What is Gross Domestic Product (GDP)?

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Definition:

Gross Domestic Product (GDP) is the total value of all goods and services that a country produces in a set period of time.

🤔 Understanding Gross Domestic Product (GDP)

Gross Domestic Product measures the value of everything that a country produces. It’s almost impossible to produce a comprehensive list of the things that are included in GDP — it’d be very long — but there is a formula that you can use to find a nation’s GDP:

Net exports + investment + consumption + government spending = GDP

You can find net exports using another, simpler equation:

Value of exports — Value of imports = Net exports

This result may be a negative number if the country imports more than it exports. Investment and consumption include any money that consumers put into investments, like stocks and bonds. Consumption is the sum total of all spending on goods and services.

Unlike GNP (Gross National Product), which accounts for all production by a nation’s citizens regardless of their geographical location, GDP focuses on production within a nation’s borders.

Example

Let’s take a look at Microsoft. Any good or service that Microsoft produces or sells in the United States adds to the country’s GDP. Every time someone buys a subscription to Microsoft’s cloud storage service, OneDrive, that purchase adds to the country’s GDP. Every time the company builds a Microsoft Surface, its value is added to GDP. Even if Microsoft later sells that Surface in another country, its value still counts as part of the United States’ GDP.

Takeaway

Gross Domestic Product is like an economic report card...

Every year, most countries record and report their GDP. Many groups, such as the World Bank and IMF, use this information and ask that member states provide it. Given that GDP can be calculated using information that tends to be publicly available, you yourself could determine the GDP of nations that don’t do the calculations themselves.The higher a country’s GDP, the more goods and services it’s produced. Higher GDPs generally indicate stronger economies. So countries like to be able to report higher GDPs each year, just as students like getting higher grades every semester.

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What is Gross Domestic Product?

Gross Domestic Product (GDP) is a measure of a country’s economic production. Nations with higher GDPs produce more than those with lower GDPs.

GDP includes the value of any goods produced within a nation’s borders, as well as the value of any services rendered. It’s the closest thing that a country has to a market capitalization (the total value of a company). Instead of measuring the value of a country, GDP measures the value of its economic outputs.

Why is Gross Domestic Product important?

Gross Domestic Product is important because it’s a rough measure of an economy’s health. Countries with strong economies will typically have high GDPs. Many economists also look at a country’s GDP per capita to gauge how healthy the economy is. GDP per capita measures how much, on average, a citizen of a nation produces.

Changes in GDP are also a crucial metric for economists. If a nation’s GDP is growing, that indicates that the country’s economy is healthy and expanding. Conversely, a shrinking GDP means that the economy is shrinking. Rising GDP is associated with employment, investment growth, and increasing wages. Shrinking GDP can indicate high levels of unemployment, shrinking wages, and economic instability.

Because GDP is used as a rough measure of an economy’s health, the stock market often shifts in response to the publication of a country’s GDP growth rate. Higher growth numbers can lead to strong market performances, while weaker numbers can lead to drops in the market.

What are Nominal GDP and Real GDP?

Nominal GDP and Real GDP are two different measures of Gross Domestic Product.

When people talk about GDP, they’re usually referring to nominal GDP. It’s the value of all goods and services produced within a country’s borders.

Real GDP is a measure of GDP that accounts for the effects of inflation. It’s most useful when you’re looking at GDP growth rates or a country’s GDP over time. To find Real GDP, divide the nominal GDP by the deflation factor, which is 1 + the change in the value of the dollar between the years you’re comparing.

Here’s an example: prices increased by 8.33% between 2015 and 2019. To find 2019’s Real GDP, which you can then use to compare the US’ GDP in 2015 and 2019, use this formula:

2019 Nominal GDP / (1 + 0.0833) = 2019 Real GDP in 2015 terms.

Accounting for inflation is important because inflation can cause nominal GDP to grow, even if there’s been no actual increase in economic output. If a nation has a nominal GDP of $1 billion and, the next year, the country’s nominal GDP is $1.1 billion, it looks like its economy has grown 10%. But if the country’s inflation rate was 10%, then its real GDP remains the same. No real growth occurred.

How do GDP, GNP, and GNI Differ?

GDP, Gross National Product (GNP), and Gross National Income (GNI) are all measures of a country’s economic output.

