GDP, or gross domestic product, is a measure of the size of a country’s economy. It is calculated using the value of final goods and services produced within the borders of a nation, whether or not the producers are of foreign nationalities. To calculate the GDP of a country, economists add the total private consumption, business expenditure, government spending, and the net exports. GDP can help determine how healthy an economy is. A rapidly growing GDP implies inflation, while the inverse indicates a recession. If the GDP decreases over a long period, then the country will experience a depression. This article will let you know what is GDP and its importance in the lives of all people in the nation.
The Concept of GDP
GDP closely relates to GNP, which is short for gross national product. The two differ in that GNP is based on the nationality of the producers, while GDP only considers the country’s borders.
The GDP of a country affects individuals, companies, investors, and governments, which is why everyone should have an idea of what is GDP. Here is a breakdown of the different sectors and how the figures affect them:
- Investors are less likely to invest in a country that is experiencing negative economic growth. They are even more predisposed to get involved with companies in countries with lower but rising, GDP.
- Individuals can use GDP to determine the security of their jobs. A recession that carries on for a long period usually leads to a depression, which means companies and businesses are making less money. That implies that they can’t afford to keep all the staff in employment. Depressions usually mean massive layoffs and high unemployment rates. Analysts also break down GDP data to determine which sectors of the economy are growing at a rapid rate, and this helps individuals decide where to apply for jobs.
- The government requires GDP figures to decide on fiscal policies. It implements expansionary or contractionary policies to get the economy back to a healthy growth rate. Governments usually target a GDP growth rate of 2 to 4 percent.
- The Federal Reserve also uses the concept to set up monetary policies, which are meant to correct the state of the economy. In the event of a recession, interest rates are reduced to allow people and companies to access credit at a lower cost. These policies will get the economy back on track.
Advantages and Disadvantages of GDP
After answering the question of what is GDP, it is essential to consider the advantages and disadvantages of this method of economic analysis. Since the methods of calculating GDP are uniform across countries, the figures have use in comparing the economies of different jurisdictions.
This gives a clearer picture of the level of economic development in the different countries. It can also help determine the rate of growth of the economy; and therefore, help the respective governments and central banks correct the situation fast.
Using GDP as a way of measuring the economy of a country has its disadvantages too. This section will give you conclusive information on the pros and cons of GDP as a method of analyzing the economy.
Advantages of GDP
This is currently the most commonly used method of determining the health of an economy, and that is why all experts have to know what is GDP. Here are some reasons why economists use GDP to track the economic development of a country:
1. High accuracy
It only considers the value of final goods and services produced within the borders of a country, and this means it is highly accurate. For example, if we take a cotton shirt, the economist does not bother with the value of the raw material it uses or even the plastic or metal that enter in the making of the buttons. All they consider is the value of the shirt when it is already on the market.
2. Useful in comparing economies
GDP per capita can help to cancel out the effect of different sized countries and populations. This makes GDP a useful method of comparing economies of the various countries. Those with bigger populations usually have larger economies, given the availability of manpower and the massive consumption involved. This is why you also need to know what is GDP per capita.
3. Aids the government in deciding upon fiscal policies
It helps the government decide what fiscal policies to implement. Remember that the government targets a consistent 2 to 4 percent growth rate of the economy. Anything beyond this will prompt the concerned authorities to step in and correct the situation.
In the event of a rapidly growing economy, the government will implement contractionary fiscal policies; which simply involve the reduction of their expenditure in the country. Conversely, if the economy is experiencing negative growth, the state will implement expansionary fiscal policies to increase the amount of money in circulation.
4. Helpful tool in deciding monetary policies
The figures can also help the central bank/Federal Reserve decide on what monetary policies to implement. These institutions have the capacity to control the interest rates in banks. If the economy is growing slower, or negatively, the organization can decide to lower the interest rate so as to stimulate individual and business expenditure. In the opposite scenario, they will raise the interest rates to reduce spending in the country.
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Disadvantages of GDP
GDP as a measure of a country’s economy is not without its limitations. In fact, experts are always trying to find better ways of calculating the growth of a country’s economy. That said, it is still the best method of determining the economy of a country. Here are some cons of GDP:
1. It fails to consider work done for free
As noted before, GDP only takes into account the value of final goods and services. Since volunteers do work for free, experts don’t include it in their calculation of the economy. It implies that the volunteer work is not valuable, yet big companies could be under contract to do the same job.
This lowers the accuracy of the GDP data provided. If economists were to actually consider volunteer work in the calculation of economic growth, the figures would go down greatly.
2. Fluctuating in times of war or natural disasters
In the event of war or natural disasters, GDP usually increases because of the amount of money spent on rebuilding. For example, after a war, a country can be left in ruins and has to pump money into the reconstruction of buildings and institutions.
These activities lead to an increase of money in circulation. After that, the GDP can sharply go down because the country returns to its normal economic state. The figure is, therefore, not very reliable as a measure of economic growth in such cases.
3. The quality of goods and services is not accounted for
The data can indicate an increase in the economy of a country when, in fact, people are spending money on cheap and low-quality products. One outcome is that they have to constantly replace their goods, therefore, end up spending more.
The figures will be distorted because it does not consider the quality of goods and services people are spending money on. Because of this, a lot of waste and inefficiency can give the impression that the economy is growing at a healthy pace.
I hope the above text has helped you understand what is GDP, and the implications it has. GDP is a very popular method of determining the economy of a country, even though it has its limitations. If you have more questions, thoughts or responses to this article, please leave them in the comment section below.