GDP - CALCULATION & LIMITATIONS

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GDP


GDP or gross domestic product measures the value of goods and services produced in an economy. GDP is calculated quarterly. It is the total expenditures on final goods and services produced in an economy in a period of time.
It also measures total revenue generated in an economy. You might think that how is it possible that a single measurement is measuring both revenue and expenditure. But it's true, as for the economy as a whole, total revenue is equal to total expenditure.
It is because if you buy a product you pay for it, and the one who is selling you also belongs to the same country. Now you may think that what if we buy a foreign product. We will discuss this when we will calculate GDP.


CALCULATION OF GDP

GDP = C + I + G + ( X-M)

where,
C = private consumption expenditure. 
It includes expenditures on all goods and services which are done by people in an economy but it does not include housing purchases. We add housing purchase in the investment section.

I = Investments. 
It includes investments on those goods which are to be used in the process of further production of goods and services like inventories, capital equipment etc. It also includes housing purchases.

G  = Government purchases
It includes all purchases done by the government. Purchases include both consumption expenditure and investment expenditure.

X-M = Exports - Imports
Here we subtract imports from exports because goods and services which are imported are not produced in our country so it can't be a part of our nation's revenue  also. On the other side Exports are added to GDP because goods and services which are exported are produced in our country and hence are a part of our nation's revenue.


REAL & NOMINAL GDP

 You may have often heard about GDP only but there are two forms of GDP one is Real GDP and other is Nominal GDP.
In nominal GDP we calculate value of goods and services on basis of current prices. But if we want to measure the economic growth or the increase in quantity of goods and services we can't draw a meaningful conclusion from nominal GDP only. It is because of "inflation" or "mehangaai". As I said nominal GDP is GDP at current price which means it includes inflation also. So in order to calculate our real economic growth we have to calculate Real GDP, which means GDP at base year prices.

In real GDP we calculate the value of goods and services on the basis of base year prices. Base year means a year which is taken as a base to calculate real GDP so that we can compare the quantity increase in GDP. Like now in India we have base year as 2011-12.
So suppose, 

quantity produced = 100
current year price = 20
base year prices = 15

Nominal GDP = P1 * Q1
where,
P1 is the current prices and Q1 is the quantity produced.

therefore
nominal GDP = 100*20
                       = 2000

Real GDP = Q1 * Po
where 
Po is the base year price.

so real GDP will be = 100*15
                                   = 1500

GDP DEFLATOR


GDP deflator =  Nominal GDP /  Real GDP
                           
                       = ( Q1 * P1) / ( Q1 * Po)
                       
                        = P1 / Po

as per the above example GDP deflator will be  = 2000/1500
                                                                               = 1.33

GDP deflator is the measure of the level of prices of domestically produced goods and services.
I will be covering this topic in another article where I will compare GDP deflator with inflation.


LIMITATIONS

GDP too has limitations as it is not a true measure of economic prosperity of an economy.

- First of all GDP does not include illegal activities as it can't be measured. But as we all know illegal activities are also there in an economy which may cover a large portion of economic activities in countries where corruption is high.

- Secondly, we can't say that high GDP means no poverty or greater income. As per capita GDP of India is around 2000 USD  but unfortunately there are many people who are still below the poverty line and are not able to get proper nutritional diet.

- We all work 5 or 6 days a week. But if we will work 7 days a week the GDP may increase as there will be an increase in production of goods and sevices but on the other hand there will be no leisure in life and everyone will not be better off. 


Shaurya Gupta
Bcom(hons), University of Delhi
Financial Markets(hons), Yale University

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