The Gross Domestic Product, also known as GDP is an important value for an economy. It is the monetary value in the local currency of the goods and services that are produced in a country over a certain period of time. The GDP is considered as the measurement of the economic activity of a country. It includes the total goods and services purchased by consumers including private expenditures, net exports, investment, and government spending. There are two ways to calculate GDP.
A common approach for measuring the Gross domestic product is a formula which is based on the money spent by different groups in the economy. The formula is:
- G is the total government spending which includes the salary of employees, public schools, military expenditure, and road repair or construction.
- C is the consumption or private consumer spending in the economy and it includes durable and non-durable goods and services.
- I is the investment spent on inventory, housing, and equipment by the country.
- NX is the net exports of the country.
The second approach takes the total income generated by the manufacture of goods and services. The formula is:
GDP= Total National Income+Sales tax+Depreciation+Net foreign factor income
- The total national income is the total of rent, wages, profits, and interest.
- Sales tax is the consumer tax applied to goods and services.
- Depreciation is the cost allocated to fixed assets over their useful life.
- Net foreign factor income is the total income that the country’s citizens generate in different countries versus the total income foreign citizens generate in this country.
The Bureau of Economic Analysis removes inflation when calculating the real gross domestic product as it allows better comparison. It uses a price deflator to calculate the GDP, which tells how much the prices have changed since the base year. Real GDP is generally lower than the nominal GDP.
What affects the value of Gross Domestic Product?
GDP has an impact on investment, employment generation, personal finance, and the overall economy. The monetary policy is decided keeping the GDP in mind. Here is what affects the GDP value.
The preference for leisure
Because of the advances in technology, the productivity of resources has increased and it has allowed workers to enjoy more leisure time. These additional hours of leisure are not priced in the market and are not reflected in the GDP.
It is important to note that not all activities are bought and sold in the market. There are several non-marketed activities that are omitted from GDP and these activities could have an effect on the value of GDP. An example is the voluntary services of NGOs. These unpaid services increase social welfare but they are not included in the GDP.
Various activities are performed unofficially. It includes legal and illegal activities. Service providers are paid in cash and these transactions go unnoticed by the government. It has a direct impact on GDP.
In expanding the manufacturing capacity, a lot of countries face a severe decline in water and air quality. Economies do not understand that excessive globalization can have a significant impact on the quality of life. Increased pollution will have long term consequences. The depletion of resources like air and water is not reflected in the GDP and it affects the value of GDP. The importance of non-renewable natural resources tends to be overlooked when calculating GDP. It is difficult to calculate intangible aspects but the fact that the benefits of environmental quality are not measured does not make them unimportant.
Quality of life
There are many factors that make a place attractive to live in. Few features do get included in a GDP like well-constructed homes or better medical facilities. But there are many other indicators of the good life which are not included in the GDP and they are not sold in the market. It undoubtedly has an effect on the value of GDP.
Due to a rise in per capita income, the level of poverty increases, and social welfare diminishes. When GDP increases, there is a rise in income inequality and it affects the GDP. The gross domestic product will show the cost of goods and services manufactured and sold but it will not reflect on who enjoyed them. Two countries might have similar GDP rates but their economic welfare will be very different.
GDP is an important parameter to learn about the economic position of a country. However, there are several factors that have an impact on GDP and due to these factors, one might not be able to get an accurate figure. Economists and bureaus employ different methods to estimate the right GDP keeping inflation in mind.