Explainer: What is GDP?

Gross Domestic Product (GDP) is one of the key indicators of how well the economy of a country is doing. It is the total value of final goods and services produced and sold in a country within a time period (usually a year).

GDP numbers are used to compare how big economies are.

Measuring it can be tricky, but it can be done in one of three ways:

i) adding up what everyone in a country earned in a year (the income approach)

ii) adding up what everyone spent in that year (expenditure approach)

iii) adding up everything that was produced in that year (the output approach). Each of these should lead to the same GDP figure.  

Perhaps the most common form is the expenditure approach which adds up total consumption by households, investment by businesses, government spending and the net exports of a country. In Nigeria, the output approach is the most commonly used. 

How is GDP calculated?

Under the expenditure approach, GDP can be broken down into consumption + government spending + investment + net exports [C + I + G + Net exports], and this tells us what is being spent in an economy.

Consumption measures the value of goods and services consumed by households. So, the money you pay to buy groceries or to an accountant for his services are all included in the GDP.

Likewise, investment calculates all of the investment in activities and projects that assist businesses in production. If a corporation buys machines or builds a factory to produce consumer goods, the cost of these machines will be added to the GDP

And when the government spends on services and goods, it is included in the GDP too. This includes salaries paid by the government, what taxpayers’ money is used for and purchase of immediate goods like fighter aircraft.

The difference between exports (foreign spending on domestic goods) and imports (foreign goods) in the country are considered part of the gross domestic product. Typically, exports will increase a country’s GDP and imports will reduce the GDP.

Is GDP a flawed method of measurement?

GDP is relevant because it provides an overview of how a country’s economy is faring. A rise in GDP may be an indication of improvements such as more people getting jobs and spending their wages or businesses investing more.

Even though it gives us an idea of the economic health of a country, it is not a perfect measure of welfare. It covers economic activity but does not consider things that affect the quality of our lives like the environment or how sustainable growth is.

For example, the negative impact of Nigeria finishing up its oil, and damaging the environment will not reflect in a negative in GDP though it worsens the country’s welfare.

The gross domestic product also counts all spending regardless of whether it is ‘good’ or ‘bad’. When floods hit the streets of Lagos, for example, and damaged buildings need rebuilding, GDP goes up. Similarly, when someone falls sick and money is spent on their care, it is counted a positive increase in GDP.

There is also the net exports factor. An increase in import reduces GDP, but imports are important for the economy and increase welfare. Imported raw materials, for example, are needed to make the final goods in Nigeria that are to be exported.

On its own, GDP is not enough to measure the welfare of a country, but it gives a bird’s eye view of how well a country is doing making it a valuable policy tool.

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