This article intends to describe the meaning of Gross Domestic Product (GDP), illustrate GDP with a hypothetical example, and GDP growth rate in very simple terms so that any starter of macroeconomics can understand it clearly. If you are new to macroeconomics and want to start a macroeconomic career, then the first and foremost thing you should be clear with is the concept of National Income Accounting. And, GDP is an 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 a specific period. It does not matter whose factors endowments produce but matters goods and services are produced within the homeland at a specific period. In more precise terms, 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 within the national boundary.
- Gross Domestic Product includes goods and services produced within a certain period, usually a quarter or year.
- The value of goods and services must be measured in terms of price.
Numerical Illustration of GDP
Let’s illustrate the concept of GDP with a hypothetical example as follows:
Despite the real-world situation of a country producing numerous goods and services, we assume for simplicity that an economy produces only two goods – apple and potato – in year 1. The 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 situations, there are many more goods and services produced in an economy at a specific period. If we add all the market value of goods and services produced during one year, we get the GDP at that period.
The 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 subverts the double-counting problem inherent in the measurement of GDP.
Similarly, final goods and services produced within the national territory imply for a nationalistic look at the economy. This way, economists and policymakers consider GDP to reflect the performance of the economy during the period. Also, the time dimension can not be disregarded, because, time-based economic data is a key for 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 – apples and oranges are different units. We can only add goods and services if expressed in a similar unit of price. We can add values expressed in terms of price, but not the goods and services. Nevertheless, it is simpler to say a GDP of Rs. 9200 than 50 apples, 80 oranges, and so forth.
Now, let’s turn to the next question.
What is the meaning of the 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 the 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 a domestic farmer produces 60 kg of apple at the market price of Rs. 125/kg, and a foreign farmer produces only 70 kg of potato at the market price of Rs. 35/kg. The calculation of the GDP of a country in year 2 proceeds in a 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 by the GDP of a previous period. It implies that the GDP growth rate is the relative measure of the expansion of economic activities. And thus, it appropriately measures the country’s productive capacity.
I hope my effort to clarify the meaning and growth rate of GDP is fruitful. If you have anything to ask or say, please leave a comment to us. Lastly, you may also read National Income Accounting: Methods and Problems.