GDP Explained Easy

In the morning, you get and step out of the house to run a few chores. On the way, you find Rs 500 note lying on the ground. You quickly pick it up and put it in your pocket while thinking of donating that money to the local charity. But you buy the latest bestseller for that money. The bookstore owner is an alcoholic and spent 500 rupees on his daily stock of alcohol.

The liquor shop owner takes the ₹500 and walks across to the local cinema and buys the ticket for the latest movie, featuring his favourite heroine. He also buys some highly expensive popcorn and a soft drink. The cinema owner has to go attend a wedding at the other end of the town and he gives that very ₹500 note to a taxi driver.

So, what’s happened here? The movement of the initial ₹500 has made everyone better off. The note of 500 has been spent four times while generating ₹2,000 worth of economic activity. In that sense, the first ₹500 contributed ₹2,000 to the Indian GDP. The same would not have happened if you had taken the ₹500 and deposited it in the bank or simply kept it in your pocket.

GDP (Gross Domestic Product), in the conventional sense, is defined as the measure of all the goods and services produced inside a country. Nevertheless, as the British journalist and novelist John Lanchester writes in How to Speak Money: “GDP can be thought of as a measure not so much of size. It measures the movement of money through and around the economy.”

The aforementioned example is also inspired by a similar example in Lanchester’s book which shows precisely how economic activity adds to the GDP. One man’s spending is, after all, another man’s income, and the income can be spent again. So, the cycle is supposed to work and add to the economic activity and the GDP.

The GDP of an economy is the sum of private consumption expenditure, investment, government expenditure and net exports. There are many high-frequency economic indicators which tell us about the state of each of these four inputs that form the GDP.