficult to measure accurately and is not reflected in GDP despite the fact that it may increase the standard of living. For example, even the richest person from 1900 could not purchase standard products, such as antibiotics and cell phones, that an average consumer can buy today, since such modern conveniences did not exist back then.
  • What is being produced–GDP counts work that produces no net change or that results from repairing harm. For example, rebuilding after a natural disaster or war may produce a considerable amount of economic activity and thus boost GDP. The economic value of health care
    Health care
    Health care is the diagnosis, treatment, and prevention of disease, illness, injury, and other physical and mental impairments in humans. Health care is delivered by practitioners in medicine, chiropractic, dentistry, nursing, pharmacy, allied health, and other care providers...

     is another classic example—it may raise GDP if many people are sick and they are receiving expensive treatment, but it is not a desirable situation. Alternative economic estimates, such as the standard of living
    Standard of living
    Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

     or discretionary income per capita try to measure the human utility
    Utility
    In economics, utility is a measure of customer satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service....

     of economic activity. See uneconomic growth
    Uneconomic growth
    Uneconomic growth, in human development theory, welfare economics , and some forms of ecological economics, is economic growth that reflects or creates a decline in the quality of life. The concept is attributed to the economist Herman Daly, though other theorists can also be credited for the...

    .
  • Sustainability of growth– GDP is a measurement of economic historic activity and is not a necessarily a projection. A country may achieve a temporarily high GDP from use of natural resources or by misallocating investment.
  • Nominal GDP doesn't measure variations in purchasing power or costs of living by area, so when the GDP figure is deflated over time, GDP growth can vary greatly depending on the basket of goods used and the relative proportions used to deflate the GDP figure.
  • Cross-border comparisons of GDP can be inaccurate as they do not take into account local differences in the quality of goods, even when adjusted for purchasing power parity
    Purchasing power parity
    In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...

    . This type of adjustment to an exchange rate is controversial because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries. For instance, people in country A may consume the same number of locally produced apples as in country B, but apples in country A are of a more tasty variety. This difference in material well being will not show up in GDP statistics. This is especially true for goods that are not traded globally, such as housing.
  • As a measure of actual sale prices, GDP does not capture the economic surplus
    Economic surplus
    In mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...

     between the price paid and subjective value received, and can therefore underestimate aggregate utility
    Utility
    In economics, utility is a measure of customer satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service....

    .


Simon Kuznets
Simon Kuznets
Simon Smith Kuznets was a Russian American economist at the Wharton School of the University of Pennsylvania who won the 1971 Nobel Memorial Prize in Economic Sciences "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and...

 in his very first report to the US Congress in 1934 said:
...the welfare of a nation can, therefore, scarcely be inferred from a measure of national income...
In 1962, Kuznets stated:
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.

Lists of countries by their GDP


List of Newer Approaches to the Measurement of (Economic) Progress

  • Human development index
    Human Development Index
    The Human Development Index is a composite statistic used to rank countries by level of "human development" and separate "very high human development", "high human development", "medium human development", and "low human development" countries...

     (HDI) – up until 2009 report HDI used GDP as a part of its calculation and then factors in indicators of life expectancy and education levels. In 2010 the GDP component has been replaced with GNI
    Gross National Income
    The GNI consists of: the personal consumption expenditures, the gross private investment, the government consumption expenditures, the net income from assets abroad , and the gross exports of goods and services, after deducting two components: the gross imports of goods and services, and the...

    .
  • Genuine progress indicator
    Genuine Progress Indicator
    The genuine progress indicator is an alternative metric system which is an addition to the national system of accounts that has been suggested to replace, or supplement, gross domestic product as a metric of economic growth...

     (GPI) or Index of Sustainable Economic Welfare
    Index of Sustainable Economic Welfare
    The Index of Sustainable Economic Welfare is an economic indicator intended to replace the gross domestic product.Rather than simply adding together all expenditures like the gross domestic product, consumer expenditure is balanced by such factors as income distribution and cost associated with...

     (ISEW) – The GPI and the ISEW attempt to address many of the above criticisms by taking the same raw information supplied for GDP and then adjust for income distribution, add for the value of household and volunteer work, and subtract for crime and pollution.
  • Gross national happiness
    Gross national happiness
    The assessment of gross national happiness was designed in an attempt to define an indicator that measures quality of life or social progress in more holistic and psychological terms than only the economic indicator of gross domestic product .-Origins and meaning:The term...

     (GNH) – GNH measures quality of life or social progress in more holistic and psychological terms than GDP.
  • European Quality of Life Survey – The survey, first published in 2005, assessed quality of life across European countries through a series of questions on overall subjective life satisfaction, satisfaction with different aspects of life, and sets of questions used to calculate deficits of time, loving, being and having.
  • Gross national happiness
    Gross national happiness
    The assessment of gross national happiness was designed in an attempt to define an indicator that measures quality of life or social progress in more holistic and psychological terms than only the economic indicator of gross domestic product .-Origins and meaning:The term...

