What Is GDP And What Does It Measure?

The Gross Domestic Product (GDP) is a metric that measures the size and health of a country’s economy over time (usually one quarter or one year). It’s also used to compare the size of various economies at different times.

What is GDP and how is it calculated?

GDP is calculated by adding up the quantities of all commodities and services produced, multiplying them by their prices, and then adding them all up. GDP can be calculated using either the sum of what is purchased or the sum of what is generated in the economy. Consumption, investment, government, exports, and imports are the several types of demand.

What exactly is GDP? What does it track, and why does it matter?

It indicates the total value of all commodities and services produced inside a country’s borders over a given time period.
Economists can use GDP to evaluate if a country’s economy is expanding or contracting.
GDP can be used by investors to make investment decisions; a weak economy means lower earnings and stock values.

Is GDP a good economic indicator?

GDP is a good indicator of an economy’s size, and the GDP growth rate is perhaps the best indicator of economic growth, while GDP per capita has a strong link to the trend in living standards over time.

Why is GDP a flawed metric?

In reality, “GDP counts everything but that which makes life meaningful,” as Senator Robert F. Kennedy memorably stated. Health, education, equality of opportunity, the state of the environment, and many other measures of quality of life are not included in the number. It does not even assess critical features of the economy, such as its long-term viability, or whether it is on the verge of collapsing. What we measure, however, is important because it directs our actions. The military’s emphasis on “body counts,” or the weekly calculation of the number of enemy soldiers killed, gave Americans a hint of this causal link during the Vietnam War. The US military’s reliance on this morbid statistic led them to conduct operations with no other goal than to increase the body count. The focus on corpse numbers, like a drunk seeking for his keys under a lamppost (because that’s where the light is), blinded us to the greater picture: the massacre was enticing more Vietnamese citizens to join the Viet Cong than American forces were killing.

Now, a different corpse count, COVID-19, is proving to be an alarmingly accurate indicator of society performance. There isn’t much of a link between it and GDP. With a GDP of more than $20 trillion in 2019, the United States is the world’s richest country, implying that we have a highly efficient economic engine, a race vehicle that can outperform any other. However, the United States has had almost 600,000 deaths, but Vietnam, with a GDP of $262 billion (and only 4% of the United States’ GDP per capita), has had less than 500 to far. This less fortunate country has easily defeated us in the fight to save lives.

In fact, the American economy resembles a car whose owner saved money by removing the spare tire, which worked fine until he got a flat. And what I call “GDP thinking”the mistaken belief that increasing GDP will improve well-being on its owngot us into this mess. In the near term, an economy that uses its resources more efficiently has a greater GDP in that quarter or year. At a microeconomic level, attempting to maximize that macroeconomic measure translates to each business decreasing costs in order to obtain the maximum possible short-term profits. However, such a myopic emphasis inevitably jeopardizes the economy’s and society’s long-term performance.

The health-care industry in the United States, for example, took pleasure in efficiently using hospital beds: no bed was left empty. As a result, when SARS-CoV-2 arrived in the United States, there were only 2.8 hospital beds per 1,000 people, significantly fewer than in other sophisticated countries, and the system was unable to cope with the rapid influx of patients. In the short run, doing without paid sick leave in meat-packing facilities improved earnings, which raised GDP. Workers, on the other hand, couldn’t afford to stay at home when they were sick, so they went to work and spread the sickness. Similarly, because China could produce protective masks at a lower cost than the US, importing them enhanced economic efficiency and GDP. However, when the epidemic struck and China required considerably more masks than usual, hospital professionals in the United States were unable to meet the demand. To summarize, the constant pursuit of short-term GDP maximization harmed health care, increased financial and physical insecurity, and weakened economic sustainability and resilience, making Americans more exposed to shocks than inhabitants of other countries.

In the 2000s, the shallowness of GDP thinking had already been apparent. Following the success of the United States in raising GDP in previous decades, European economists encouraged their leaders to adopt American-style economic strategies. However, as symptoms of trouble in the US banking system grew in 2007, France’s President Nicolas Sarkozy learned that any leader who was solely focused on increasing GDP at the expense of other indices of quality of life risked losing the public’s trust. He asked me to chair an international commission on measuring economic performance and social progress in January 2008. How can countries improve their metrics, according to a panel of experts? Sarkozy reasoned that determining what made life valuable was a necessary first step toward improving it.