Unlike GDP, which looks at production within a country’s borders, GNP includes the value of everything produced by a country’s residents, regardless of where it’s produced. For example, if an American owns a company that produces goods in Canada, that company’s output is part of the United States’ GNP and Canada’s GDP. If a foreign resident owns a company in the US, that company’s production isn’t part of the US’ GNP, though it is included in the US’ GDP.

GNI measures all of the income earned by a country’s residents and companies. This includes income from the sale of goods and services, investment income, and foreign aid. You can think of GNI as GDP + income from overseas sources. (Source: OECD).

How to calculate GDP using spending

Many countries record and publish their own GDP data for public use. For example, the US Bureau of Economic Analysis reports the GDP of the US every quarter. If you want to do your own calculations, there are a few different methods you can use to calculate a country’s GDP, though each calculation should produce the same result.

To calculate GDP by using spending, you can use the following formula:

Consumer Spending + Investor Spending + Government Spending + Net Exports = GDP

By measuring how much the residents of a country spend and how much a country exports, you can find the value of everything that the country produced, because production and spending should be equal to one another.

How to calculate GDP using production

To calculate GDP using production, use this formula.

Price of all Goods Produced and Sold + Price of all Services Produced and Sold = GDP

It’s important to only include the final sale of a product or service, not every sale along the supply chain. Including the value of goods sold between companies during the production of a good sold to consumers will inflate the GDP that results from this calculation.

How to calculate GDP using income

To calculate GDP using the income approach, use this formula.

Employee wages + rents + interest + profits + sales taxes + depreciation + net foreign income

You can think of net foreign income as a similar calculation to net exports. Here’s an equation to calculate net foreign income:

Payments received from other countries — payments made to other countries = net foreign income.

Keep in mind that these are payments to and from residents and businesses in other countries.

Net foreign income is the difference between the payments made by the country’s businesses and residents to residents and businesses of other nations and the payments received from residents and businesses of other nations.

What are the drawbacks of using GDP data?

GDP is not a perfect measure of a country’s economic output.

One issue with GDP is that nominal GDP is the measure that economists use most often. This measure doesn’t account for inflation, which can skew the GDP growth rate. With inflation, a country’s nominal GDP can grow even as economic production shrinks.

Another drawback is that GDP and GDP per capita don’t necessarily reflect the equality of a country’s economy. If a country has 100,000 citizens who each produce $100,000 in goods and services, its GDP will be $10 billion. If another nation has 100,000 citizens — 1,000 who produce $10 million in products and services and 9,000 who produce nothing — its GDP would still be $10 billion.

GDP also doesn’t account for the non-economic aspects of a society’s wellbeing. A country’s GDP would likely increase if it enforced a seven-day workweek and 12-hour workdays, but societal happiness would decrease.

It’s worth noting that GDP doesn’t account for externalities (the costs, many non-monetary, incurred by production and services), which include things like the long-term costs of pollution. If a company can produce more goods by polluting, it might increase production even if the cost of that pollution is greater than the products’ value.

Finally, GDP only measures the value of goods and services provided through traditional markets. Activities that occur outside the typical markets, such as trading in illicit drugs, don’t get included in GDP. Similarly, goods and services that are provided under the table or outside of standard regulations aren’t included in a nation’s GDP.

Where can I find GDP data?

GDP data is available from a wide variety of sources.

The CIA World Factbook offers information about countries’ geography, people, culture, politics, infrastructure, military, and economy. Included in each nation’s entry is its GDP, including GDP per capita, Purchasing Power Parity (an economic measure that relates GDP to the cost of a set basket of goods in that country), and GDP growth rates. It also breaks down the percentage of the nation’s GDP that is produced by each segment of its economy.

If you want in-depth information about the United States’ GDP, the Bureau of Economic Analysis publishes regular updates about the GDP of the US and its territories.

For an international source of GDP data, you can visit the International Monetary Fund’s website, which includes GDP information for its member nations as well as aggregate GDP calculations for different regions, groups of countries, and the entire world.

The Organization for Economic Cooperation and Development also publishes GDP information for its member states. You can view historical data stretching back to the 1960s, including annual and quarterly GDP growth, future forecasts, and other economic data.

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