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What is Gross Domestic Product (GDP)?

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  • What is Gross Domestic Product (GDP)?

    Gross Domestic Product (GDP) like the CPI can be heard daily as a common economic terms, yet one not always understood.

    As defined by economics theory, Gross Domestic Product measures a country's production output as a way of calculating the growth or decline of its economy. GDP sums up the value of all goods and services production by a nation within its borders over a specified time period, typically a year or 12 months.

    GDP replaced another kind of measure, Gross National Product (GNP), in the United States in 1992, in order to be more consistent with the economic measures used by other countries. GDP centers on the locations where the goods and services are produced, e. G. Within a country's legal borders, whereas GNP measures the output of all companies owned by a nation's citizens no matter where those factories might be sited geographically.

    According to theories of macroeconomics, Gross Domestic Product can be measured in three ways: expenditure, national income and value-added. Theoretically, all three methods must yield the same results, as expenditures for services and goods must equal total income paid to the producers, which must equal the total output value. The expenditures approach, represented by the following formula, is used most commonly.

    GDP = Consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) - Imports (M))

    "Consumption" represents the sum of all households' personal expenditures, also termed private consumption, for things like housing, health care, food, etc. Not included in this term is new housing.

    "Investment" represents the amount spent for capital improvements by business or households. This total includes such purchases as software, equipment or machinery for business and new housing, but not purchases of financial products, which are termed "savings" in economic theory.

    "Government spending" represents the amount that a government spends for such items as military weapons, public employees' salaries, etc. Not included here are any benefits, such as old-age pensions, unemployment, etc.

    "Exports" represents gross exports, or those products that a nation creates which are purchased by other nations.

    "Imports" represents gross imports, meaning those items produced outside a country that are bought by its citizens, businesses or governments. These purchases have already been accounted for in the categories of Consumption, Investment or Government, so this value is subtracted.

    Some economists like the national income method of figuring Gross Domestic Product to provide a more real image of corporate and personal wealth, that is, the capacity of businesses and individuals to exchange income for goods and services. This method is calculated by the formula:

    GDP = Employee salaries and wages + Corporate gross financial surplus (profit) + Income of Proprietors + Income from Rentals + Net Interest

    The third method, the value-added approach, is also known as the output method. This method focuses determining the total output of a nation by directly calculating the total value of all goods and services a nation produces. Its formula is:

    GDP = The value of goods sold - cost to buy intermediate goods to produce goods sold.

    International standards for computing Gross Domestic Product are found in a book titled "System of National Accounts, " published in 1993. Termed SNA93, this reference was created by representatives from the World Bank, International Monetary Fund, United Nations, the Organization for Economic Co-operation and Development and the European Union.

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