Our first report, provocatively titled Mismeasuring Our Lives: Why GDP Doesn’t Add Up, was published in 2009, just after the global financial crisis highlighted the need to reassess economic orthodoxy’s key premises. The Organization for Economic Co-operation and Development (OECD), a think tank that serves 38 advanced countries, decided to follow up with an expert panel after it received such excellent feedback. We confirmed and enlarged our original judgment after six years of dialogue and deliberation: GDP should be dethroned. Instead, each country should choose a “dashboard”a collection of criteria that will guide it toward the future that its citizens desire. The dashboard would include measures for health, sustainability, and any other values that the people of a nation aspired to, as well as inequality, insecurity, and other ills that they intended to reduce, in addition to GDP as a measure of market activity (and no more).

These publications have aided in the formation of a global movement toward improved social and economic indicators. The OECD has adopted the method in its Better Life Initiative, which recommends 11 indicators and gives individuals a way to assess them in relation to other countries to create an index that measures their performance on the issues that matter to them. The World Bank and the International Monetary Fund (IMF), both long-time proponents of GDP thinking, are now paying more attention to the environment, inequality, and the economy’s long-term viability.

This method has even been adopted into the policy-making frameworks of a few countries. In 2019, New Zealand, for example, incorporated “well-being” measures into the country’s budgeting process. “Success is about making New Zealand both a terrific location to make a livelihood and a fantastic place to create a life,” said Grant Robertson, the country’s finance minister. This focus on happiness may have contributed to the country’s victory over COVID-19, which appears to have been contained to around 3,000 cases and 26 deaths in a population of over five million people.

What is the purpose of GDP?

GDP is significant because it provides information on the size and performance of an economy. The pace of increase in real GDP is frequently used as a gauge of the economy’s overall health. An increase in real GDP is viewed as a sign that the economy is performing well in general.

What effect does GDP have on the stock market?

A country’s GDP measures both its economic growth and its residents’ purchasing power. As a result, the growth of India’s GDP will affect the success of your investment portfolio. We’ll learn what GDP is, how it’s calculated, and how a change in GDP affects your financial portfolio in this post. Let’s start with the fundamentals.

What is GDP?

A country’s GDP, or Gross Domestic Product, is the total value of products and services generated over a given time period. GDP statistics is calculated in India for each financial year, which runs from April 1 to March 31. The information is published on a quarterly and annual basis.

GDP statistics is a measure of a country’s economic health. A high rate of GDP growth suggests that the economy is growing and doing well. A negative GDP growth rate, on the other hand, implies that the economy has contracted and is not in good shape.

To address the expanding needs of the enormous population in a developing economy like India, a high GDP growth rate is essential. We can do so by investing heavily in infrastructure such as roads, railways, healthcare, and education, among other things.

How is GDP calculated in India?

The National Accounts Division (NAD), which is part of the Central Statistical Office in India, compiles and prepares GDP data (CSO). The GDP statistics is released by the CSO, which is part of the Ministry of Statistics and Program Implementation (MoSPI).

Expenditure method

The expenditure-based method shows how the Indian economy’s various sectors are performing.

The amount spent by households on goods and services is referred to as private consumption.
The term “gross investment” refers to the amount of money spent on capital goods by the private sector.
Government spending refers to how much money the government spends on things like paying employees’ salaries, pensions, subsidies, and running social programs, among other things.

Value Addition Method

India also uses the Gross Value Addition (GVA) Method or Value Addition Method to calculate GDP. As it goes through the supply chain, each sector of the economy adds value. The GVA approach calculates GDP by taking into consideration the following eight sectors:

The nominal GDP is calculated first when computing GDP. After that, it’s corrected for inflation, and the real GDP is calculated.

India’s GDP in the last few quarters

India’s quarterly GDP data for the last three years is depicted in the figure above. Positive increase was seen in the first quarter of 2020. Following that, COVID-19 struck, resulting in two quarters of negative growth. The Indian economy recovered from the pandemic’s effects in the fourth quarter of 2020, growing at a rate of 1.6 percent.

India’s GDP growth over the last decade

From 2012 to 2016, India’s GDP grew at a faster rate every year, as shown in the graph above. However, beginning in 2017, growth began to decline until 2019. COVID-19’s impact at the start of 2020 exacerbated the situation.

How a change in GDP affects your investment portfolio

Stock markets are directly associated with a country’s GDP, according to the general rule. India is no different. Because markets and GDP are intimately interrelated, your investment portfolio is also directly correlated with GDP.

The stock markets will be energized by a positive shift in the GDP (a higher GDP growth number), and the market will rise as a result. If the stock market rises, it will have a beneficial impact on your investment portfolio.
A negative change in the GDP (a lower GDP growth statistic or a GDP contraction) will undoubtedly cause the financial markets to react negatively. As a result, the stock market will fall. If the stock market falls, it will have a negative influence on your investment portfolio.

There is a positive association between India’s GDP growth and the NIFTY 50 Index, as shown in the graph above:

India’s GDP expanded at an annual pace of roughly 8% from 2004 to 2008. During this time, the NIFTY 50 Index climbed from 2000 to 4000 points. During this time, your investment portfolio should have done well.
The subprime mortgage crisis hit the United States in 2008-2009, with global ramifications. During this time, India’s GDP growth slowed from 8% to roughly 3%, and the NIFTY 50 Index dropped from highs of 4000 to lows of 3000. During this time, it would have had a detrimental influence on your financial portfolio.
Between 2009 and 2011, the GDP recovered, and the NIFTY 50 Index did as well. Your financial portfolio would have rebounded as well.
GDP growth slowed between 2011 and 2013, owing to reasons such as high crude oil prices, high inflation, and the European debt crisis, among others. During this time, the NIFTY 50 Index also saw a correction. Your investment portfolio would have suffered as well.
The GDP increased significantly from 2013 to 2018, surpassing 8% for the second time. During this time, the NIFTY 50 Index performed admirably. During this time, your investment portfolio would have produced impressive gains.
In recent years, the direct association between GDP growth and the NIFTY 50 Index appears to have weakened. In truth, there is a significant gap between the two. So, despite the fact that GDP growth has slowed, your investment portfolio has produced excellent results.

Divergence between GDP growth and stock markets

The relationship between GDP growth and stock markets is usually direct, as shown in the graph above, but this is not always the case. The Nifty 50 Index and GDP growth headed in different directions in 2019, and this trend persisted in 2020 and 2021. The following things may contribute to such a scenario:

Stock markets that are always looking ahead: Stock markets are always looking ahead. So, even if GDP growth is currently modest, the stock markets are anticipating strong GDP growth in the future and are trading at higher levels as a result.

High liquidity: In the previous year and a half, central banks and governments around the world, including India, have implemented various stimulus initiatives to mitigate the impact of COVID-19. People have received cash as a result of this. The majority of this money has been placed in the stock markets, which has resulted in greater stock market trading levels.

Other than stock, there aren’t many investing options: To counteract the pandemic’s effects and jump-start the economy, the RBI slashed interest rates dramatically. As a result, banks’ fixed deposit rates have dropped to multi-year lows. When the pandemic hit, gold spiked, but it has since adjusted and remained static. As a result, except from stock, Indian individual investors have few other investing options. As a result, most investors have put their money into stocks, causing the NIFTY 50 Index to rise.

Foreign fund flows: In the recent year, foreign institutional investors (FIIs) have invested massive sums of money in Indian stock markets, in addition to Indian ordinary investors. The NIFTY 50 Index has also risen as a result of this.

Better company profitability: The pandemic has impacted the whole Indian corporate sector. The unlisted economy, SMEs, MSMEs, and the informal economy continue to suffer. Large publicly traded corporations, on the other hand, have been able to weather the storm much more quickly and effectively. As a result, huge publicly traded firms’ profits have increased, and their stock values have increased, causing the NIFTY 50 Index to rise.

Divergence between GDP growth and stock markets is temporary

We’ve seen how the GDP growth rate and stock market performance can diverge. This type of divergence, however, is just transitory and will be corrected at some point. Either the GDP growth rate will rebound and the Indian economy will return to its previous high growth rate, or the stock market will correct in tandem with the low GDP growth rate in the future.

India’s GDP growth rate has a better chance of increasing than the stock market falling. Still, only time will tell what will transpire. What appears likely is that, over time, the pace of GDP growth and the stock market will re-establish a direct relationship.

