This article intends to describe the meaning of Gross Domestic Product (GDP), illustration of GDP with hypothetical example, and GDP growth rate in very simple term so that any starter of macroeconomics could understand it clearly. If you are new to macroeconomics and want to start macroeconomic career, then the first and foremost thing you should be clear with is, the concept of National Income Accounting. And, GDP is the integral part of national income accounting.
Accordingly, this article aims at answering the following questions:
What is the meaning of GDP?
GDP is a shorthand for Gross Domestic Product. It stands for the total market value of the finally produced goods and services within a national boundary at the specific time period. It does not matter whose factors endowments produces, but matters goods and services be produced within homeland at specific time period. In more precise term, the definition of GDP includes the following inevitable features:
- Gross Domestic Product includes final goods and services, and excludes intermediate goods and services.
- GDP incorporates newly produced goods and services with in the national boundary.
- Gross Domestic Product includes goods and services produced within the certain time period, usually quarter or year.
- Value of goods and services must be measured in terms of price.
Numerical Illustration of GDP
Lets illustrate the concept of GDP with a hypothetical example as follows:
Despite real world situation a country producing numerous goods and services, we assume for simplicity that an economy produces only two goods – apple and potato – in year 1. Domestic farmer produces 50 kg of apple at the market price of Rs. 120/kg, and the foreign farmer produces 80 kg of potato at the market price of Rs. 40/kg. Consider for now these products are final goods, which are used for consumption.
Now, what is the GDP of a country in year 1?
The GDP of a country (in year 1) = Total Market Value of Apple + Total Market Value of Potato
= (Per kg Price of Apple * Quantity of Apple) + (Per kg Price of Orange * Quantity of Orange)
= (120 * 50) + (40 * 80) = 6000 + 3200 = 9200.
Hence, the GDP of a country is Rs. 9200 in year 1. But, in real world situation, there are many more goods and services produced in an economy at specific time period. If we add all the market value of goods and services produced during one year, we get the GDP at that time period.
Rationale of Four Key Features of GDP
I think, you are not figuring out the rationale behind the inclusion of four key features in the definition of GDP. The solid reason is the definition per se, eh! Other rationale relies on the accuracy, nationality and simplicity of the definition. Taking only the final goods and services subvert the double counting problem inherent in the measurement of GDP.
Similarly, final goods and services produced with in the national territory imply for the nationalistic look at the economy. This way, economists and policy makers consider GDP to reflect the performance of the economy during the time period. And also, the time dimension can not be disregarded, because, the time-based economic data is a key for the economic planning and policy making.
Finally, GDP must be expressed in terms of price, primarily because we can not add goods and services in different units – apple and orange are different units. We can only add goods and services, if expressed in similar unit of price. We can add values expressed in terms of price, but not the goods and services. Nevertheless, it is more simpler to say GDP of Rs. 9200 than 50 apples, 80 oranges and so forth.
Now, lets turn to the next question.
What is the meaning of GDP growth rate?
As we found elsewhere the term GDP growth, it makes sense to know what this refers to. More precisely, it is the percentage change in current year’s GDP figure in comparison to the previous year’s GDP figure.
Now, let us discuss the GDP growth rate with an illustration. In year 2, suppose that domestic farmer produces 60 kg of apple at the market price of Rs. 125/kg, and foreign farmer produces only 70 kg of potato at the market price of Rs. 35/kg. The calculation of GDP of a country in year 2 proceeds in the similar manner as in year 1.
GDP in year 2 = Total Market Value of Apple + Total Market Value of Potato
= (Per kg Price of Apple * quantity of Apple) + (Per kg Price of Orange* Quantity of Orange)
= (125 * 60) + (35 * 70) = 7500 + 2450 = 9950.
Hence, the GDP of a country is Rs. 9950 in year 2. Now, what is the GDP growth rate in year 2? Simply, the answer to this question is given by the percentage change in the GDP figures like this:
GDP growth rate in year 2 = (GDP in year 2 – GDP in year 1)/ GDP in year 2 * 100
= (9950-9200)/9200 = 0.815 *100 = 8.15%.
Hence, the GDP growth rate in year 2 is 8.15%. This growth rate is determined in relation to the GDP of previous time period. It implies that GDP growth rate is the relative measure of the expansion of the economic activities. And thus, it appropriately measures the country’s productive capacity.
I hope my effort to clear you the meaning and growth rate of GDP is fruitful. If you have anything to ask or say, please leave up a comment to us. Lastly, you may also read National Income Accounting: Methods and Problems.