GDP is the indicator that shows the value of the total production of final goods and services of the economic agents that operate in a country, during a given period.
Before explaining the three calculation approaches to estimate the GDP of an economy, it is needed to have a good knowledge about some basic concepts that appear in every definition of GDP.
First, what are final goods and services? Those that are sold for their final use; the so-called intermediate goods and services, which are those used to produce the previous ones, are not included, because, otherwise, the value of the product would be doubled. For example, if a company purchases goods worth 100 c.u., 200 c.u., and 300 c.u. to manufacture its product, which it sells for 1,200 c.u., only 1,200 c.u. are computed, which already include the amounts paid to other suppliers for the goods purchased.
Second, GDP includes goods and services produced by residents within the country under study, regardless of whether whoever manufactured them is a national of that country or a foreigner. For example, if an American company has a factory in Portugal, the value of the products of this factory will be part of the Portuguese GDP.
As noted above, there are several approaches to estimating GDP:
- Production approach (supply): Considers the GDP as the sum of the total production of each of the sectors of the economy.
- Income approach: Considers the GDP as the sum of the income paid to the factors that have participated in the production (labour, capital, machinery, real estate).
- Expenditure approach (demand): It is the approach commonly used and consists of the sum of the expenditure on final goods and services made by families, companies, governments and the foreign sector.
It is assumed that the higher the GDP, the more activity and, the more activity, the higher the income. Regarding the limitations presented by GDP, the following should be highlighted:
- In the first place, it is inoperative when it comes to accounting for transactions that occur outside the market.
- It does not take into account possible quality improvements in production.
- It does not consider the effects of (negative) externalities of growth (e.g., air pollution).
- It does not reflect how the income it generates is distributed: A country may have a very high GDP, but income may be concentrated in a small part of the population.
- For the calculation of GDP, some economic activities that can be considered to deplete natural resources, such as the construction of houses in a natural setting, compute in a positive way.
