CONCEPT OF GDP.

 GDP=The total final value of goods and services produced within the domestic territory of a country in a specified time period (generally a financial year) is called Gross Domestic Product.

          CALCULATION OF GDP.

GDP can be calculated by three methods:

1. The Product or Value Added Method

In this method we calculate the aggregate annual value of goods and services produced 

and to arrive at this we add up the value of all goods and services produced by all the 

firms in an economy. Let us take an example:

Suppose there are only two kinds of producers in the economy. One is the farmer who 

produces wheat and the other is the baker who produces bread. Assume that the farmer 

who produces wheat do not require any input other than the physical labour. Suppose 

the farmer produces Rs. 100 worth of wheat, out of which he consumes Rs. 50 of wheat 

and sells Rs. 50 of wheat to the baker. And suppose the baker do not require any input 

other than the Rs. 50 wheat which he purchases from the farmer. The baker uses this 

Rs. 50 of wheat completely and produces bread worth Rs. 200.

Farmer Rs. 50 + Rs. 50 (consumed) = Rs. 100 wheat produced

Baker Purchase + Value Addition = Rs. 200 bread produced.

The farmer has produced Rs. 100 of wheat for which it did not need assistance of any 

inputs. Therefore, the entire Rs. 100 is rightfully the contribution or the value addition 

of the farmer. But the Rs 200 bread produced by the baker is not entirely his own 

contribution because to produce this bread the baker has purchased wheat from the 

farmer worth Rs. 50. So the value added by the baker will be equal to the value of 

production of the firm (baker) - value of intermediate goods used by the firm.

Since, there are only two firms in the economy, one is baker and the other is farmer, to 

calculate the GDP we will add value addition by both these firms.

GDP = Value addition by Baker + Value addition by Farmer

 = (Rs. 200 - Rs. 50) + (Rs. 100)

 = Rs. 150 + Rs. 100

 = Rs. 250

By the standard definition, GDP should be equal to the final value of all goods and 

services produced in the economy. So, we can cross check the above example.

GDP = Final value of all goods produced

 = Final value of wheat + Final value of bread

 = Rs. 50 + Rs. 200

 = Rs. 250 (which is same as above calculated from the value added method)

Out of the Rs. 100 wheat produced by the farmer, only Rs 50 wheat consumed by the 

farmer is final good. The wheat that the farmer sold to the baker worth Rs. 50 is an 

intermediate good and not final gMethod

2. Expenditure Method:

An alternative way to calculate GDP is by looking at the expenditure side of all the 

sectors. Whatever goods and services are produced in the economy are ultimately 

purchased by the four sectors of the economy i.e. household sector, government sector, 

private sector and external sector. So, if we add the expenditures done by these four 

sectors on the purchase of final goods and services produced by the firms within the 

domestic territory then it shall be equal to the GDP of the country.

The household sector spends only on the consumption goods (denoted by C')

The private sector spends only on capital goods (investment) barring some exceptions 

when firms buys consumables to treat their guest or for their employees (denoted by I')

The government sector purchase both capital and consumption goods (denoted by G')

The external sector also purchases both consumption and capital goods from our 

economy which is basically called the exports from India (denoted by X).

GDP = C' + I' + G' + X

 = C - Cm + I - Im + G - Gm + X

 = C + I + G + X - (Cm + Im + Gm)

 = C + I + G + X - M

GDP = C + I + G + X - M

C', I' and G' are all expenditure on domestically produced final goods as we are trying 

to calculate GDP. And C, I and G are expenditure by the three sectors on domestic and 

imported both final goods. 

 Since C' is expenditure of household sector on domestically produced consumption 

goods which can also be calculated as expenditure on domestic and imported both 

consumption goods (C) - expenditure on imported consumption goods (Cm) i.e. C -

Cm. 

 Similarly, I - Im will represent the expenditure by private sector on domestically

produced capital goods i.e. investment expenditure; and 

 G - Gmwill represent the expenditure by government sector on domestically

produced consumption and capital goods. 

 And Cm +Im + Gm represents the total imports by the country combining the 

household, private and government sector.

3. Income Method:

It has already been stated in the beginning that the sum of the final goods produced in 

the economy must be equal to the income received by all the four factors of production 

i.e. wages, rents, interests and profits. This follows from the simple idea that the 

revenues earned by all the firms put together must be distributed to those who has 

contributed in the production process which are basically the four factors of production 

entrepreneurship, labour, capital and natural resources.

GDP = Profit earned by all the firms + Interest received by all the capital deployed + Rent 

received for the natural resources + Wages earned by all the labourers 

GDP = Profit + Interest + Rent + Wages.