Last words

You would be getting strong returns on your investment portfolio right now, even if GDP growth is sluggish. However, this may not last long, therefore let’s hope India’s GDP growth picks up rapidly so that our current investment returns remain stable and grow in the future. In the long run, proper asset allocation will ensure that your investment portfolio earns the best possible returns, even if GDP growth is sluggish. When the equity markets are performing poorly, the debt and gold sections of your investing portfolio can provide good returns. As a result, ensure that you have a suitable asset allocation between equity, gold, debt, and other assets, so that you can continue to achieve optimal returns regardless of GDP growth.

Is income included in GDP?

All economic expenditures should equal the entire revenue created by the production of all economic products and services, according to the income approach to computing gross domestic product (GDP).
The expenditure technique, which starts with money spent on goods and services, is an alternative way for computing GDP.
The national income and product accounts (NIPA) are the foundation for calculating GDP and analyzing the effects of variables such as monetary and fiscal policies.

What is a GDP example?

The Gross Domestic Product (GDP) is a metric that measures the worth of a country’s economic activities. GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a given time period. Within this seemingly basic concept, however, there are three key distinctions:

GDP is a metric that measures the value of a country’s output in local currency.
GDP attempts to capture all final commodities and services generated within a country, ensuring that the final monetary value of everything produced in that country is represented in the GDP.
GDP is determined over a set time period, usually a year or quarter of a year.

Computing GDP

Let’s look at how to calculate GDP now that we know what it is. GDP is the monetary value of all the goods and services generated in an economy, as we all know. Consider Country B, which exclusively produces bananas and backrubs. In the first year, they produce 5 bananas for $1 each and 5 backrubs worth $6 each. This year’s GDP is (quantity of bananas X price of bananas) + (quantity of backrubs X price of backrubs), or (5 X $1) + (5 X $6) = $35 for the country. The equation grows longer as more commodities and services are created. For every good and service produced within the country, GDP = (quantity of A X price of A) + (quantity of B X price of B) + (quantity of whatever X price of whatever).

To compute GDP in the real world, the market values of many products and services must be calculated.

While GDP’s total output is essential, the breakdown of that output into the economy’s big structures is often just as important.

In general, macroeconomists utilize a set of categories to break down an economy into its key components; in this case, GDP is equal to the total of consumer spending, investment, government purchases, and net exports, as represented by the equation:

The sum of household expenditures on durable commodities, nondurable items, and services is known as consumer spending, or C. Clothing, food, and health care are just a few examples.
The sum of spending on capital equipment, inventories, and structures is referred to as investment (I).
Machinery, unsold items, and homes are just a few examples.
G stands for government spending, which is the total amount of money spent on products and services by all government agencies.
Naval ships and government employee wages are two examples.
Net exports, or NX, is the difference between foreigners’ spending on local goods and domestic residents’ expenditure on foreign goods.
Net exports, to put it another way, is the difference between exports and imports.

GDP vs. GNP

GDP is just one technique to measure an economy’s overall output. Another technique is to calculate the Gross National Product, or GNP. As previously stated, GDP is the total value of all products and services generated in a country. GNP narrows the definition slightly: it is the total value of all goods and services generated by permanent residents of a country, regardless of where they are located. The important distinction between GDP and GNP is based on how production is counted by foreigners in a country vs nationals outside of that country. Output by foreigners within a country is counted in the GDP of that country, whereas production by nationals outside of that country is not. Production by foreigners within a country is not considered for GNP, while production by nationals from outside the country is. GNP, on the other hand, is the value of goods and services produced by citizens of a country, whereas GDP is the value of goods and services produced by a country’s citizens.

For example, in Country B (shown in ), nationals produce bananas while foreigners produce backrubs.

Figure 1 shows that Country B’s GDP in year one is (5 X $1) + (5 X $6) = $35.

Because the $30 from backrubs is added to the GNP of the immigrants’ home country, the GNP of country B is (5 X $1) = $5.

The distinction between GDP and GNP is theoretically significant, although it is rarely relevant in practice.

GDP and GNP are usually quite close together because the majority of production within a country is done by its own citizens.

Macroeconomists use GDP as a measure of a country’s total output in general.

Growth Rate of GDP

GDP is a great way to compare the economy at two different times in time. This comparison can then be used to calculate a country’s overall output growth rate.

