Debitoor's accounting dictionary

GDP – What is GDP?

GDP – an abbreviation of gross domestic product – is the total monetary value of all final goods and services produced within a country throughout a specific period of time.

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Gross domestic product is usually calculated on an annual basis, which means that the numerical value of GDP reflects a country’s total economic output over twelve months. However, GDP might also be calculated on a quarterly basis, measuring a country’s economic output over a four-month period.

GDP only considers new, finished goods and services that are legally sold for money, it does not include:

  • Unpaid work (such as volunteer work or domestic labour)
  • Sales of unfinished products
  • Sales of used goods
  • Illegal activities or products sold on the black market.

To make it easier to compare the GDP of different countries, gross domestic product is usually presented in US Dollars.

Types of GDP

There are a few different types of GDP, including:

  • Nominal GDP: the face value of a country’s economic output, which has not been adjusted for inflation. Nominal GDP is also known as current GDP. Nominal GDP is usually used when comparing quarterly GDP within the same year.

  • Real GDP: the value of a country’s economic output adjusted for inflation or deflation. Real GDP is also known as constant GDP. Real GDP is usually used when comparing annual GDP between different years.

  • GDP per capita: nominal GDP divided by the total population of a country. It measures the average economic output of each person living in a country, rather than the economic output of the country as a whole.

How to calculate GDP

There are three main ways to calculate a country’s gross domestic product: the production approach, the expenditure approach, and the income approach. In principle, all three approaches should produce the same figure.

A country’s GDP is usually calculated by that country’s national statistical agency using one of these three approaches.

Calculating GDP with the production approach

The expenditure approach to calculating gross domestic product involves adding together the ‘gross value added’ of every industry within a country. To calculate the ‘gross value added’ of an industry, you need to determine the industry’s output (the value of the goods and services produced) and input (the value of the goods and services used in the production of final goods and services). The ‘gross value added’ is the difference between an industry’s input and output.

Calculating GDP with the expenditure approach

The expenditure approach to calculating gross domestic product involves adding together the value of every sale of goods or services made within a country. The formula for calculating GDP with the expenditure approach is:

GDP = private consumption + gross private investment + government investment + government spending + (exports – imports)

Calculating GDP with the income approach

The income approach to calculating gross domestic product involves adding together all of the different types of income generated by a country’s production process, including wages, salaries, bonuses, taxes payable to the government, and operating surpluses.

The impact of GDP on small businesses

It is important that small businesses understand the meaning and relevance of gross domestic product, as changes to a country’s GDP can have a big impact on the activities and finances of start-ups, freelancers, and entrepreneurs.

For example, businesses tend to hire more employees and wages often increase when GDP increases. If you employ other people, your payroll expenses might therefore fluctuate based on changes to your country's gross domestic product.

Another important reason for understanding GDP is because investors pay close attention to trends in gross domestic product. If GDP is decreasing, investors are less likely to invest in new projects or business ventures, which could limit a small business’s chance of securing an angel investor.

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