Question

How do we calculate GDP of a country? Why are only final goods and service counted in GDP ? Explain with the help of example

Answer 1

Why does GDP only include finished products?
GDP only includes final products — goods for sale, rather than intermediate goods that are used to make final products. So a raw steak sold to a customer at a supermarket is part of GDP, but a raw steak sold to a restaurant isn't — only the cooked steak the restaurant sells to its customers counts. This is to avoid double-counting.

That doesn't mean intermediate goods don't count. It means that each intermediate step in a supply chain counts the value added at each step.

Think about a dress as an example. GDP only counts the total value of the dress that's eventually sold. But that doesn't mean only the contributions made by the final seller count.

Instead it means that a GDP calculation would first count the sale of the raw cotton from the farmer to the textile mill. Then it would count the value added by the textile mill when it makes the cotton into fabric — that is, it would take the value of the fabric created and subtract out the cost of the cotton. Likewise, it would count the value of the dress made by the dressmaker, subtracting out the cost of the fabric (not to mention buttons, thread, and whatever other components the dressmaker uses).

At each of these steps, labor and skill help increase the value of the dress — 4 yards of fabric are more valuable in dress form than in raw form at the fabric store, after all. The final dress is the sum of all of the dress' parts, plus value added.

In this process, we're single-counting all of the components, because we're subtracting out the intermediate costs every step of the way. If we didn't do that, we would count the cotton three times (once for each step) and the fabric twice and end up with a much higher value on the dress.

Not everybody is happy with the emphasis placed on final goods. Some people believe that intermediate production should be highlighted, and that the current system overstates the role that consumer spending plays in the economy. The Bureau of Economic Analysis in 2014 started producing a figure it calls gross output that doesn't seek to avoid double-counting, and thus gives us more visibility into the size of different industries.