Understanding the Gross Domestic Product (GDP)
Let us delve into an economic model known as the “circular flow of income" to understand the factors that make an economy good or bad. We need to have a clear grasp of how money flows into a system and how it should be kept in circulation. Comprehend that money is the main factor that keeps every component of a basic unit working like a well-oiled machine.
News that makes reference to GDP, which stands for Gross Domestic Product, is a reference to the country’s growth rate in terms of goods and services produced as output. However, there is much complexity in determining the GDP concept used in macroeconomics as an indicator of a country’s economic growth. Part of such complexity is to make sure that the measure of all outputs (goods and services produced and rendered) are not counted twice.
By way of example, suppose a food firm produces hamburger buns for the entire year on a nationwide scale. Including the dollar value of the total buns produced by the firm would likely result in a double count, because some of those hamburger buns form part of the output of another firm such as a fast food chain.
Thus, economists make use of a diagram called the “circular flow of income" to avoid the double-counting dilemma as it works on the assumption that all outputs produced by firms were sold and that income earned by households were spent.
We will use the same approach as we study the chart on the left and understand that business organizations provide income by paying salaries to employees. The latter’s household in turn uses their pay checks for domestic expenses comprising goods and services. If the goods include the purchase of buns, the household members would have bought them either as a purchase from the retail (grocery) industry or from the fast food industry, or both.
Hence, the more accurate value to consider as the total dollar value of hamburger buns produced for consumption would be the amount spent by the household and not the total dollar value of the buns produced by the food firm. This eliminates the possibility of counting the dollar value of hamburger bun production twice; first as the output of the food firm and second as the output of the fast food industry.
Determining the growth rate doesn’t stop there since it’s only a measure of the GDP. There is still the matter of using GDP as the indicator of economic growth.