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GDP Formula
How to calculate a country's Gross Domestic Product
What is Gross Domestic Product (GDP)?
Gross Domestic Product (GDP) is an economics term for the total value of all final economic goods and services produced in a country during a specific period of time in local currency.
It is the broadest financial measurement of a nation’s total economic activity and encompasses the total goods and services consumed by private expenditures, government spending, investments, and net exports.
What is the GDP Formula?
There are two primary methods or formulas by which GDP can be determined:
1. Expenditure Approach
The expenditure approach is the most commonly used GDP formula, which is based on the money spent by various groups.
GDP = C + G + I + NX
C = consumption or all private consumer spending within a country’s economy, including, durable goods, non-durable goods, and services.
G = total government expenditures, including salaries of government employees, road construction/repair, public schools, and military expenditure.
I = sum of a country’s investments spent on capital equipment, inventories, and housing.
NX = net exports or a country’s total exports less total imports.
2. Income Approach
This GDP formula takes the total income generated by the goods and services produced.
GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income
Total National Income – the sum of all wages, rent, interest, and profits.
Sales Taxes – consumer taxes imposed by the government on the sales of goods and services.
Depreciation – cost allocated to a tangible asset over its useful life.
Net Foreign Factor Income – the difference between the total income that a country’s citizens and companies generate in foreign countries, versus the total income foreign citizens and companies generate in the domestic country.
What are the Types of GDP?
GPD can be measured in several different ways. The most common methods include:
- Nominal GDP – the total value of all goods and services produced at current market prices over a time period, including the effects of inflation or deflation.
- Real GDP – a more accurate measure of the sum of all goods and services produced at constant prices. The prices used in determining the Gross Domestic Product are based on a certain base year or the previous year, thereby making it inflation-adjusted.
- Actual GDP – real-time measurement of all outputs at any interval or any given time. It demonstrates the existing state of business of the economy.
- Potential GDP – ideal economic condition with 100% employment across all sectors, steady currency, and stable product prices.
Why is GDP Important to Economists and Investors?
Gross Domestic Product is one of the primary indicators used to determine the overall well-being of a country’s economy and standard of living.
One way to determine how well a country’s economy is doing is by its GDP growth rate, which reflects the increase or decrease in the percentage of economic output in monthly, quarterly, or yearly periods.
GDP enables economic policymakers to assess whether the economy is weakening or strengthening and if threats of recession or inflation are imminent, in order to determine what policies are needed.
Investors place importance on GDP growth rates to decide how the economy is changing so that they can make adjustments to their asset allocation. Investors are also on the lookout for potential investments, locally and abroad, basing their judgment on countries’ growth rate comparisons.
What are Some Drawbacks of GDP?
Gross Domestic Product does not reflect the black market, which may be a large part of the economy in certain countries. In these cases, GDP may not be an accurate measure of the economic state of a country.
Income generated in a country by an overseas company that is transferred back to foreign investors is not taken into account. This overstates a country’s economic output.
Sources of GDP Information
For US GDP information, please the Bureau of Economic Analysis website.
Additional Resources
Thank you for reading CFI’s guide on How to Calculate GDP. To keep learning about important economic concepts, see the additional free resources below:
