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To explain the term GDP, the market value of all final products and services generated by all producing units located in a country’s domestic territory during an accounting year is referred to as the concept of GDP at Market Price. It comprises the value of depreciation or fixed capital consumption.

However, there are three significant variations within this apparently simple definition:

  • GDP is a figure that represents the value of a country’s production in local currency
  • GDP attempts to capture all final commodities and services generated inside a nation, ensuring that the ultimate monetary worth of everything made in a country is reflected in the GDP
  • GDP is measured over a certain time period, often a year or a quarter of a year

Further, when we talk about GDP, it is significant to look into terms like nominal and real GDP:

Nominal and Real GDP

Real GDP:

  • The calculation of goods and services is assessed at some constant set of prices
  • With fixed prices in the picture, changes in the Real GDP are seen when there is a change in the real volume of production
  • It provides a more precise picture of a nation’s economic growth. While calculating real GDP, a base year is chosen to regulate inflation; It captures the quantities of products in different years using the prices from the same base year
  • Real GDP= Nominal GDP/GDP Deflator

Nominal GDP:

  • Nominal GDP is a calculated GDP at the current prevailing prices in the market
  • It includes all the changes in Market Price (M.P.) due to inflation and deflation during the current year
  • It is the M.P. of GDP
  • Nominal GDP= (Deflator)*(Real GDP)/100

GDP Deflator:

  • It’s the ratio of nominal GDP to real GDP
  • The ratio gives us an idea of the change in prices in an economy during the subsequent years (Nominal GDP), with respect to the prices of a base year, for determining the Real GDP
  • GDP Deflator= Nominal GDP*100/Real GDP
  • The other name of GDP Deflator is Implicit Price Deflator for GDP Price Deflator

Consumer Price Index (CPI):

  • Additional way to measure the change of prices in an economy
  • Usually expressed in percentage, this is the index of prices of a given basket of commodities that are bought by the representative consumer
  • Consumer Price Index is the increase/decrease of prices in the current year over the base year is represented in percentages
  • Like CPI, the index for wholesale prices is known as the Wholesale Price Index (WPI)
  • Consumer Price Index= Current Item Price*Base Year CPI/Base Year Price
  • Consumer Price Index= Price of baskets of goods and services in current year*100/Price of one basket in one base year

GDP and People’s Welfare:

To explain welfare in the words of Alfred Marshall, an adventurer and neoclassical economist, the study of economics investigates all of the activities that individuals engage in in order to achieve economic well-being. 

Broadly, higher levels of GDP are seen as better prosperity and well-being for the people residing in that economy.

Yet, there are certain other factors to consider apart from just GDP growth. These are:

  • Uniformity in Distribution of GDP: If the rise in GDP is concentrated in the hands of a few individuals/firms, then it may not increase prosperity for all in the nation
  • Non-monetary exchanges: Productive activities like the domestic services by women at home or barter exchanges in the informal sectors etc. are not seen in monetary terms. Therefore, they’re not counted in the estimated GDP. This leads to the underestimation of GDP with an unclear idea about the overall well being of a country
  • Externalities: It refers to the advantages or disadvantages a firm has over individual causes in non-financial terms
    • For example: During the course of manufacturing, an industry may pollute a local river or lake, impacting the fish in the water and further hampering the catch that the fishermen may be able to obtain. GDP being an estimation of people’s welfare may be overestimated by not accounting for such negative externalities like pollution, environmental degradation etc

Albeit, there may also be positive externalities.

Conclusion

We have looked into the concept of GDP in macroeconomics. We can conclude by saying that GDP in simple terms GDP is an indicator that shows a country’s annual economic output. GDP is calculated using market prices, and there is a base year for the calculation. The GDP growth rate gauges how quickly the economy grows. It does this by comparing the country’s gross domestic output in one quarter to that in the preceding one, as well as to the same quarter the previous year.