Gross Domestic Product
GDP is an indispensable macroeconomic indicator for policy makers and economic analysts in the estimation of economic performance and the general standards of living. GDP statistics are by far, the most closely followed and critical economic indicators of any economy. In many instances, GDP statistics are published on National Accounts using volumes of extensive statistical data sets prepared on monthly, quarterly, or yearly basis. According to the Bureau of Economic Analysis (2012), the most used economic indicator of aggregate economic production of a country is the Gross Domestic Product (GDP). This economic measure represents the money value of all services and goods produced within a given economic within the specified measurement period. This value is evaluated at the prevailing market prices in the said economy. These goods and services include government purchases, paid-in construction costs, personal consumption, foreign trade balance (exports less imports), and private inventories. However, the measurement of GDP does not include the value of money value for all unpaid work within the economy. Good examples of unpaid work within an economy comprises of the value of reproductive labor such as home caring. GDP calculation is obtained by adding up the value-added in every production stage while at the same time deducting the cost of inputs incurred. GDP is denoted as:
GDP = C + G + I + NX Where
C- Consumption
G- Government Spending
I – Gross Investment
NX- Net exports (Exports-Imports)
Forms of GDP
GDP can be subdivided into several forms that include, nominal GDP, real GDP, GDP deflator, and GDP per capita. Nominal GDP is not only the simplest form GDP but also the most direct measure of GDP. Real Gross Domestic Product refers to the form of GDP that has been attuned to include the level of overall prices within an economy. The base year is a prerequisite item during the calculation of real GDP. For instance, 2005 prices form the base year for calculating the current real GDP of the United States. The Real GDP is used in determining the health of the economy because the release of its figure is of immense importance to economists, policymakers, investors, and economic analysts. Speaking of the GDP deflator, is a price index or indicator that provides a true reflection of the average increase in the total domestic output and is equivalent to the ratio of nominal GDP to real GDP. GDP Per Capita GPD level divided to the total population and GDP Per Capita is a crucial measure in calculating the average living standards of the people.
Determination of GDP
Three ways can be used in the determination of Gross Domestic Product, and by principle means, the three formulas must produce equal results. The approaches are the income approach, the expenditure approach, and product (or output) approach (Godfred, 2009).
The Expenditure Approach
The expenditure approach involves the calculation of the final GDP figure through the addition of total costs incurred in the purchase of goods and services. Ideally, the working principle behind the expenditure approach is that individuals have to purchase products in the economy, and the value of the purchased goods is equal to their overall spending costs (Godfred, 2009). The expenditure approach is comprised of several parts that include private consumption, gross investment, net exports, and private spending.
GDP by Expenditure Method = C + I + G + (X-M)
The Income Approach
The determination of Gross Domestic Product using the income approach entails the summation of the total entire income accumulated by producers and individuals across the country. The income approach, by the nature of the above definition, is the most direct and simplest form of calculating GDP. The Income approach is divided into five distinct categories under the National Expenditure and Income Accounts (this is particular for the case of the US). This income accounts include corporate profits, miscellaneous investment income and interests, salaries, wages, and supplementary income, farmers’ income, and income obtained from other unincorporated businesses that are nonfarm related (Godfred, 2009). A summation of these items at their factor costs yields the total net domestic income. Getting the GDP using this approach requires two adjustments. Capital consumption allowance must be deducted from the net domestic product while subsidies must be deducted from indirect taxes. This yields market prices from factor costs.
The Product Approach
The product approach calculates the GDP through the estimation of the total worth of services and goods produced within a given economy. Three production stages are followed when estimating the GDP using this approach and this entails the estimation total gross value in all economic activities, estimation of the intermediate consumption, and reducing the value of intermediate consumption from the total gross value to get the domestic output net value.
How is GDP Interpreted?
The GDP not only provides a true reflection regarding the performance of any economy is performing within specified periods but it also provides an ideal way of estimating the growth rate of any economy. The sign on the value of GDP gives an overview of the overall economic performance. For instance, a positive GDP value implies positive performance for a specific economy while a negative GDP value implies a decline of the same economy (Farzad and Quade, 2003). Equally, when the value of GDP declines over two consecutive quarters, the economy of the US will be undergoing a recession. However, economists are capable of obtaining the performance of different economic variables such as consumer spending, private investment, and fixed investments from the GDP figure.
