To assess the growth of the economy, people often use the GDP index. So what is GDP? What does GDP mean and how is it calculated? We will learn about GDP in the following article.
Table of Contents
What is GDP?
GDP stands for the English phrase “Gross Domestic Product”. Or more specifically, GDP is the total value of goods and services produced within the geographical boundaries of a country during a specified period of time, be it a quarter, or 6 months, or 9 months, or 1 year.
GDP is an extremely important indicator, showing the economic size and growth rate of a country.
What is GDP per capita?
GDP per capita is an indicator showing the average production and business results per capita of a country in a year. High GDP per capita is directly proportional to the income level and life of the bride in that country.
The GDP per capita of a country at a point in time is calculated by dividing the GDP of the country by the total population of the country at that time.
What is nominal GDP?
Nominal GDP in English is Nominal Gross Domestic Product which means GDP at current market prices. Nominal GDP will reflect price changes due to inflation and the price growth rate of the economy. If all price levels increase or stay the same, nominal GDP will be larger.
What is real GDP?
Real GDP in English is Real Gross Domestic Product (or Real GDP), which is understood as a measure of the total product of goods and services in the country adjusted for the rate of inflation. If inflation is positive, real GDP will be lower than nominal GDP because the formula for calculating real GDP = nominal GDP / GDP deflator.
What is green GDP?
Green GDP – Green GDP is the remaining GDP after deducting part of the costs to restore the environment as a result of the reproduction process. Green GDP = GDP – all environmental regeneration costs in the production cycle.
What GDP means for a country
The GDP index has important implications for the country’s economy as follows:
- GDP is a measure that reflects the economic growth rate of a country, showing the changes in the price of goods and services over time.
- GDP per capita will show the average income of the people as well as the quality of life, the standard of living of the people of each country.
- A decrease in GDP will show economic recession, inflation and price stagnation, unemployment, directly affecting people’s quality of life.
However, besides that, the GDP index also has some limitations which are:
- Does not fully reflect goods production activities and goods quality.
- It is not possible to accurately measure the economic development of the country or the quality of life of the people.
- Only final goods production and new capital investment are considered, ignoring cooperation between businesses
- It does not take into account self-sufficient activities within the country, does not quantify the value of informal economic activities.
Factors affecting GDP index
The three factors that affect the GDP index are:
- Population: GDP and population have a reciprocal relationship, based on population to calculate GDP per capita. Population is the labor force that creates material and is also the object of consumption of products and services.
- FDI: FDI index also affects GDP index. Long-term forms of foreign investment include money, materials, infrastructure, means of production, etc.
- Inflation: Inflation is the loss of value of money, escalating prices, increasing continuously over time. Excessive inflation will lead to an economic crisis but is mistaken as an increase in GDP.
How to calculate GDP index
There are 3 ways to calculate GDP index that are:
- Calculate the total score.
- Calculated by income.
- Calculated by production method.
Calculating GDP by target method (total indicator)
Recipe
Calculating GDP by total indicator is the most accurate method with the following formula:
GDP = C + G + I + NX
Inside:
- C is the household indicator: includes indicators for household products and services.
- G is the government indicator: total spending on education, health care, security, transportation, etc.
- I is the total investment: expenditures of the enterprise including equipment, factories
- NX is the balance of trade: the economy’s net exports. NX = X (export) – M (import).
Example: A simple economy consists of: households (H), flour mill owners (M) and bakery owners (B). H buys bread from B for 100 and flour from M for 10 (as expenditures on the final product). B buys flour from M for 40 to make bread.
Assume that M uses no other intermediate products. Both B and M receive labor and capital services from H; B has paid H amounts including: 30 for labor costs and 30 for capital services. Similarly, M has paid to H the following items: 40 for labor hire and 10 for capital rental.
From the above information, GDP by expenditure method will be calculated as follows:
GDP = C + G + I + NX (since there is only household spending, I=0, G=0, NX=0) => GDP = 10 + 100 = 110
Calculating GDP by cost method (earnings)
Recipe
The formula for calculating income is:
GDP = W + I + Pr + R + Ti + De
Inside:
- W is salary.
- I is the profit.
- Pr is profit.