     – The Centre for Bhutanese Studies in Bhutan
    Bhutan
    Bhutan , officially the Kingdom of Bhutan, is a landlocked state in South Asia, located at the eastern end of the Himalayas and bordered to the south, east and west by the Republic of India and to the north by the People's Republic of China...

     is working on a complex set of subjective and objective indicators to measure 'national happiness' in various domains (living standards, health, education, eco-system diversity and resilience, cultural vitality and diversity, time use and balance, good governance, community vitality and psychological well-being). This set of indicators would be used to assess progress towards gross national happiness, which they have already identified as being the nation's priority, above GDP.
  • Happy Planet Index
    Happy Planet Index
    The Happy Planet Index is an index of human well-being and environmental impact that was introduced by the New Economics Foundation in July 2006. The index is designed to challenge well-established indices of countries’ development, such as Gross Domestic Product and the Human Development Index...

     – The happy planet index (HPI) is an index of human well-being and environmental impact, introduced by the New Economics Foundation
    New Economics Foundation
    The New Economics Foundation is a British think-tank.NEF was founded in 1986 by the leaders of The Other Economic Summit with the aim of working for a "new model of wealth creation, based on equality, diversity and economic stability"....

     (NEF) in 2006. It measures the environmental efficiency with which human well-being is achieved within a given country or group. Human well-being is defined in terms of subjective life satisfaction and life expectancy
    Life expectancy
    Life expectancy is the expected number of years of life remaining at a given age. It is denoted by ex, which means the average number of subsequent years of life for someone now aged x, according to a particular mortality experience...

     while environmental impact is defined by the Ecological Footprint
    Ecological footprint
    The ecological footprint is a measure of human demand on the Earth's ecosystems. It is a standardized measure of demand for natural capital that may be contrasted with the planet's ecological capacity to regenerate. It represents the amount of biologically productive land and sea area necessary to...

    .
  • OECD Better Lives Dashboard - The better lives compendium of indicators produced in 2011 reflects some 10 years by the organisation to develop a wider of set of indicators more closed attuned to the measurement of wellbeing or welfare outcomes. There is felt to be considerable convergence (in 2011) in high income countries about the kinds of dimensions that should be included in such multi-dimensional approaches to welfare measurement - see for instance the capabilities measurement research project capabilities approach.

See also



  • Annual average GDP growth
  • Chained volume series
    Chained volume series
    A Chained volume series is a series of economic data from successive years, put in real terms by computing the production volume for each year in the prices of the preceding year, and then 'chain linking' the data together to obtain a time-series of production figures from which the effects...

  • Circular flow of income
    Circular flow of income
    In economics, the terms circular flow of income or circular flow refer to a simple economic model which describes the reciprocal circulation of income between producers and consumers...

  • Eco-sufficiency
    Eco-sufficiency
    Eco-sufficiency requires a reduction of the level of production/consumption in those parts of the world with the highest standards of living beyond reducing the use of natural resources as well as waste and emissions per unit of production/consumption...

  • Green gross domestic product
    Green Gross Domestic Product
    The green gross domestic product is an index of economic growth with the environmental consequences of that growth factored in. Green GDP monetizes the loss of biodiversity, and accounts for costs caused by climate change...

  • Gross domestic product per barrel
    Gross domestic product per barrel
    Energy efficiency as it relates to oil usage can be described by the gross domestic product per barrel of oil used . The original data for this is taken from two sources, the and the List of countries by GDP article from Wikipedia...

  • Gross output
    Gross Output
    Gross output is an economic concept used in national accounts such as the United Nations System of National Accounts and the US National Income and Product Accounts...


  • Gross regional domestic product
    Gross regional domestic product
    Gross Regional Domestic Product or Gross Domestic Product of Region is a subnational gross domestic product for measuring the size of that region's economy. It "is the aggregate of gross value added of all resident producer units in the region...

  • Gross state product
    Gross state product
    Gross state product is a measurement of the economic output of a state or province...

  • Gross value added
    Gross value added
    Gross Value Added ' is a measure in economics of the value of goods and services produced in an area, industry or sector of an economy...

  • Gross world product
    Gross world product
    Gross world product is the total gross national product of all the countries in the world. This also equals the total gross domestic product. See measures of national income and output for more details...

  • Intermediate consumption
    Intermediate consumption
    Intermediate consumption is an economic concept used in national accounts, such as the United Nations System of National Accounts , the US National Income and Product Accounts and the European System of Accounts .Conceptually, the aggregate "intermediate consumption" is equal to the amount of the...

  • Inventory investment
    Inventory investment
    Inventory investment is a component of gross domestic product . What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced. Conversely, some of the goods sold in a...

  • List of countries by average wage

  • List of countries by household income
  • List of economic reports by U.S. government agencies
  • Misery index (economics)
    Misery index (economics)
    The misery index is an economic indicator, created by economist Arthur Okun, and found by adding the unemployment rate to the inflation rate. It is assumed that both a higher rate of unemployment and a worsening of inflation create economic and social costs for a country...

  • National average salary
    National average salary
    The National Average Salary is the mean salary for the working population of a nation. It is calculated by summing all the annual salaries of all persons in work and dividing the total by the number of workers...

  • Potential output
    Potential output
    In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...

     Natural gross domestic product
  • Real gross domestic product

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