Gross domestic product (GDP) and gross national income (GNI)

Gross domestic product (GDP) measures the total value of all final goods and services produced within an economy over a set period, typically a year or quarter. It focuses on output generated inside the country's borders, regardless of who owns the factors of production.

Key features of GDP

• Value calculation - Determined by multiplying the quantity of goods and services produced by their market prices.
• Final goods only - Includes only end products to prevent double counting; intermediate goods used in production are excluded.
• Value added - Represents the extra worth a firm adds to raw materials or components, calculated as total revenue minus the cost of inputs bought from other firms.
• Exclusions from GDP - Does not count sales of second-hand items, financial deals like stock trades, or government transfers such as benefits.

Methods to calculate GDP

There are three main approaches to measuring GDP, each providing a different perspective but yielding the same total:

1. Output approach - Sums the value added by all industries or sectors in the economy.

   $\text{GDP}=\text{sector 1}+\text{sector 2}+\text{sector 3}+\cdots +\text{sector n}$

2. Expenditure approach - Adds up all spending on final goods and services.

   $\text{GDP}=C+I+G+(X-M)$

   Where:

   • C = Household spending on goods and services
   • I = Business investment in capital items
   • G = Government expenditure on public services
   • X - M = Net exports (value of exports minus imports)

3. Income approach - Totals all earnings from production.

   $\text{GDP}=\text{rents}+\text{wages}+\text{interest}+\text{profits}$

Gross national income (GNI)

Gross national income (GNI) adjusts GDP to reflect income earned by a country's residents, including from abroad.

$\text{GNI}=\text{GDP}+\text{factor income from abroad}-\text{factor income sent abroad}$

• Includes profits or wages earned overseas by nationals.
• Excludes income generated domestically by foreign-owned firms or workers.
• In major economies, GNI is often close to GDP, but in smaller nations, the difference can be substantial due to foreign investments or remittances.

Nominal and real values, including per capita figures and PPP

Economic measures can be expressed in nominal or real terms to account for price changes over time. Per capita calculations and purchasing power parity (PPP) adjustments provide more accurate comparisons of living standards.

Nominal versus real GDP

• Nominal GDP - Values output using current prices from the period being measured, which can be inflated by rising prices.
• Real GDP - Adjusts for inflation by using prices from a fixed base year, showing actual changes in production volume.

The GDP deflator

The GDP deflator measures price level changes and helps convert nominal GDP to real GDP.

$\text{GDP deflator}=\frac{\text{nominal GDP}}{\text{real GDP}}\times 100$

$\text{Real GDP}=\frac{\text{nominal GDP}}{\text{GDP deflator}}\times 100$

Per capita figures

Per capita values divide total figures by population size to indicate average output or income per person, offering a basic gauge of living standards.

$\text{GDP or GNI per capita}=\frac{\text{total GDP or GNI}}{\text{population}}$

Real GDP or GNI per capita at purchasing power parity (PPP)

PPP accounts for varying costs of living across countries, expressing values in a common unit (often PPP dollars) that equalises buying power. This makes international comparisons fairer, as it reflects what people can actually afford rather than just exchange rates.

Worked example - Calculating real GDP using the GDP deflator

In 2022, nominal GDP was £2,500 billion, and the GDP deflator was 125 (using 2015 as the base year). Calculate real GDP.

Step 1: Identify the values

• Nominal GDP = £2,500 billion
• GDP deflator = 125

Step 2: Apply the real GDP formula

$\text{Real GDP}=\frac{\pounds \mathrm{2,500}\text{ billion}}{125}\times 100$

Step 3: Calculate real GDP

$\text{Real GDP}=\pounds \mathrm{2,000}\text{ billion}$

The business cycle

The business cycle describes short-term ups and downs in real GDP, showing how economic activity fluctuates around a long-term growth trend.

Stages of the business cycle

• Peak - The highest point of output before a downturn begins.
• Contraction or recession - A period of falling real GDP; a recession is officially two or more consecutive quarters of decline.
• Trough - The lowest point of output before recovery starts.
• Expansion - A phase of rising real GDP as the economy grows.
• Long-term trendline - Represents the average growth rate over many years, smoothing out short-term variations.

Limitations of GDP and GNI as measures of well-being

While GDP and GNI indicate economic size and income, they have drawbacks as indicators of overall quality of life.

Key limitations

• Income distribution - Do not show how wealth is shared, so high GDP could mask inequality.
• Environmental impact - Ignore damage like pollution from production.
• Leisure time - Fail to value non-work activities or shorter working hours.
• Wealth stocks - Focus only on income flows, not accumulated assets.
• Public services - Overlook variations in access to education or healthcare.
• Damage repairs - Count spending on fixing problems (e.g., disaster recovery) as positive.
• Output composition - Do not distinguish between beneficial goods (e.g., healthcare) and harmful ones (e.g., weapons).

Alternative measures of economic well-being

Beyond GDP and GNI, other indices provide broader assessments of living standards by incorporating social, environmental, and subjective factors.

Better Life Index

The Better Life Index (BLI) was developed by the Organisation for Economic Co-operation and Development (OECD).

The BLI evaluates well-being across 11 areas:

• Housing
• Income
• Jobs
• Community
• Education
• Environment
• Civic engagement
• Health
• Life satisfaction
• Safety
• Work-life balance

Happiness Index

This index gauges life satisfaction using the Cantril Ladder, where people rate their lives on a scale from 0 (worst possible) to 10 (best possible). In recent data, top countries included Finland (7.65), Norway (7.55), and Denmark (7.50), while lower-ranked nations were Burundi (2.88), Central African Republic (3.10), and South Sudan (3.20).

Happy Planet Index

The Happy Planet Index (HPI) combines three elements to measure sustainable well-being:

• Average life expectancy
• Subjective well-being (life satisfaction)
• Ecological footprint (environmental impact)

High-ranking countries often have modest GDP per capita (under $9,000), emphasising efficiency in achieving happiness with lower resource use.