Criticisms
Whereas the GP provides valuable information to economic analysts and policymakers, it has been subjected to a wide level of criticisms. It is argued that GDP fails to give a true reflection regarding the overall well-being. The critics suggest that GPD is more of an economic indicator as opposed to being an overall measure of estimating the health of the economy including the standards of living (Froud, Haslam, and Williams, 2000). Other criticisms include the failure of GDP to capture the structural performance of economic performance, being a poor measure of government output, and lack of inclusion of nonmarket activities.
Strengths and Weaknesses
GDP being the main measure of the level of a county’s economic growth it has a number of strengths. Firstly, it gives a clear indication of the rate of economic growth. It gives a summary of all the information regarding the economy in one value. With the decomposition of GDP, the various sectors’ performance can be highlighted. This will help the key policy makers come up with necessary solutions to economic problems in a country. In addition, it can give a comparison between the economic growths of two or more countries.
GDP is also a good measure of the business cycles. Technically, economic depression may be two sequential periods of a decreasing GDP, but to the policy makers it is a wakeup call to alter their policies.
Secondly, the growth in GDP is an important factor in the contribution to the general welfare of the society. This can be because of increased employment and the income levels. This makes it a measure of social welfare changes ceteris paribus. The reason why it is the best measure of the overall welfare is that it is easily measurable.
Weaknesses of GDP
A growth in GDP does not necessarily mean that there is an improvement in the People’s living standards. This is because GDP overlooks the cost on society and the environment as a whole thus giving a misleading measure of a country’s prosperity. It ignores a number of attributes that are important in the determination of the social welfare. If these factors tend to shift at a rate contrary to the GDP, then this makes it unreliable in measuring the economic welfare.
GDP ignores activities that occur out of the market economy. These activities include those that do not have any price attached on them, and those that occur in the black market. Examples of these activities include; volunteering work, drug trafficking, elderly care, and housework (Lawton, and Tazeeb, 2011). They are just a fraction of key contributors to a county’s economy that are not considered by GDP. Some of the expenditures measured in GDP have no contribution to the welfare growth. The use of GDP as the only measure of welfare does not give a clear overall view of the welfare. In this case, the externalities such as epidemics, war outbreaks, and natural disasters like earthquakes will lead to increased expenditure. Consequently, this increase in expenditure can be considered positive since it increases economic activity (Lawton, and Tazeeb, 2011). However, the use of GDP does not put into consideration the losses brought about by an occurrence such earthquake, even though reconstruction gives a positive contribution to both GDP and welfare.
GDP ignores the setbacks brought about by debt financing in an economy. Most countries in the world including the United States sustain their economies using borrowed money. However, this in the end will call for a repayment. Most people will always borrow to finance consumption and not capital investment. This personal and national debts are not reflected in the GDP. Lastly, the GDP does not put into consideration the income distribution. It is always assumed that an increase in GDP will always increase the income of all the citizens. However, in reality an increase in GDP will always benefit a small fraction of the population. This is because it does not measure personal income. A country’s economic production may increase whereas the real income of the majority falls. This will lead in the widening of the social classes gap such as the rich will continue being richer and the poor becoming poorer.
Despite the above criticisms and weaknesses, GDP by far, is one of the economic indicators of economic performance. Instead of criticizing its application in estimation of economic issues, several adjustments can be made to alter the identified weaknesses (Lawton, and Tazeeb, 2011). This includes inclusion of income and consumption rather production during the evaluation of its component parts. Other recommendations that can be used to enhance GDP include placing more emphasize on household perspectives, considering income and consumption jointly with wealth, and allocating more prominence to the distribution of consumption wealth and income. Finally yet important, it is emphatically crucial to broaden income measures to cater for non-market activities (Froud, Haslam, and Williams, 2000).
References
Bureau of Economic Analysis (2012). GDP and the Economy: Advance Estimates for
the Fourth Quarter of 2011. Bureau of Economic Analysis
Farzad F., and Quade, S. (2003) "An Empirical Analysis of the Relationship between
GDP and Unemployment,” Humanomics, 19 (3), pp.1 – 6
Froud, J. Haslam, C. and Williams, K. (2000) "Representing the household: in and after
national income accounting", Accounting, Auditing & Accountability Journal, 13
(4), pp.535 - 560
Godfred A. B., (2009) "Macroeconomic development and capital structure decisions of
firms:
Evidence from emerging market economies", Studies in Economics and
Finance, 26 (2), pp.129 – 142
Lawton, T., and Tazeeb, R., (2011). Strategic reorientation and business turnaround:
the case of global legacy airlines, Journal of Strategy and Management 4(3), 215
– 237
