GDP - Gross Domestic Product

 

What is GDP?

Economic growth is measured in terms of an increase in the size of a nation’s economy. A broad measure of an economy’s output. A most widely used measure of economic output is the Gross Domestic Product.

Gross Domestic Product (GDP), a calculation method in national accounting is defined as the total value of final goods and services produced within a country's borders in a year, regardless of ownership. GDP measures only final goods and services, that is those goods and services that are consumed by their final user, and not used as an input into other goods. Measuring intermediate goods and services would lead to double counting of economic activity within a country. This distinction also removes transfers between individuals and companies from GDP. There are three approaches to calculating GDP with rendering same results.

Expenditure Approach: Calculates the final spending on goods and services.

Product Approach: Calculates the market value of goods and service produced.

Income Approach: Sums the income received by all products in the country.

Expenditure Approach to determine GDP:

GDP = private consumption + government purchases + investment + net exports

· Consumption is calculated by adding durable and non - durable and service expenditures. It is unaffected by the estimated value of imported goods.

· The investment includes investment in fixed assets and increase in inventory.

· Government purchases are equal to the government expenditures less government transfer payments.

· Net Exports are exports minus imports.

NOMINAL GDP AND REAL GDP

Without any adjustment, the GDP calculation is distorted by inflation. This unadjusted GDP is known as the nominal GDP. In practice, GDP is adjusted by dividing the nominal GDP by a price deflator to arrive at the real GDP.

In an inflationary environment, the nominal GDP is greater than the real GDP. If the price deflator is not known, an implicit price deflator can be calculated by dividing the nominal GDP by the real GDP:

Implicit Price Deflator = Nominal GDP / Real GDP

The composition of this deflator is different from that of the consumer price index in that the GDP deflator includes government goods, investment goods, and exports rather than the traditional consumer-oriented basket of goods. GDP usually is reported each quarter on a seasonally adjusted annualized basis. GDP GROWTH Countries seek to increase their GDP in order to increase their standard of living. Note that growth in GDP does not result in increased purchasing power if the growth is due to inflation or population increase. For purchasing power, it is the real, per capita GDP that is important. While investment is an important factor in a nation's GDP growth, even more important is greater respect for laws and contracts.

Real Gross Domestic Product (RGDP) and Stock Prices:

The measure of aggregate output in the national income accounts is Gross Domestic Product (GDP) according to Blanchard (1997). He stated that there are three ways of thinking about an economy’s GDP. These are that:

• GDP is the value of the final goods and services produced in the economy during a given period

• GDP is the sum of value added in the economy during a given period

• GDP is the sum of incomes in the economy during a given period.

Nominal GDP is simply the sum of the quantities of final goods produced times their current price. Economists use nominal for variables expressed in units of the currency of the relevant country. Nominal GDP increases over time for two reasons.

The first is that the production of most goods increases over time. The second is that the price of most goods increases over time. In order to measure production and its change over time, the effect of increasing prices need to be eliminated.

Hence, focus is on real GDP rather than nominal. Carstrom (2002) expressed that stock prices and future RGDP growth are related. He gave two prominent explanations for this; the first explanation was that changes in information about the future course of RGDP cause prices to change in the stock market today. He also said that changes in stock prices, no matter what the source is, will reduce firms’ asset positions and affect the cost of their borrowing. When it costs more for firms to borrow money, they borrow and invest less, RGDP growth slows. Changes in information about the future course of RGDP may cause prices to change in the stock market. This explanation suggests that while stock prices are used to predict future economic activity, the actual causality is from future GDP growth in current stock prices