Methods of Calculating GDP

Methods of Calculating GDP

GDP is known as Gross Domestic Product. It is calculated to know the growth of the nation. GDP is nothing but realizable market value of all goods and services produced in a country during the period of time. It is generally calculated on annual basis but in some countries it is also calculated on quarterly basis. More GDP attracts more investment in the country and vice versa. GDP plays an important role in development and growth of country. There are three methods of calculating GDP.

Methods of calculating GDP:

GDP can be calculated in three ways. Ways of calculating GDP are:

(i) Expenditure method

(ii) Income method

(iii) Output method

The detailed explanation of each method is as under:

Expenditure method for calculating GDP:

Under the expenditure method, all the money spent by different groups like businesses, government, consumers etc. on purchase of the goods and services during the period under calculation are to be included. The spending’s for goods and services which are exported are also to be added and the spending’s for goods and services which are imported is to be deducted. In all, impact of net exports (exports – imports) is to be given while calculating GDP under expenditure method.

Example of consumer spending’s = spending’s on goods and services and other household needs like gas bill, car etc.

Example of business investment/ spending = investment in purchase of goods and services and investment in machinery, property etc.

Example of government spending = spending’s by government on various development activities like road repairing, making new roads, investment in making airports etc.

Formula for calculating GDP under expenditure method:

= consumer spending’s + investment in goods and services by businesses + government spending’s + net exports (exports – imports) 

In short above formula can be written as:

C+I+G+(X-M)

Income method for calculating GDP:

Under income approach for calculating GDP, income earned by all factors of production is to be added. Factors of production are the inputs which contribute in the final production of goods and services and this includes wages paid to labourers, rent earned by landlords, return on capital in form of interest, profits earned by entrepreneurs etc. It also includes the depreciation (being non-cash in nature) and net foreign income (i.e. Income from exports – income spent on imports)

Formula for calculating GDP by income method

= Wages + Rent + Interest + Profits + Depreciation + Net foreign income

If we add indirect taxes and subsidies in above formula, we get GDP at market cost.

Output (production) method for calculating GDP:

Under output or production method of calculating GDP, we add realizable or market value of goods and services which are produced in the country less indirect taxes on goods and services added by subsidies provided by government.

Formula for calculating GDP by output/ production method:

Market/ monetary value of all goods and services produced within country + subsidies on production – taxes paid on goods and services.

Practical Example:

The Details about the various expenses, incomes and production of Country A is as under:

ParticularsAmount ($)
Spending’s by Various Consumers on their needs500,000
Wages and Salaries earned by the total population of the country700,000
Investment/Spending’s by various business enterprises of the country15,000,000
Earnings by way of Profit by business enterprises of the country780,000
Rent earned by landlords of the country during the year900,000
Government spending’s10,000,000
Return on Capital (in $)900,000
Fair Value of Goods Produced within the country19,000,000
Taxes paid on production500,000
Value of Imports600,000
Value of Exports900,000
Depreciation850,000
Subsidies provided by Government400,000

Calculate GDP of the country by all Three Methods:

GDP by Expenditure Method = consumer spending’s + investment in goods and services by businesses + government spending’s + net exports (exports – imports) 

= 500,000 + 15,000,000 + 10,000,000+ (900,000 – 600,000)

= 25,800,000

GDP by Income Method = Wages + Rent + Interest + Profits + Depreciation + Net foreign income

= 700,000 + 900,000 + 900,000 + 780,000 + 850,000 + (900,000 – 600,000)

= 4,430,000

GDP by Production Method = Market/ monetary value of all goods and services produced within country + subsidies on production – taxes paid on goods and services.

= 19,000,000 + 400,000 – 500,000

= 18,900,000

Final Thought

GDP is the value of all goods and services produced during the period of time within the country. There are three methods of calculating GDP. Each method is valid and equally important. Income and production method are generally used as method of calculation by developed countries and expenditure method is used by developing countries to arrive at GDP. GDP is the important indicator of growth and performance of country on which various decisions by investors are based and it also can be used as guide for various business strategies.

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