The Hindu Business Line : Pulse of the economy

Read up any discussion paper on past and projected economic growth or, currently, the lack of it , and you will almost certainly come across the term Gross Domestic Product (GDP) time and again. Ever wondered what exactly it is, what it’s made up of, what it indicates?

In simple terms, you can gauge the development of a country based on the level of goods and services produced within the country. The monetary value of these goods and services is what GDP is and, together, services, manufactured goods and agricultural products make up the figure.

Measuring GDP

The most commonly used calculation method is by determining expenditure on consumption and addition to investment. By this token, GDP is the sum of three things.

The first is spending by consumers — or households — for their various needs such as food, clothes, furniture, appliances and so on. The second is capital investment by companies in machinery, plants, buildings — anything that will be used in the production of goods. The third is spending by the Government on goods and services.

With step-ups in spending, there will be a similar growth in production that again generates income and so forth, resulting therefore in the growth of the economy. In the context of GDP ‘spending’ is taken during calculation because it is an easier representation of domestic production.

That’s why, while a country exports products, these are domestically produced. Similarly, imports are consumed domestically, but are not produced here. Imports are deducted from exports and the resultant figure — positive or negative — is added to the GDP.

Being at a gross level, GDP includes depreciation costs. When GDP is adjusted for inflation, it becomes real GDP, which is a more effective measure of the real production of the economy adjusted for price hikes .

Using GDP

The standalone GDP figures may not tell you much and can mislead you at times. GDP can instead be paired with different figures resulting in a good many indications on the health of an economy.

For example, divide GDP by population, which will give you the GDP per person, which is a useful tool to compare the level of economic development between countries.

Quite obviously, GDP has to increase year on year for the economy to grow or at least stay flat. As has been seen, this need not necessarily be the case. A fall in growth rate to below zero for two or more consecutive quarters sends an economy into recession.

Impact of monsoons

Monsoons will have a direct bearing on GDP figures since agricultural output constitutes a good share of the GDP, while being connected to a vast number of industries. A weak monsoon will set off a chain of effects, starting with reduced agricultural output, resulting in lower income for the rural community that holds a chunk of purchasing power which, in turn, leads to dips in consumption and demand.

Not a perfect measure

However, widespread its use may be, GDP figures are not without limitations. To being with, it ignores income disparities or the rich and the poor gap and cannot be used to measure the standard of living or income levels. Transactions which go unreported to the government, quite obviously, are excluded; such parallel markets may actually be quite big. Quality of goods is also not questioned; a lot of people could be buying really cheap goods, increasing private consumption but actually indicating a low living standard.

Other indicators

There are other indicators targeted at specific aspects of the economy such as unemployment figures, national income, industrial production, inflation, and so on.

Another widely used economic measure is the Purchasing Managers Index, which is based on five indicators: New orders, inventory levels, production, supplier deliveries and employment. A PMI of more than 50 indicates a comparative expansion of the manufacturing sector, while a score of less than 50 represents a contraction. A reading at exactly 50 shows no change.

More Stories on : Economy | Young Investor

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page