How to Calculate Gross Domestic Product

Gross Domestic Product is the current value of all final goods and service produced in a country at a given point in time, usually annually.  Economists often refer to this term when they compare the outputs produced by two countries. GDP can be calculated in three ways, the expenditure approach, the income approach and the product approach.


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    Expenditure approach

    It is the most common approach when calculating GPD which takes into account four basic factors where GDP = C + I + G + Xn

    'C' is consumption, which is the biggest component of GDP, and can be further split into private and public consumption. When deciding what to consider as consumption, only brand new products sold within that year with be counted. For instance, if you bought a second-hand car, it won’t be counted, as the value had already been accounted for in calculating GDP of some past year. However, the commission made by the dealer will be added because of the ‘service’ he/she has delivered.

    Moreover, each service will have a separate value attached to it. For instance, if I have $100 and I used it to buy groceries, before the store owner used that same note to pay for bills, then all services will be added separately.

    'I' denotes investments made by individuals and firms during a particular year in fixed assets (machines factories), residential and business inventories.

    'G' refers to the purchases made by government (federal, state, local) on final goods and services. This will include all government spending on schools, roads, buying military equipment, etc, along with salaries to employees who are rendering their services. Essentially, government purchases are calculated by subtracting government transfer payments from government expenditure.

    'Xn' or net export is calculated by adding all export money and subtracting all import value because these goods are not produced in the country.

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    The Income Approach

    The income approach takes into consideration the incomes of people living in country during a year. GDP will be calculated by adding incomes that firms pay to all households. This will incorporate factors of production such as wages for labor, interest for capital, rent for land, and profits for entrepreneurs. However, this may not give a true picture as some factors cannot be accounted for such as credit buying and selling.

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    The Product approach

    It calculates GDP by adding the value of goods at each stage of production. For instance, wheat is produced by farmer, sold to flour mills, which is then used to make bakery items. The value will be then added after every stage.

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