Economics Part A

Methods of Calculating GDP or Gross Domestic Product

Calculating GDP

In the previous example, GDP can be calculated in three different ways: 

  • As the added value of the factories in Country A. 
  • As the total sales of Country A, minus its imports.
  • As the national income. 


 1. GDP equals the total added value of all the factories in Country A 

 In the previous example, GDP equals $2,000 (i.e., the Added Value Row in Column 4). The

 added value of a country equals the total added value of all of its industries. In this case, there are only two factories.


2. GDP equals total sales (revenue) of finished goods

In the example, the GDP also equals $2,000 according to this method (The Total Revenue Row in Column 3). Sales of finished goods total $2,000. The entire production of intermediate goods flows to factories that produce finished goods. These intermediate goods are integrated into finished goods, and both are sold as a single unit. In this manner, everything produced in a country eventually becomes finished goods.    

It will be seen later that when a country imports raw materials, its GDP equals total sales minus imports.


Another Explanation

Assume for simplicity’s sake that the bakery buys the flour mill, threby leaving Country A with only one factory - the bakery. The bakery’s economic situation is now as follows: 

In later examples, the flour mill imports wheat from abroad, or the bakery imports flour from abroad.

In these cases, the value of the imports (either by the flour mill or bakery) must be subtracted from sales in order to obtain the added value for the country. 


Another example

This example illustrates the calculation of GDP using finished goods. 

Country B has six factories: Three bread bakeries and three shoe factories. 

  • Each factory has 10 workers. 
  • Each worker producing intermediate goods earns $20 per year. 
  • Each worker producing finished goods earns $30 per year. 

The production process in the bread sector is as follows:

The farm grows a raw material, wheat, which it sells to the flour mill.  The flour mill produces intermediate goods, i.e., flour, which it sells to the bakery. In the bread sector, only the bakery produces finished goods.

The production process in the shoe sector is as follows:

  • Only Factory no. 3 produces finished goods, while the other factories manufacture intermediate goods.
  • Factory no. 1 sells its entire production to Factory no. 3.
  • Factory no. 2 sells its entire production to Factory no. 3.  

The following table shows the revenues and expenses of the bread sector. 

The following table demonstrates the revenues and expenses of the shoe sector.


Conclusion

According to the added value method, Country B’s GDP is $6,000 (i.e., six factories, each with added value of $1,000).

According to the sales of finished goods method, Country B’s GDP is $6,000. Only two factories produce finished goods: the bakery and the shoe factory. There are no imports.

Methods of Calculating GDP or Gross Domestic Product590Methods of Calculating GDP or Gross Domestic Product