Gross Domestic Product (GDP) Calculates Economic Growth

Businesses and individuals alike often like to compare their respective economic health with that of their nation. One way to figure economic growth is by a measurement known as Gross Domestic Product (GDP).

Gross Domestic Product, or GDP, calculates the value of a nation's production to determine the growth of its economy. GDP accounts for the total value of all services and goods produced by a country inside its legal borders over a period of time, usually 12 months or a year.

The United States replaced its previous form of economic measurement, Gross National Product, with GDP in 1992, in order to match up with the economic measures used by other nations. GDP concentrates where services and products are created, that is, within a nation's borders, as opposed to GNP's method, which measures the production of all citizens and the businesses they own, no matter their location.

There are three accepted ways to calculate Gross Domestic Product: by expenditure, by national income or by output, also known as value-added. Economics theory requires that all three methods must provide the same results, since total output value should equal the expenditures for those goods and services, which should equal the salaries and wages paid to the producers. The expenditures approach is used most often, represented by the following formula:

GDP = Consumption of goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) - Imports (M))

"Consumption" totals up all private consumption, or the sum of all personal expenditures by households for food, shelter, health care, etc. New housing is exempt from this total.

"Investment" adds up the money spent on business or personal capital improvements. Examples of business expenses in this category would be computers and the software to run on the computers. For households, a new home would be considered an investment. However, the purchase of any financial products such as individual stocks, government bonds or mutual funds would be considered "savings" and not included in this category.

"Government spending" totals up how much a government spends on the salaries and wages of public employees, the cost for operation and upkeep of governmental buildings, purchases of weapons for the military and similar expenses. However, whatever benefits the government pays out, such as Social Security or unemployment, is not included. These are considered "transfer payments" since they transfer money to citizens who then spend the money for personal upkeep, which is already calculated in the "Consumption" category

"Exports" totals the value of a nation's gross exports, or those products sold to other countries.

"Imports" adds up the gross value of gross items produced outside a nation that are purchased by government, businesses or individuals. Since these purchased are included in the sums for Consumption, Investment or Government, this value must be subtracted to avoid the error of "double counting."

Some economists like the national income formula for Gross Domestic Product to gauge the capacity of individuals and businesses to trade their incomes for services and goods. This calculation is:

GDP = Employee compensation + Corporate profits + Proprietor's Income + Rental income + Net Interest

The output, or value-added, method seeks to determine the value of a nation's total production by calculating the final value of any product or service. This formula is:

GDP = The value of sales of goods - purchase of intermediate goods to produce the goods sold.

A book called "System of National Accounts, " also known as SNA93, sets out the international standards for calculating Gross Domestic Product. Representatives of the the European Union, the International Monetary Fund, the Organization for Economic Co-operation and Development, the United Nations and the World Bank created this reference work in 1993.