Gross domestic product (GDP) is the market value of all final goods and services produced within an economy in a given period of time. This means that we take into account the market value of products of a given country, including nationals and foreigners working in that country. This is the main difference with the gross national product, which considers goods produced only by nationals of a country, without considering their residence.
Note that GDP is calculated over a given period of time, which makes it easy to compare it with other periods or the GDP of other countries. It has also two important implications: goods resold are not considered in the GDP; and goods finalised but not sold are considered as inventory.
We can estimate it using one of three methods. The income approach considers all wages, interests paid, rent and other sources of income to estimate GDP. The production approach estimates gross value and then subtracts intermediate consumption, considered as goods and services used in the making of final goods and services. Finally, there is the expenditure approach, which looks at the demand side.
The expenditure approach considers total expenditure, considering everyone in the economy, such as households, firms and government. GDP (also denoted as Y, production) can be disaggregated into four big components that classify the nature of the expenditure. These components are consumption (C), investment (I), government spending (G) and net exports (NX). With all these variables we can define the following identity:
Y = C + I + G + NX
Any amount of money spent in an economy can be classify into one of the four components of the identity, taking into account the nature of the product, the buyer and the purpose of the spending.
The evolution during the years of a country’s GDP shows the performance of its economy. When GDP is bigger year after year, we can consider it as a sign of a growing economy. Inflation must be considered when analysing gross domestic product, in order to differentiate nominal and real GDP. Nominal GDP considers only current prices, while real GDP is calculated using prices of a base year, in order of eliminate the effects of inflation
Additionally, if we look at the GDP per capita, dividing the GDP between that country’s total population, we can compare the living standards among countries. However, this measures does not completely represent the welfare of a country’s population, since other things must be taken into consideration.