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What does GDP mean?

How is the Gross Domestic Product of a country


measured?
GDP (Gross Domestic Product) is a measure of country's production or income. You can
simply understand this as the sum of incomes all people living in a particular country. For
instance, the GDP of US is $15 trillion. This is the sum total of incomes of 313 million
Americans (at an average of $50,000 per person).
This is one of the most simplest & intuitive measures to track the economy. If incomes go up,
wellness go up. Thus, most government prioritize maximizing this measure. The annual growth
in GDP is the most used metric to figure out if an economy is going up or going down.

How is the GDP measured?


The village of utopia has 6 cows (generating 100 liters of milk everyday), 100 acres of wheat
field (generating 100 tons of Wheat everyyear), 100 acres of cotton fields, 1000 sets of clothing
(at an average price of $10 each). Assuming that nothing else is produced in the village, the GDP
of the village is:
1

100 liters *365 = 36500 at $1/liter. Annual product: $36500

100 tons of Wheat at $500/ton. Annual product: $50000

1000 sets of clothing at $10 each. Annual product: $10000

The total GDP of this village is: $365000+$50000+$10000 = $96500.


(Note: We don't take the value of cotton produced here, as it will be accounted in the Textile
production).
When you have millions of people living a country, it can be hard to measure the GDP. Most
often it takes a couple of years to fully know what happened on a particular year. Thus, there is a
lot of guesswork involved in the process to make it more timely.
There are 3 ways to measure GDP:
1

Measuring through Consumption: This is the total amount spent & invested by people.
Since all money generated in the economy has to be either spent or invested, it indirectly
measure economy. Given that governments have tax collectors all over the nation, it
becomes relatively easy to measure how much people spend. Thus, this is one of the best
ways to measure GDP. GDP = Spending by common people + Spending by
government + Investments + Exports - Imports. In the short term, GDP can be
increased by increasing government spending, leading to some leftist economist such as
arguing for more government spending during recessions.

Measuring through Incomes: Add the wages, corporate profits, taxes, interests and
rents of all labor+facilities. This measure can be delayed given the fact that businesses &
people file taxes only the following year. If you subtract the tax component from this, you
get the GDP measure: Total Factor Income.

Measuring through Production: Calculate the market value of all products & services
produced in the economy. You need to make sure that you subtract the value of
intermediate goods (such as the cotton from the fields). This is what we did in our basic
utopia example. One of the hardest way to measure GDP as you need to track all products
& services. If you add all the taxes & reduce subsidies, you get GDP at Producer Price.

Due to the various guesswork involved, the 3 measurements could lead to different results:
detailed of 3
1) The Expenditure Approach
This method of determining GDP adds up the market value of all domestic expenditures
made on final goods and services in a single year, including consumption expenditures,
investment expenditures, government expenditures, and net exports. Add all of the
expenditures together and you determine GDP.
2) The Production Approach
This method also called the Net Product or Value added method requires three stages of
analysis. First gross value of output from all sectors is estimated. Then, intermediate
consumption such as cost of materials, supplies and services used in production final output
is derived. Then gross output is reduced by intermediate consumption to develop net
production.
3) The Income Approach
This method of determining GDP is to add up all the income earned by households and
firms in the year. The total expenditures on all of the final goods and services are also
income received as wages, profits, rents, and interest income. By adding together all of the
wages, profits, rents, and interest income, you determine GDP:
The three methods of measuring GDP should result in the same number, with some
possible difference caused by statistical and rounding differences. The credibility of data
is always a significant concern in any form of research. An advantage of using the
Expenditure Method is data integrity. The U.S. Bureau of Economic Analysis considers the
source data for expenditure components to be more reliable than for either income or
production components..

As such we will concentrate on the Expenditure Approach which is the most commonly
discussed method of representing GNP particularly in non-academic examinations of
economic activity.
GDP as examined using the Expenditure Approach is reported as the sum of four
components. The formula for determining GDP is: C + I + G + (X - M) = GDP
C = Personal Consumption Expenditures
I = Gross Private Fixed Investment
G = Government Expenditures and Investment
X = Net Exports
M = Net Imports
Before moving forward in our discussion, it should be noted, the income approach is
gathering a growing following. This is true particularly among economic blogs, investment
publications and cable news business programs due to its concentration on the importance
of wages. An alternative method of calculating GNP using the Income Approach is
RIPSAW.
The mnemonic RIPSAW breaks down as follows: GDP = R + I + P + S + A + W
R = rents
I = interests
P = profits
SA = statistical adjustments (corporate income taxes, dividends, undistributed corporate
profits
W = wages
At this point, we could spend the next thousand words describing alternate means of
computing GNP. While that might be beneficial in its attempt to be exhaustive, for our

purposes what you need to remember is, in economics, there is rarely only one way to
develop and analyze data
Additionally, GDP is impacted by variables beyond economists control such as the
economic health of our trade partners, monetary factors such as the value of the dollar,
restrictions in state and local governments spending to the subjective views by consumers to
business which influence their consumption/investment choices.
If all you remember from this essay is, jobs are created and lost based on the relative
strength of the various components of GDP. Those components can and do fluctuate from
internal and external factors beyond the control of any our economic sages. Then you realize
why economists are not Einstein and economics isnt physics.
Please consider joining us if you the readers of PolicyMic wish to see this series continue as
we next explore C = personal consumption expenditures, perhaps the most factor necessary
to stimulate our economic recovery.

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