What is GDP, and what does it say about the economy?
- Gross Domestic Product, or GDP, is the sum total of all the goods and services produced within a country. It's used to compare economic performance between countries.
- GDP can be measured by adding either consumption and investment, the value of final goods or total income.
- A 1% fall in the unemployment rate yields a roughly 3% rise in GDP.
What is gross domestic product (GDP)?
Gross domestic product (GDP) is used to measure the health and well-being of an economy. GDP is the monetary value of all the finished goods and services produced within a country's borders – its total output – during a certain period of time. It takes into account all the goods and services produced, imports and exports and government spending.
GDP vs. GNP (gross national product) vs. GNI (gross national income)
Gross national product (GNP) and gross national income (GNI) are two other ways to quantify a country's economic strength.
Like GDP, GNP is the total value of a country's goods and services. Whereas GDP represents all production – foreign or domestic – within a country's borders, GNP represents all production by a country's citizens or native corporations, whether it's domestic or abroad.
GNI, meanwhile, represents the total income of a country's nationals or corporations. Like GNP, it takes nationality, not geography, into account.
As the world becomes increasingly globalized and geography becomes increasingly relevant, GNI is now being recognized as a more relevant indicator over GDP.
What is GDP per capita?
GDP per capita is GPA "per head," or per person. It's calculated by dividing GDP by the country's population. GDP per capita is useful for comparisons between different countries because it takes population size into account.
What does GDP say about the economy?
Overall, the GDP is the most closely watched economic indicator. Domestically, it is used to determine whether the economy has grown or slowed down since the previous quarter. For example, when the GDP has dropped for at least two consecutive quarters, the economy is considered to be in a recession. GDP is also used to compare both the size and growth of economies around the world.
What is the GDP formula?
GDP is the sum of four components, represented by the following formula:
GDP = C + G + I + NX (gross domestic product = private consumption + government consumption + investment + net exports)
C = private consumption expenditure, or consumer spending. This is the amount of money consumers spend on goods or services, accounting for about two-thirds of GDP. Thus, consumer confidence and GDP are closely related.
G = government consumption expenditure and gross investment. This is the amount of money the government spends, including employee payroll and infrastructure.
I = private domestic investment, or capital expenditures. This is the money businesses invest in inventory, property and other physical assets, such as machinery.
- NX = net exports, or total exports minus total imports. Total exports include anything produced domestically, even if that company is foreign-based. If a country imports more goods and services than it exports, net exports are negative.
How is GDP calculated?
There are three methods for determining GDP: expenditure, production (value added) and income. While the mathematical approaches are different, when done correctly, all yield the same final figure.
Expenditure approach: This is the most common approach, represented by the formula above. It's a summation of the four components: private consumption, government consumption, investment and net exports.
Production approach: Also known as value added, this method calculates GDP by measuring the value of all final goods in an economy. Final goods are used to prevent double counting; this is done by taking the value of all goods in the economy and subtracting the value of intermediate goods. For example, the cost of the grain would be deducted from the value of bread; the cost of labor would be deducted from the value of petroleum.
- Income approach: If expenditure is adding up all the costs of an economy, and production is adding up all the value, then the income approach calculates GDP by adding up all the income earned. In addition to wages, this includes rent earned by land, return on capital (interest) and corporate profits. Depreciation is subtracted.
What's not included
Not all production that is taking place within a nation's borders is accounted for in GDP. Any unpaid work or activity in the underground economy, or black market – such as illegal drugs, weapons, pirated music, movies and games and exotic animals – is not taken into consideration when calculating GDP.
GDP also does not include traditional "women's work," or unpaid household labor, such as sewing or food production. As a result, some see GDP as flawed, as this exclusion disproportionately affects agrarian societies where much of the production is done at home.
What is real vs. nominal GDP?
Whereas nominal GDP represents the raw calculation, real GDP is GDP adjusted for inflation. Since inflation is decrease in the value of currency, inflation will cause prices to rise, and thus, GDP to artificially rise, even if the value of goods and services remains the same. For that reason, real GDP is used to accurately measure changes in an economy during periods of inflation.
In the United States, GDP is measured by the Bureau of Economic Analysis (BEA) and is publicly reported each quarter. Real GDP is calculated by setting a base year and adjusting the GDP in the following years with a GDP price deflator to reflect the value of consumer goods in the base year. For example, if prices inflate by 10% from the base year, the nominal GDP would be divided by the price deflator 1.10 to yield the real GDP.
Most stand-alone GDP figures will be nominal GDP since real GDP varies depending on the base year. Real GDP is used for comparison over time.
What's the relationship between GDP and employment?
Employment represents one factor in a country's economy, whereas GDP is a measurement of total economic performance. This means that while employment alone does not drive GDP, employment levels and GDP are historically correlated. The relationship between unemployment and GDP is known as Okun's law, after economist Arthur Okun.
The exact correlation in Okun's law has changed over time, but roughly, a 1% fall in the unemployment rate yields a 3% rise in GDP.
How long has GDP been around?
Economist Simon Kuznets first introduced GDP measurements in the United States in the 1930s. In a report to Congress, Kuznets proposed a single economic indicator to measure a country's economic output.
However, it wasn't until 1944, following the end of World War II and the establishment of the International Monetary Fund and the International Bank for Reconstruction and Development, that GDP was used as the standard economic measurement worldwide.
Historically, the U.S. GDP Growth Rate has averaged 3.2%. GDP reached an all-time high of 17.2% in 1950 and a low of -10.4% eight years later.
When reviewing its accomplishments in 1999, the U.S. Department of Commerce declared the GDP to be one of the greatest inventions of the 20th century.
Additional reporting by Chad Brooks.