Buzz
GDP, which stands for Gross Domestic Product, is a key metric used to assess the total value of goods and services produced by a country within a year. It is commonly used in economics to compare the economic output between different countries. Economists calculate GDP using two primary methods: the expenditure approach, which measures total spending, and the income approach, which measures total income. The CIA World Factbook provides comprehensive data needed to calculate GDP for every country worldwide.
Steps
Calculating GDP using the expenditure method
Start with personal consumption. Personal consumption measures the total spending on goods and services by consumers in a country over the course of a year.
- Examples of personal consumption include expenditures on goods like food and clothing, durable goods like tools and furniture, and services like haircuts or doctor visits.
Add investment. For economists, when calculating GDP, investment refers not to the purchase of stocks and bonds, but to the amount of money businesses spend to acquire goods and services that support or sustain business operations.
- Examples of investment include materials or contract services used when a company builds a new factory, orders of equipment, and software that help the business operate more efficiently.
Include the trade surplus. Since GDP only measures domestic production, imports must be excluded. Exports, on the other hand, must be added, as once they leave the national borders, they are no longer part of personal consumption. To account for exports and imports, subtract the total value of imports from the total value of exports, then add the result to the equation.
- If a country imports more than it exports, the number will be negative. If it's negative, you should subtract rather than add.
Add government consumption. The amount of money a government spends on goods and services must be included when calculating GDP.
- Examples of government consumption include salaries for public employees, spending on infrastructure, and defense. Social security and unemployment benefits are considered transfers and are not included in government consumption, as this money simply moves from one person to another.
Calculating GDP using the income method
Start with wages and employee benefits. This refers to the total of all wages, salaries, benefits, pensions, and social security contributions.
Include rental income. Rental income refers to all earnings derived from property ownership.
Add interest income. All interest (income earned from providing capital) must be included.
Include owner’s income. Owner's income is the money earned by business owners, including those of corporations, partnerships, or sole proprietorships.
Include corporate profits. This represents the income earned by shareholders.
Add indirect business taxes. These are all taxes on sales, business property taxes, and licensing fees.
Calculate and add total depreciation. This refers to the decrease in the value of goods over time.
Include net income from abroad. To calculate this, subtract the total payments made by domestic production to foreign entities from the total income earned abroad by citizens of the country.
Distinguishing between Real GDP and Nominal GDP
Understand the difference between real GDP and nominal GDP for a more accurate picture of a country’s economic performance. The main distinction between real GDP and nominal GDP is that real GDP takes inflation into account. Without adjusting for inflation, you might believe that a country’s GDP is growing, while in reality, prices are simply increasing.
- Consider it this way: If Country A’s GDP in 2012 was 22 trillion VND and in 2013 the country printed and circulated 11 trillion VND, naturally its GDP in 2013 would be higher than in 2012. However, this increase doesn’t truly reflect the production of goods and services in Country A. Real GDP effectively removes this inflation-driven rise.
Select the base year. Your base year can be one year ago, five years ago, ten years ago, or even a hundred years ago. You must choose a year to compare inflation, because real GDP is essentially a comparison. And a comparison only holds true if two or more elements — year and data — are being compared. For a simple real GDP calculation, pick the year before the point you are examining.
Determine how much the price has increased compared to the base year. This figure is also referred to as the 'deflator index'. For instance, if the inflation rate from the base year to the current year is 25%, the inflation rate would be represented as 125, or 1 (100%) plus .25 (25%) multiplied by 100. In all cases of inflation, the deflator index will be greater than 1.
- For example, if the country you're calculating for is undergoing a period of deflation, where the purchasing power of money increases instead of decreasing, the deflator index will be less than 1. Suppose the deflation rate from the previous period to the current period is 25%. This means one unit of currency can buy 25% more than it could in the base period. The deflator index would be 75, or 1 (100%) minus .25 (25%) multiplied by 100.
Divide nominal GDP by the deflator index. Real GDP is equal to this ratio multiplied by 100. This can be expressed in the following equation: Nominal GDP ÷ Real GDP = Deflator Index ÷ 100.
- So, if your nominal GDP at the current time is 220 trillion VND and the deflator index is 125 (with inflation from the base period to the current period being 25%), here’s how to set up your equation:
- 220,000,000,000 VND ÷ Real GDP = 125 ÷ 100
- 220,000,000,000 VND ÷ Real GDP = 1.25
- 220,000,000,000 VND = 1.25 x Real GDP
- 220,000,000,000 VND ÷ 1.25 = Real GDP
- 176,000,000,000 VND = Real GDP
Advice
- GDP per capita measures the average domestic production produced by an individual in a country. GDP per capita can be used to compare labor productivity between countries with significant differences in population size. To calculate GDP per capita, divide the total domestic output by the population of the country.
- A third method for calculating GDP is the value-added approach. This method calculates the total value added at each step of production for goods and services. For instance, adding the value of rubber when it is converted into tires. Then, adding the value of all the car parts when they are assembled into a complete car. This method is not widely used because it may result in double counting and exaggerate the actual market value of GDP.
