What is GDP in economics?

Canvas of GDP

GDP is a topic that everyone is interested in, but don’t get too worked up over it. What exactly is GDP in Economics? This problem is addressed everywhere, from TV talk programs to private meetings, by young and old, men and women, laymen and experts, politicians, and economists, and so on. Its popularity stems from the assumption or perception that GDP is an important metric for measuring a country’s well-being.

Politicians argue that GDP was higher and expanded quicker during their reign than during their opponents’. They believe that their policies and superior management have accelerated the economy. Living standards have risen all throughout the world because of economic expansion. Modern economies, on the other hand, have lost sight of the reality that the conventional metric of economic growth, gross domestic product (GDP), just measures the size of a country’s economy and does not reflect the welfare of that country.

However, politicians and economists frequently use GDP, or GDP per capita in some situations, as an all-encompassing metric for measuring a country’s progress, combining economic success with societal well-being. As a result, measures that promote economic growth are perceived as positive for society.

The COVID-19 and GDP

The COVID-19 outbreak, which began in early 2020, has had a significant impact on the global economy, particularly in developing countries. The pandemic overtook the entire world, having a negative effect on many developed countries’ healthcare systems. Initially, the supply shock generated by enterprises abruptly closing around the world morphed into an unexpected demand shock, with socio-economic ramifications. The COVID-19 epidemic imposed extraordinary limitations on people’s travel as well as a wide range of economic and financial activity. Tourism, travel, hotels & hospitality, transportation, and education were all adversely damaged by supply chains and businesses.

Divergences in the speed of recovery within and across nations, reflecting differences in pandemic-induced disruptions and the level of governmental support, pose substantial challenges to the global picture. Even after one and a half years since the COVID-19 epidemic began, the global community continues to face hurdles in terms of social and economic mitigation.

Unemployment and underemployment remained high even despite significant support and recovery that began in mid-2020. In most nations, vaccination has begun, with the hope of reducing the severity and frequency of illnesses in the future. So far, coverage varies a lot, and nations are projected to reach broad vaccination at different timeframes. New virus mutations, on the other hand, have raised serious concerns for the global economic picture.

The severity of the health crisis, the efficacy of the vaccine against new COVID-19 strains, the successful implementation of well-coordinated economic strategies, and the development of financial conditions all influence the global outlook. The variance of these drivers, as well as their relationship with country-specific features, will determine the speed of recovery and the level of medium-term harm.

The origins of GDP

The modern concept of GDP, like so many other commonplace concepts, emerged through battle. While Simon Kuznets has often been credited with establishing GDP (after attempting to measure US national income in 1932 to appreciate the full scope of the Great Depression), John Maynard Keynes developed the current idea of GDP during WWII.

In 1940, one year into the war with Germany, Keynes, who was working in the UK Treasury at the time, published an essay stating that economic statistics were insufficient in determining what the British economy might generate with the existing resources. He said that measuring Britain’s mobilization and combat capacity was difficult due to a lack of data categories.

He believes that national income should be calculated using the sum of private consumption, investment, and government spending. He rejected Kuznets’ version, which represented the government’s income but not it’s spending. According to Keynes, if the government’s wartime purchases were not factored into national income estimates, GDP would fall even though the economy was expanding. Even after the war, his method of calculating GDP, which included government spending in a country’s income and was motivated by wartime needs, gained widespread support. It is still going on in various parts of the world.

GDP in economics as defined in textbooks

GDP is a measure of the size and health of our economy. GDP is the total market value (gross) of all goods and services produced (product) by a country each year. What, however, is included in GDP? We can use the textbook formula for measuring GDP to assist us to break down the number: 

C + I + G + (X-M) = GDP.

C is Personal Consumption Expenditures. (Also known as consumer expenditure, or the total of all products and services purchased by consumers, including anything from groceries to health insurance.)

I is Gross Private Investment. (Includes company expenditure on fixed assets like machinery, equipment, and buildings, as well as inventory investment; also includes house purchases by consumers.)

G is Government Purchases. (Includes spending by the federal, state, and municipal governments on goods and services ranging from schools and highways to national security.)

X-M is Exports minus Imports. (Or net exports: the value of exports to other nations minus the value of imports into the country; “the dollar value of imports is deducted to guarantee that only domestic spending is measured in GDP.”)

The output of the economy depends on two things,

  • Factors of production also known as inputs
  • And its ability to turn inputs into output, as represented by the production function.

Theoretical View of GDP

The production approach calculates the “value-added” at each stage of the manufacturing process, with value-added defined as total sales less the cost of intermediate inputs. Flour, for example, is an intermediate input with bread as the ultimate output; similarly, architectural services are an intermediate input with the final product being the building.

