GDP and Its Role in Welfare Analysis

Gross Domestic Product (GDP) is a measure of commercial value that produces final goods and services in a particular time period. GDP per capita (also called GDP per person) measures a country’s standard of living. Each country draws up and brings out its GDP data regularly. A country with a higher rate of GDP is regarded as well off in economic perspectives than a country with a lower rate.

GDP Calculation in Economics

The subject of Economics, to a large extent, includes the study of the way goods and services are produced, distributed and consumed. In Economics, a purchaser of goods and services can be classified into three main categories -

• Households

• Businesses

• Government

GDP is calculated through an expenditure avenue which means adding up those expenditures made by those three groups of purchasers. If you want to know how GDP is calculated in simpler forms, please follow the formula that is mentioned below -

GDP = Consumption + Investment + Government Spending + Net Exports

[GDP = C + I + G + NX]

Where C denotes private utilisation of household and non-profit organisation, I denote business spending and home purchases, G denotes government’s spending on goods and services, and NX shows nation’s exports minus imports.

Understanding of GDP Price Deflator

The GDP price deflator mainly shows the effect of price changes on GDP by initiating a base year and comparing current prices to prices in the base year. It explains the price level changes, hikes within the economy, and keeps tracking of the prices paid by the businesses, government and consumers.

Are you finding a problem in understanding GDP price deflator?? If yes, then please follow the formula provided below -

GDP Price Deflator = (Nominal GDP/ Real GDP) × 100

Importance of GDP

GDP qualifies policymakers and central banks to analyse whether the economy is contracting or developing. It also indicates any signs of recession or uncontrolled inflation. GDP differs because of the following reasons -

• When the economy is flourishing, GDP is rising, and then it needs to be controlled by implementing “tighter monetary policy” to get hold of the inflation.

• Similarly, if interest rates rise, companies and consumers reduce spending, and the economy holds back.

• The ongoing process leads companies to cut out employees and hence affects consumer confidence and demand.

GDP for Economists and Investors

Students who are interested in studying the subject of economics should definitely need to know what is GDP in Economics. As we know, GDP includes the measurement of goods and services of a market manufactured in a specific period of time. But there are certain activities that GDP does not include. To be very precise, GDP does not account for any transaction that is not administered through the market. The activities include - household production etc. 

Economists examine constructive GDP growth between different time periods to have an idea of how much an economy is prospering. Investors also take notice because a notable change in GDP can have a significant impact on the stock market. If a company faces lower earnings, then it can lead to lower stock prices.

According to the current statistics, India faced economic fall off of 23.9% year-on-year in the second quarter of 2020. It is the biggest contraction of the Indian economy on record. Several sectors suffered huge economic downfall that led to massive revenue reduction for the government. 

GDP as an Economic Welfare

Since GDP estimates both the economy’s total income and expenditure on goods and services, one may have a question is GDP a good measure of economic welfare or not. 

Well, GDP cannot be considered as a perfect measure of economic well-being. 

For instance, if everyone in the economy suddenly starts working every day of the week rather than enjoying leisure periods on holidays. There will be more production of goods and services and hence would rise. Despite the rise of GDP, the loss from reduced leisure can lead to poor quality of products and thus would negate the gain from producing and consuming a greater quantity of goods and services. Therefore, GDP and welfare may not always go hand in hand. It can be a fair assessment of economic well-being but not all purposes.

More GDP does not necessarily mean an increase in happiness. But more GDP does mean the measurement of the production of goods and services. 

Students who are inclined to know much more about the importance of GDP in Economics can surely follow our online classes in Vedantu’s official website!