The gross domestic product, or GDP, is one of the most common measures on the state of the economy for any nation. Unfortunately, unless you took an Economics 101 class in college and managed to not fall asleep, you may not know exactly what the GDP is – or why it is important.
Simply stated, GDP is the total market value of all goods and services produced in a country for a given time period. The time period most often used is one year, which is then compared to past years as a way to measure the improvement or decline of a country’s economic situation. Some of the measurable items utilized in GDP calculations include the sales of automobiles, food, salon services, financial services, and movie tickets. Generally, the higher the number, the better the economy is doing.
If the GDP number drops below the point where it stood during the prior year, then it is assumed that the economy is lagging. If the GDP numbers decline for two or more quarters, economists believe the country is in a recession.
Methods of Calculating GDP
The general definition of GDP is rather simple – however, economists seldom like simplicity, and therefore there are three different ways to calculate GDP.
1. Production Method
The production approach to GDP is the market value of all final goods and services. Also called the “net product” method, it includes three statistics:
Gross Value Added: Estimation of the gross value of various domestic economic activities.
Intermediate Consumption: Determination of the cost of materials, supplies, and labor used to create goods and services.
Value of Output: Deduction of the intermediate consumption from the gross value, which gives you the GDP. This is how you determine GDP via the production method.
Weakness of the Production Method
The major problem with the production method of measuring GDP is that there is no 100% accurate way to determine what is true production. Services like babysitting have no way of being measured, and therefore are not included – though it can be argued that a babysitter allows parents to go out and spend money on a service, like dinner at a restaurant, and therefore has a positive effect on the economy. Also, if you make baked goods or have a small garden, you are producing, but your output is likely not included in the GDP, especially if you do not sell your goods.
If you do sell your baked goods, that could be considered part of the underground economy. For example, if you pay a person cash under the table to fix your car, it does not count toward GDP, although a service has been rendered.