The expenditure method sums up the value of final user purchases, such as food, televisions, and medical services used by households; firm machinery investments; and government and foreigner purchases of goods and services.

The income approach sums together all of the output’s earnings, such as employee salary and corporate operating surplus (sales less costs).

A government agency or a national statistics agency gathers data from a range of sources on a regular basis to calculate a country’s GDP. In their calculations, most countries, on the other hand, adhere to internationally agreed-upon standards. The International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank created the System of National Accounts in 1993 as the international standard for estimating GDP.

In 1993, the UN Statistical Division, the International Monetary Fund, the World Bank, Eurostat, and the Organization for Economic Cooperation and Development collaborated on the System of National Accounts (SNA). It is designed for international use and provides a clear structure for compiling national account data. However, due to the SNA’s complexity, it might be difficult to locate explicit explanations of terminology commonly used in national accounting.

As a result, the OECD developed this glossary, which can be used as a quick reference for the language often used in national accounts. The OECD and other international organizations involved with the SNA are working on a series of handbooks that will provide additional information on various aspects of the SNA.

The volume of an economy’s output, or the actual incomes of its citizens, are used to measure its growth. The amount of gross domestic product (GDP), real gross domestic income, and real gross national income are three viable metrics for estimating growth according to the United Nations System of National Accounts (2008 SNA). The sum of value created by households, government, and industries working in the economy, evaluated at constant prices, is the volume of GDP. GDP includes all domestic production, regardless of whether the income is distributed to domestic or international agencies.

The state of Pakistan’s GDP

Over the years, Pakistan‘s economy has had a turbulent growth pattern, with recurrent boom and bust cycles, making it difficult to achieve long-term and inclusive growth. Long-standing structural difficulties, such as loss-making State-Owned Enterprises (SOEs), a weak external position due to limited export capacity and low FDI, an under-reformed energy sector, and low savings and investment, all contributed to unsustainable economic development.

In the face of these obstacles, the current government has concentrated on an economic strategy of achieving long-term economic growth through boosting efficiency, lowering the cost of doing business, improving the regulatory environment, raising productivity, and expanding investment.

Private consumption accounts for a major portion of GDP. This high proportion indicates that Pakistan’s economy is based on consumption. Improved consumer confidence can have an impact on domestic production by raising demand for long-lasting goods. Private consumption increased by 17 percent in FY2021, compared to 4 percent the previous year.

However, growth in Public Consumption remained at 11.4 percent, down from 19.3 percent the previous year, owing to fewer interest payments and the squeezing of superfluous spending.

In FY2021, Gross Fixed Capital Formation (GFCF) increased by 13.8 percent and remained at 13.6 percent of GDP. The private and governmental sectors, including the General Government, grew by 6.6 percent and 38.1 percent, respectively, in the GFCF.

Historically, Net Exports’ contribution to aggregate demand has been negative. Exports of goods and services increased by 13.6 percent in the fiscal year 2021, while imports of goods and services increased by 20.1 percent. However, capital goods and raw materials were the key imports this year, assisting in the rise of exports as well as the revival of the local economy.

Pakistan’s economy returned well in FY2021, growing at 3.94 percent, significantly higher than the previous two years (-0.47 and 2.08 percent in FY2020 and FY2019, respectively), and above the objective (2.1 percent for FY2021). Despite tight fiscal limitations, the government’s timely and appropriate policy initiatives resulted in a V-Shaped economic rebound.

Real GDP

People want to know whether an economy’s total output of goods and services is increasing or decreasing. However, because GDP is calculated at current, or nominal, values, it is impossible to compare two periods without taking inflation into account.

To calculate “real” GDP, the nominal value must be adjusted to account for price changes, allowing us to assess whether the value of output has increased because more is produced or just because prices have risen. The price deflator is a statistical technique that is used to convert GDP from nominal to constant prices.

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. When real GDP grows rapidly, employers are more willing to hire additional workers for their factories, and people have more money in their purses.

When GDP falls, as it happened in many nations during the recent global economic crisis, employment usually falls. In some circumstances, GDP may be increasing, but not quickly enough to produce enough jobs for individuals looking for work.

However, real GDP growth occurs in cycles across time. Economies go through phases of rapid expansion and then periods of slow growth or even recession (with the latter often defined as two consecutive quarters during which output declines). Between 1950 and 2011, the United States, for example, experienced six recessions of different lengths and intensities. The dates of U.S. business cycles are determined by the National Bureau of Economic Research.

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