The Gross domestic product (shortly called as GDP) is a primary indicator for countries economic performance. The value of GDP is calculated by adding everyone’s incomes in that particular period or the gross values of all goods or services that were produced within the country plus any taxes on products minus any subsidiaries given in any products, and those products not included in value of the products. GDP is calculated by using the formula:
GDP = C + G + I + (X – M)
- C is equal to all private consumption, or consumer spending in a nation’s economy. It includes Food, Medical expenses, services, Household expenses, Rent etc.
- G is the sum of government spending (or expenditure) which include investment in weapons purchase for the military, highways, railways, dams and also the salaries to the public servants.
- I is the sum of all the country’s business investment which may include purchasing plant and equipment, software purchase, but it does not include investment in financial products because it relates to savings.
- X stands for total value of all goods or services that were exported
- M stand for the value of goods or services that were imported for consumption.
There are three methods for computing GDP
- Production (output) approach
- Income approach.
- Expenditure approach
GDP Production (output) approach
The value of all final goods or services (don’t include intermediary goods), taxes on goods produced within the country and imported goods(excise duty, customs duty, VAT) minus subsidy on products. Most countries using this approach to calculate GDP since 1979 but it has a major drawback. In this method it is difficult to differentiate between final goods and intermediate goods. The GDP formula behind the Production (output) approach is:
GDP= (value of final goods or services intermediary goods or services) at market prices + taxes on products and imports – subsidy on products.
TIP: Intermediate goods like material, supplies and services used to produce final goods or services.
GDP Income approach
Income approach is the second way to estimate GDP. In this method GDP will be calculated by adding incomes that firms pay to households for factors of production and they are – wages for labour, land rents, interest for capital, and profits for entrepreneurship.
GDP = W + R + I + PR + BT + D + F
- W stands for Wages, salaries, benefits, pension and social security contribution.
- R stands for rental income
- I stands for all interest income earned
- PR stands for business profits and income earned by stockholders
- BT stands for indirect business taxes like property tax (wealth tax), sales tax, custom duty and other fee.
- D stands for depreciation
- F stands for foreign income
Above two approaches are most popular but this is the most widely used approach to measure GDP. In this approach, GDP means all final goods or services (expect intermediate goods)
GDP = C + I + G + (X – M)
We already explained the formula so please refer above.