Understanding GDP and how it is measured
What is gross domestic product?
Gross domestic product (GDP) is a measure of economic activity which captures the value of goods and services that the UK produces during a given period. GDP can be expressed in nominal or real terms. Nominal GDP reflects the value of all the goods and services which are produced in the UK during a given period, using their price at the time of production. Real GDP also reflects the value of produced goods and services, but it uses constant consumer and producer price indices to remove the effects of rising price levels (inflation). Periods of real GDP growth are thought to enhance the welfare of individuals as economic growth allows average incomes to rise, supporting a higher level of consumption. Periods of negative real GDP growth are associated with lower incomes, lower consumption and consequently a lower standard of living.
The three approaches
GDP can be estimated using three different methods:
The production estimate is based on the value of final output in the economy less the inputs used up in the production process. Final outputs include products such as cars, while intermediate goods are inputs used in the production of another good or service, such as car tyres, electricity and advertising. As the value of the final good (the car’s price) reflects both the value of its inputs (the tyres) and the engineering expertise of the manufacturer, adding the final output of the tyre manufacturer to final output of the car manufacturer together would overestimate GDP. To avoid this double counting, the value-added at each stage of production is calculated and aggregated. This is known as gross value added (GVA), which is further adjusted for taxes and subsidies on products to create a GDP estimate.
The expenditure estimate is based on the value of total expenditure on goods and services, excluding intermediate goods and services, produced in the domestic economy during a given period. Whereas the production approach captures the value of production, the expenditure approach reflects the value of spending by corporations, consumers, overseas purchasers and government on goods and services. The primary data for this measure come from expenditure surveys of households and businesses, as well as from data on government expenditure. Specifically, information from the Living Costs and Food Survey, the International Trade in Services survey and the Retail Sales Inquiry are used, along with data on producer and consumer prices.
The income estimate measures the incomes earned by individuals (for example, wages) and corporations (for example, profits) directly from the production of outputs (goods and services). The main
data for this approach to measuring GDP come from the Quarterly Operating Profits, Average Weekly Earnings and employer surveys, along with administrative data from HM Revenue & Customs.
Using the three different methods avoids sole reliance on one source and allows greater confidence in the overall estimation process. GDP is estimated on a quarterly basis and if perfect data were available, the three approaches would generate equal estimates. However, as the data collected and processed by ONS are based on a variety of statistical surveys and administrative datasets, the three estimates can be different. In order to obtain the best estimate of GDP (the published figure), the estimates from all three approaches are reconciled.
When is each approach used?
It is not possible to use the production approach in the short term as value added data are not readily available. Therefore GDP is based on turnover data from monthly surveys as well as other data sources. The data used are considered the most timely and robust over a short time horizon. At the preliminary estimate, produced 25 days after the end of the quarter, approximately 44% of the output data is available and no information is available for the expenditure or income approaches.
The second (55 days) and third (85 days) estimates contain expenditure and income data as well as more comprehensive output data. For both these estimates, in order to produce a single quarterly figure, the income and expenditure estimates are brought into line with output through an adjustment (alignment adjustment) which is published alongside GDP. After the third estimate, a quarterly GDP estimate may be revised in each subsequent Quarterly National Accounts publication (within the National accounts revision period) as more data become available.
Further revisions may also occur at Blue Book. The Blue Book is the annual publication of National Accounts Statistics, and is where more detailed annual data sources are incorporated into the estimate. This is also the first time that methods improvements and new international standards can be included. Revisions can go back several years and impact both annual and quarterly data.
GDP data can also be revised at Blue Book due to the incorporation of Input-Output Annual Supply and Use Tables. This involves using data on flows of output, expenditure and income to show the interactions of different industries, the household sector and the rest of the world. This process aligns the three annual estimates of GDP, averaging out the alignment adjustment across the four quarters.
More information on data sources (518.9 Kb Pdf) for all three approaches is also available.Source: www.ons.gov.uk