What is GDP? What does the GDP of a country reflect?

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What is GDP?

GDP (Gross Domestic Product), also known as the total domestic product, measures the total value of all final goods and services produced within the territory of a country over a specified period.

One concept you need to understand clearly is “final goods and services.” These are goods and services purchased and used by the end consumer, not bought, processed, and resold to another buyer (known as intermediate goods and services). The value of intermediate goods is not included in GDP.

Since GDP measures the total output produced and consumed in a country, it is the most commonly used indicator to assess the health of an economy.

How to calculate GDP

The total value of final goods and services is exactly equal to the total expenditure of entities in the economy on those goods. Therefore, GDP can be calculated based on the expenditure method: equal to the total spending of entities in the economy, including spending from consumers, businesses, government, and foreigners. The formula for calculating GDP by the expenditure method is constructed as follows:

GDP = C + I + G + (EX – IM)

Where:

• C (consumption) is personal consumption expenditure,
• I (investment) is private investment,
• G (government spending) is government expenditure,
• EX (export) is the total value of exports,
• IM (import) is the total value of imports.

Consumer spending

Typically, consumer spending accounts for the largest portion of a country’s GDP. High consumption indicates that many goods and services produced in the economy are being consumed.

Some economic figures such as retail sales and the number of orders reflect consumer spending components to some extent.

Private investment

The term “investment” used here does not refer to investments in financial assets like stocks and bonds, but rather investments by businesses in fixed assets, such as machinery, equipment, and inventories. Therefore, private investment reflects business spending.

Government spending

Government spending reflects the expenditure from the national government, local authorities, or state governments on goods and services. Examples include investment in roads, factories, hospitals, or military development costs. Government spending is also categorized into two types: consumption and investment.

Net exports

Net exports (the difference between exports and imports, or the trade balance) are also a component of GDP. Exports represent spending by foreign individuals and businesses on a country’s goods, reflecting the amount of goods and services consumed by foreigners. Conversely, within the expenditure and investment components, they include spending and investment on both domestic and foreign goods. Since foreign goods are not counted in GDP, the total value of imports must be subtracted in the GDP expenditure formula.

Additionally, GDP can also be calculated using the income method, equal to the total income of all entities in the economy: wages of workers, after-tax corporate profits, income taxes, etc.

GDP statistics

A country’s GDP is usually compiled and calculated by the relevant national authorities, often the Bureau of Statistics. GDP is published monthly, quarterly, or annually depending on each country’s regulations. After a month, quarter, or year ends, the Bureau of Statistics needs a relatively long time to compile and calculate GDP, so GDP figures are usually published with some delay.

The longer the compilation time, the more accurate the data, but to publish GDP figures as soon as possible, countries often release several versions. For example, the United States publishes three versions of quarterly GDP:

• Flash GDP is published 30 days after the quarter ends.
• Preliminary GDP is published 60 days after the quarter ends.
• Final GDP is published within 85 days after the quarter ends.

Nominal GDP and Real GDP

Nominal GDP shows the total value of all goods and services consumed in the economy over a specified period at current prices. Therefore, evaluating GDP growth by nominal GDP sometimes does not reflect the growth in total output of the economy due to the presence of inflation. To eliminate this, real GDP is used, which records the total value of final goods in the economy at a specified base price.

The difference in prices at different times in the economy creates the difference between nominal GDP and real GDP over the same period; in other words, the discrepancy between these two types of GDP is due to inflation. The ratio between nominal GDP and real GDP is called the GDP deflator, and the inflation rate calculated by the GDP deflator is determined based on changes in the GDP deflator, as follows:

GDP Growth

GDP growth is the change in real GDP over a specified period compared to a previous period. Quarterly GDP growth can be compared to the previous quarter or the same quarter of the previous year to eliminate cyclical factors.

Some countries also publish quarter-on-quarter GDP growth in annualized form, so you need to pay close attention when analyzing GDP growth figures from different countries, as each country reports growth in different formats.

Example: The US GDP for Q2/2020 decreased by 31.4% compared to the previous quarter (annualized), meaning a decrease of 9.0% compared to the previous quarter.

(1 – 0.09)^4 = 1 – 0.314

The GDP growth of a country is regarded as the expansion of its economy. Conversely, if GDP in the subsequent quarter is lower than in the previous quarter, the GDP growth rate will be negative, indicating economic contraction.

Additionally, the following concepts related to the economy are defined by the GDP growth rate:

• Boom: GDP growth exceeds the potential growth rate of the economy.
• Stagnation: Low GDP growth occurs over a long period. Currently, there is no exact definition of what constitutes low.
• Recession: The economy experiences negative growth for two consecutive quarters.
• Depression: A prolonged economic recession often accompanied by other negative effects, such as high unemployment rates.
• Recovery: GDP growth returns to pre-recession levels.

GDP and GNP

Another concept often used alongside GDP is GNP (Gross National Product), which measures the total value of final goods and services produced by all citizens of a country. While GDP calculates the total output generated within a country’s territory regardless of domestic or foreign citizens, GNP reflects the total output produced by a country’s citizens living domestically and abroad, excluding foreign citizens working within the country.