Gross Domestic Product (GDP) is an attempt to figure the market value for the production of goods and services in an economy within a specified period, usually tallied annually. Measuring GDP is meant to show the economic output of an economy, generally the economy of a nation. GDP can be measured in three ways, which are the production approach, expenditure approach and income approach. Most often used is the production approach, though in theory, all three approaches should produce the same result. Understanding a nation's GDP can help that nation ascertain how to raise its standard of living.
Considered as output, the production approach is used in measuring GDP by adding the total production output of all enterprises to achieve a total. Three steps comprise the method to arrive at this total. First, economists will attempt to estimate the gross value of domestic production in all economic sectors. Then, they will figure the expenses incurred in achieving that production, referred to as immediate consumption. Lastly, economists will subtract the immediate consumption value from the total output value to arrive at the GDP.
With the expenditure approach, economists measure GDP by adding four different types of expenditures. Consumption is calculated by adding expenditures of both goods and services, while investment is figured by including both fixed assets and increases in inventory. Government purchases is figured by adding all government expenditures minus social benefit payments, such as welfare or unemployment. Figuring of net exports is done after the minus of all imports, as imports are not considered a reflection of domestic economic output. Overall, the expenditures approach accounts for all spending on goods and services domestically.
Measuring GDP using the income approach involves calculating national income. This is figured by adding four components. The first, labor income includes salaries, wages and benefits, such as health insurance, in addition to social security and unemployment. Rental income includes rental on property and royalties on assets, while interest income accounts for interest paid on money loaned to corporations and businesses. Profits is figured on what businesses have left after paying all employee compensation, debt interest and rents, but does not account for accounting or economic profit for GDP purposes.
Countries measuring GDP can use the figure to ascertain the nations standard of living and use it as a measure of economic health. Inflation and population increases, however, can skew the measurement of GDP in this respect since the increases do not reflect increased purchasing power. Instead, economists use the term real GDP to identify GDP that minuses inflation and population increases in the final total.