Nominal/Real GDP

Alternative Approaches to Calculating GDP

There are three approaches to calculating GDP:

• expenditure approach - described above; calculates the final spending on goods and services.
• product approach - calculates the market value of goods and services produced.
• income approach - sums the income received by all producers in the country.

These three approaches are equivalent, with each rendering the same result.

Final Sales as a GDP Predictor

Note that an increase in inventory will increase the GDP but possibly result in a lower future GDP as the excess inventory is depleted. To eliminate this effect, the final sales can be calculated by subtracting the increase in inventory from GDP. The final sales can be either larger or smaller than GDP. The change in inventory is an important signal of the next period’s GDP.

Nominal GDP and Real GDP

Without any adjustment, the GDP calculation is distorted by inflation. This unadjusted GDP is known as the nominal GDP. In practice, GDP is adjusted by dividing the nominal GDP by a price deflator to arrive at the real GDP.

In an inflationary environment, the nominal GDP is greater than the real GDP. If the price deflator is not known, an implicit price deflator can be calculated by dividing the nominal GDP by the real GDP:

Implicit Price Deflator = Nominal GDP / Real GDP

The composition of this deflator is different from that of the consumer price index in that the GDP deflator includes government goods, investment goods, and exports rather than the traditional consumer-oriented basket of goods.

GDP usually is reported each quarter on a seasonally adjusted annualized basis.

GDP Growth

Countries seek to increase their GDP in order to increase their standard of living. Note that growth in GDP does not result in increased purchasing power if the growth is due to inflation or population increase. For purchasing power, it is the real, per capita GDP that is important.

While investment is an important factor in a nation’s GDP growth, even more important is greater respect for laws and contracts.

GDP versus GNP

GDP measures the output of goods and services within the borders of the country. Gross National Product (GNP) measures the output of a nation’s factors of production, regardless of whether the factors are located within the country’s borders. For example, the output of workers located in another country would be included in the workers’ home country GNP but not its GDP. The Gross National Product can be either larger or smaller than the country’s GDP depending on the number of its citizens working outside its borders and the number of other country’s citizens working within its borders.

In the United States, the Gross National Product (GNP) was used until the early 1990’s, when it was changed to GDP in order to be consistent with other nations.