Income, Expenditure Approach | GDP Calculation Formulas

[ Keywords: What is GDP. GDP Formula. Income Method. Expenditure Method. Value Added Method. Nominal GDP. Real GDP.]
Hi guys. Welcome to my article. In this article I am going to write about GDP formulas. The formula of GDP depends on various factors. The most important is about the types of economy of your country. There are three GDP formulas around the world. Read this full article the know about GDP.

What is GDP?

GDP is the economic value of total production of product and service created within a particular area or country within one year. 

GDP Formula:

There are three formulas for GDP.

Income Method: 

Well some people really confuse this method. For some the formula is Total National income + sale taxes + Depreciation + Net foreign Factor Income and for some the formula is Net domestic income + Indirect taxes + Depreciation - Subsidy. The second one is correct and the 1st one is completely incorrect.

First let us talk about first formula.
Wrong GDP Formula: The formula is GNI or Gross National Income + Sale Taxes + Depreciation + Net Foreign Factor Income. Net foreign factor income is included in GNI. So, why should you include that in the GDP? In GDP we don't care whether the salary is paid to the foreigner or to the domestic employees.

Now let us talk about the 2nd formula.
Right GDP Formula: The formula is Net Domestic Income + Indirect Taxers + Depreciation - Subsidy. Now let us break down the formula of Net Domestic Income. NDI = Compensation of employees + Net Interest ( Interest Paid by Business or entities to bank - Interest Earned by Business or entities from bank) + Income of Business + Corporate Profits + Rental Income

Expenditure Method:

If the economy is closed economy, the country will have no import or export. If the economy is open, the country will export and import goods. So the formula will be different for both economy.
In expenditure method, the formula for GDP in closed economy is C + G + I and for the open economy it is C + I + G + Export - Import. I am going to explain it.

C means Consumption cost. I means Investment. G means Government cost. C is the expense of people to lead their lives. I is the amount of money invested. It is also one kind of expense. G is expense of the government. All of these expenses is income to someone. Our aim is to estimate the production of the region. People earn money from the expense of government or investment because the investor buys goods for his business but doesn't consume from his business. That is not part of business. That is part of consume. Government also buys something and must pay salaries to employees. This way service by the government employees is created. In open products doesn't come just from its own region. People import and export. So the produced goods are going from the country by exports and produced goods by other region is coming to the country by import. So, to find out the real production amount of the region we must reverse the situation. This is why we add export and subtract import. Because by adding export we are including the exported product that is out of the region but produced within the region and subtracting import we are not including the imported product that is not created in the region.
So the formula for expenditure method:
For Closed Economy: C + I + G
For Open Economy: C + I + G + Export - Import

Value Added Method:

Calculating in this method is very easy but when we apply it, it is very complex. We calculate the economic value of all goods and services produced in the country and subtract all kinds of expenses from it. Its first challenge is that it is very hard to get the right data.

How the value of GDP is set?

It is a bit of complex if I start with normal definition. So I will start with an example.

Imagine, ABC is a country and it produced goods worth of $1 billion. In the previous year, the GDP was $500 million. Its annual inflation was 100%. So, does this mean there was an actually increase in production?  No. To solve this problem, the economist use two kinds of GDP. One is Nominal GDP and the other is Real GDP.

Nominal GDP:

When we calculate GDP in the price of current year, we may get the estimation of GDP but it will not reflect the economic situation of the country. In the previous example, we have seen that the annual inflation of the country was 100%. Which means if  one apple was sold at $1 in the previous year, the apple is sold at $2 this year. So we understand that the worth of the goods are increased by inflation. If we calculate GDP at the inflated price, it will be Nominal GDP. It doesn't represent the real growth of economy.

Real GDP:

To get the real growth result of GDP, we must calculate the price of GDP on a standard price. For example, the standard price for apple is one dollar. No matter what the price is the apple will be calculated at one dollar. So, even if the inflation rate is 100%, it will not affect GDP. So, if the price of apple increased to $2, the price of apple will be $1 in GDP.

To Sum Up:

There are three methods to calculate GDP. The intention of all formula is to estimate the production of the region. When it comes to the valuation of GDP, there are two types of GDP. One is Real GDP and the other is Nominal GDP.

I hope I have been able to make it clear about GDP formulas.