Subtract 1 from the amount obtained by dividing the GDP for the first year by the GDP for the second year to arrive at the GDP growth rate.

This technique of calculating total output growth has an obvious flaw: both increases in the price of products produced and increases in the quantity of goods produced result in increases in GDP.

As a result, determining whether the volume of output is changing or the price of output is changing from the GDP growth rate is challenging.

Because of this constraint, an increase in GDP does not always suggest that an economy is increasing.

For example, if Country B produced 5 bananas value $1 each and 5 backrubs of $6 each in a year, the GDP would be $35.

If the price of bananas rises to $2 next year and the quantity produced remains constant, Country B’s GDP will be $40.

While the market value of Country B’s goods and services increased, the quantity of goods and services produced remained unchanged.

Because fluctuations in GDP are not always related to economic growth, this factor can make comparing GDP from one year to the next problematic.

Real GDP vs. Nominal GDP

Macroeconomists devised two types of GDP, nominal GDP and real GDP, to deal with the uncertainty inherent in GDP growth rates.

The total worth of all produced goods and services at current prices is known as nominal GDP. This is the GDP that was discussed in the previous parts. When comparing sheer output with time rather than the value of output, nominal GDP is more informative than real GDP.
The total worth of all produced goods and services at constant prices is known as real GDP.
The prices used to calculate real GDP are derived from a certain base year.
It is possible to compare economic growth from one year to the next in terms of production of goods and services rather than the market value of these products and services by leaving prices constant in the computation of real GDP.
In this way, real GDP removes the effects of price fluctuations from year-to-year output comparisons.

Choosing a base year is the first step in computing real GDP. Use the GDP equation with year 3 numbers and year 1 prices to calculate real GDP in year 3 using year 1 as the base year. Real GDP equals (10 X $1) + (9 X $6) = $64 in this situation. The nominal GDP in year three is (10 X $2) + (9 X $6) = $74 in comparison. Because the price of bananas climbed from year one to year three, nominal GDP grew faster than actual GDP during this period.

GDP Deflator

Nominal GDP and real GDP convey various aspects of the shift when comparing GDP between years. Nominal GDP takes into account both quantity and price changes. Real GDP, on the other hand, just measures changes in quantity and is unaffected by price fluctuations. Because of this distinction, a third relevant statistic can be calculated once nominal and real GDP have been computed. The GDP deflator is the nominal GDP to real GDP ratio minus one for a particular year. The GDP deflator, in effect, shows how much of the change in GDP from a base year is due to changes in the price level.

Let’s say we want to calculate the GDP deflator for Country B in year 3 using as the base year.

To calculate the GDP deflator, we must first calculate both nominal and real GDP in year 3.

By rearranging the elements in the GDP deflator equation, nominal GDP may be calculated by multiplying real GDP and the GDP deflator.

This equation displays the distinct information provided by each of these output measures.

Changes in quantity are captured by real GDP.

Changes in the price level are captured by the GDP deflator.

Nominal GDP takes into account both price and quantity changes.

You can break down a change in GDP into its component changes in price level and change in quantities produced using nominal GDP, real GDP, and the GDP deflator.

GDP Per Capita

When describing the size and growth of a country’s economy, GDP is the single most helpful number. However, it’s crucial to think about how GDP relates to living standards. After all, a country’s economy is less essential to its residents than the level of living it delivers.

GDP per capita, calculated by dividing GDP by the population size, represents the average amount of GDP received by each individual, and hence serves as an excellent indicator of an economy’s level of life.

The value of GDP per capita is the income of a representative individual because GDP equals national income.

This figure is directly proportional to one’s standard of living.

In general, the higher a country’s GDP per capita, the higher its level of living.

Because of the differences in population between countries, GDP per capita is a more relevant indicator for measuring level of living than GDP.

If a country has a high GDP but a large population, each citizen may have a low income and so live in deplorable circumstances.

A country, on the other hand, may have a moderate GDP but a small population, resulting in a high individual income.

By comparing standard of living among countries using GDP per capita, the problem of GDP division among a country’s residents is avoided.

Is a higher or lower GDP preferable?

Gross domestic product (GDP) has traditionally been used by economists to gauge economic success. If GDP is increasing, the economy is doing well and the country is progressing. On the other side, if GDP declines, the economy may be in jeopardy, and the country may be losing ground.