What is GDP and how is it measured? GDP dropped over 20% in April in the UK. This article will explain what GDP is and will discuss a few limitations of GDP.
Welcome to Simply Economics. This article is the ninth in a series to explain economics to those who want to broaden their scope of the subject. Click here to find out more about the series.
WHAT IS GDP?
GDP stands for gross domestic product. It measures the value of all finished goods and services in a country over a year. It is given in the currency of the country it is being measured in (the GDP of USA would be given in dollars etc).
However, economists typically look at the percentage change in GDP rather than the actual figure. The percentage change in GDP is given in real terms which means that inflation has been taken into account for.
If the GDP has been growing for the past 3 months, then the economy has been growing.
However, if there has been a decline in GDP then the economy is shrinking and if there has been a GDP decline for 2 consecutive quarters (6 months) then the economy is experiencing a recession.
HOW IS GDP MEASURED?
The GDP of a country can be measured using 3 methods:
- Value of goods and services – The main way GDP is measured is measuring the value of all the goods and services produced in a country over the past year. This includes all sectors of the economy.
- A measure of income – Another way to measure GDP is by measuring the value of the income earned in a country over the past year.
- Sum of expenditure – The final way of measuring GDP is by measuring the value of goods and services bought in a country.
WHY IS GDP USEFUL?
The GDP of a country is used to indicate whether the economy is growing or not which will affect the policy decisions the government and the central bank will take in order to stimulate the economy.
For example, if the economy is booming and prices are rising too fast, the central bank may raise interest rates in order to increase the rate of interest on retail loans such as mortgages. This would increase repayments prices which would mean consumers have less disposable income, reducing spending, hence controlling the rising prices.
WHAT ARE THE LIMITATIONS OF GDP?
- Hidden Economy – When goods are sold without being declared for tax or when goods are swapped for other goods, the value of them is not recorded. This is known as the informal economy which can account for over 60% of economies in some Sub-Saharan African countries.
- Informal Economy – If goods are not bought then their value is not recorded. An example of this would be when a gardener grows and consumes their own vegetables; because they are not selling those vegetables or buying them from a market, the value is not recorded hence the GDP figure may seem less than what it may be in reality.
- Distribution of Income – GDP growth does not show how the growth incomes is split across the whole economy. For example, GDP growth could be due to the growth incomes for the rich only rather than the entire economy growing as a whole.
In conclusion, GDP is a measure of economic growth and it can be calculated by using three methods: measure the value of goods and services sold, measure the expenditure, measure the total income. However, the GDP comes with limitations as it does not take into account for the hidden or informal economies and does not show the distribution of economic growth.