- R is the rent.
- Ti is an indirect tax (tax not levied directly on income and assets, but indirectly through prices of goods and services).
- De is the depreciation (depreciation) of fixed assets.
Example: A simple economy consists of households (K), flour mill owners (A) and bakery owners (B). K buys bread from B for 200 and flour from A for 20 (as expenditures on the final product). B buys flour from A for 50 to make bread.
Assume A uses no other intermediate products. Both B and A receive labor and capital services from K; B has paid K amounts including: 40 for labor costs and 40 for capital services. And A has paid to K the following amounts: 50 for labor hire and 20 for capital rental.
Applying the formula for calculating GDP using the cost (income) method, instead of looking at who buys the product, you can find out who gets paid to make the product.
Calculating GDP by production method
Recipe
The formula for calculating GDP by the production method is:
GDP = Value Added + Import Tax
or
GDP = Value of production – intermediate costs + import tax
Value added can be producer’s income, wages, insurance, production tax, depreciation of fixed assets, surplus value, other incomes…
Example: A simple economy consists of households (C), bakery owners (B) and flour mill owners (A). C buys bread from B for 100 and flour from A for 10 (as expenditures on the final product). B buys flour from A for 40 to make bread.
Assume A uses no other intermediate products. Both B and A receive labor and capital services from C; B has paid C amounts including: 30 for labor costs and 30 for capital services. And A has paid to C the following amounts: 40 for labor hire and 10 for capital rental.
In fact, not all market transactions are included in GDP. Because if you do so, the same product will be counted multiple times.
Therefore, to get an accurate GDP index, you must distinguish intermediate goods from goods purchased to be used as inputs to produce another product and used only once in the production process.
At this point we have:
- B buys flour from A for 40 and sells it to C for 100, now B gets 60
- C is paid 40 by A for labor and 10 for capital, thus C earns 50.
=> GDP = added value + import tax = (10 + 40) + (100 – 40) = 110
Difference between GDP and GNP
GDP and GNP are the same, both are indicators of the economic development of a country over a certain period of time.
The difference between GDP and GNP is:
| Criteria | GDP index | GNP index |
| Concept | GDP refers to the total value of all goods, products, services, etc. within a country within a year. The higher the GDP, the stronger the economy of that country and vice versa. | GNP – Gross National Product is the gross national product, which refers to the total value in money of the goods and services produced by all the citizens of a country in a year. GNP measures the economic development of a country. |
| Calculation formula | GDP = C + I + G + NX | GNP = C + I + G + (X – M) + NR |
| Nature | – Gross domestic product index (domestic)
– GDP index is the total value created by economic sectors operating in the territory of the country in a year. – Economic sectors contributing to the GDP index include domestic and foreign economic sectors operating in that country. |
– GNP is an index reflecting gross national product (domestic and foreign). – GNP is the total value produced by citizens of that country in a year. Citizens of that country can create values both inside and outside of that country. |
Note:
- C = Personal consumption expenses
- I = Total personal investment
- G = Government expenses
- NX = “net exports” of the economy
- X = Exports of goods and services
- M = Import turnover of goods and services
- NR= Net income from goods and services invested abroad (net income)
Compare GDP and CPI
When you compare GDP and CPI, you are actually comparing the CPI and the GDP deflator, also known as the GDP deflator, denoted by D GDP. These two indicators have the following similarities and differences:
| Comparative criteria | GDP Deflator | CPI (Consumer Price Index) |
| similar | Two main indicators to measure macroeconomics. | |
| different | ||
| nature | Measure all the prices of goods and services produced. | Measures the prices of goods and services purchased by consumers (excluding prices of goods and services purchased by governments, firms) |
| Calculated value | Only for domestically produced goods and services | Charged for all goods and services purchased, including imported goods |
| Changeability | There is a change. That is, this index allows the change of the basket of goods when the components of GDP change. Called Paasche index | Fixed influence that is, it is calculated by the fixed cart. Called the Laspeyres index |
| Meaning | Reduce the trend of increasing cost of living | Measure the cost of living |
Conclusion
What is GDP? GDP is the total value of goods and services produced in a country during a specified time period. GDP represents the economic size and growth rate of a country.
