The Hindu Business Line : GDP demystified

GDP or Gross Domestic Product is usually defined as the `the monetary value of the all finished goods and services produced in a certain geographical area during a certain time period'.

Of course, `a certain geographical area' refers to a country and `a certain time period' more often than not refers to a financial year though GDP is also measured for every quarter.

The financial year, in the case of India, refers from April to March (for example, April 2007 to March 2008), while in the US it is from January to December. In essence, it is the size of the economy. One thing that should be remembered is that this GDP is measured using market prices.

The three components that make up GDP are agriculture, industry, and services. For example, if there are three items in agriculture, two in industry and 10 in services. Now imagine, they all sold for Rs 10 each. Now add them all up and one would get Rs 150.

That would be the GDP for the country. Of course, in the real world, there are millions of goods and services. Another way of measuring GDP is through the following equation: GDP = C + I + G + NX where `C' is personal consumption and includes the expenditure of households on different items such as food and medical expenses. `I' refers to investments in machinery, building new houses, buildings etc.

It should be remembered that investment does not refer to investing in shares or bonds. `G' is government spending and includes money spent on paying government employees, as also investment expenditure by the government such as on roads.

However, it does not include transfer payments such as retrials and subsidies. `NX' means net exports and is simply exports less imports. Therefore, if imports are more than exports, then `NX' would be negative and vice-versa.

GDP is the most important macroeconomic number but what one should really look out for is the real GDP growth number. `Real', as opposed to nominal, means that it is adjusted for inflation. The GDP growth number tells us about the strength of the economy or how well it is performing.

It tells us whether an economy is growing from strength to strength or if it is faltering. Of course, GDP growth rates never stay the same. Sometimes, they are high, sometimes low, sometimes positive and sometimes negative.

There are many factors that affect GDP growth and they can be government policies, people spending more or less, the level of investment. Of course, various factors affect these factors.

For example, in India, the government has put in place some sensible policies to help the economy.

Now people, outside India as well as inside, see the potential in the country and start to invest more. Because of this people earn more money. They now spend this money on buying clothes. The clothes manufacturer makes more clothes and she pays her employees more. Those employees then spend their money on other goods.

This build a whole virtuous cycle. One can actually now see the effect of this virtuous cycle when one looks at the rate of growth of India's GDP. On the other hand if the government had bad economic policies, the exact opposite of the above would have happened.

If there is one factor that can make or break an economy, it is certainly how good or bad the government economic policies are.

It doesn't take rocket science to figure this one out. Look at India, China, and Brazil and one sees strong economic growth and then see countries such as Zimbabwe, Venezuela and one can see the effects of poor economic policies.

It is from this government policy that things such as consumer confidence, investor confidence and every other kind of confidence rise.

SUNIL RONGALA (The author is Economist, Murugappa Group. The views expressed are personal. Send in your queries on economics to Whackonomics@gmail.com

More Stories on : Economics | Economy | Whackonomics

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Meetings and resolutions

Sticklish Issues

Playing a winning game

Suitable rent for different suites

Who will deduct my tax?

Certification course for business analysis

RBI mulls creating housing stat index

GDP demystified

Just Do IT

Number Crunch

Soar with your dreams

Life is too precious to be wasted looking for a job

Be ‘positively compelling’