Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced in a specific time period by a country.
From cars to machinery to your hairdresser’s services, GDP is an important factor for understanding the financial health of a country. Investors often use GDP to determine whether an economy is growing or in a recession, then make investment decisions based on that data.
GDP can be calculated in three ways, using expenditures, production, or incomes. It can be adjusted for inflation and population to provide deeper insights. Now, let’s take a look at 3 ways of calculating GDP .
1. The Expenditure Approach:
The expenditure approach, also known as the spending approach, calculates spending by the different groups that participate in the economy.
This approach can be calculated using the following formula: GDP = Consumption + Government spending + Investment + Net exports.
Consumption refers to the money spent by consumers to acquire goods and services, such as groceries and haircuts. Government spending represents government consumption expenditure and gross investment. Governments spend money on equipment, infrastructure, and payroll. Investment refers to businesses spending money to invest in their business activities. For example, a business may buy machinery. Net exports refer to a calculation that involves subtracting total exports from total imports (Net exports = Exports – Imports).
2. The Production (Output) Approach:
The production approach also called the output approach is the reverse of the expenditure approach. It measures GDP as the difference between the value of output and the value of goods and services used in producing these outputs during an accounting period.
3. The Income Approach:
The income approach calculates the income earned by all the factors of production in an economy, including the wages paid to labor, the rent earned by land, the return on capital in the form of interest, and corporate profits.
GDP provides an economic snapshot of a country. It’s used to estimate the size of an economy and growth rate and guides policymakers, investors, and businesses in strategic decision making.