Gross Domestic Product and How It Affects You

Illustration of GDP as a percentage of different sectors

 © The Balance, 2018

Gross domestic product is the best way to measure a country's economy. GDP is the total value of everything produced by all the people and companies in the country. It doesn't matter if they are citizens or foreign-owned companies. If they are located within the country's boundaries, the government counts their production as GDP. The only exception is the shadow or black economy.

Calculating GDP

The components of GDP include Personal Consumption Expenditures plus Business Investment plus Government Spending plus (Exports minus Imports). Now that you know what the components are, it's easy to calculate a country's gross domestic product using this standard formula: C + I + G + (X-M).

Types

There are many different ways to measure a country's GDP. It's important to know all the different types and how they are used.

Nominal GDP: This is the raw measurement that includes price increases. The Bureau of Economic Analysis measures nominal GDP quarterly. It revises the quarterly estimate each month as it receives updated data. In 2017, the nominal U.S. GDP was $19.485 trillion.

When economists talk about the “size” of an economy, they are referring to GDP.

Real GDP: To compare economic output from one year to another, you must account for the effects of inflation. To do this, the BEA calculates real GDP. It does this by using a price deflator. It tells you how much prices have changed since a base year. The BEA multiplies the deflator by the nominal GDP. The BEA makes the following three important distinctions:

  1. Income from U.S. companies and people from outside the country are not included. That removes the impact of exchange rates and trade policies.
  2. The effects of inflation are taken out.
  3. Only the final product is counted. For example, a U.S. footwear manufacturer uses laces and other materials made in the United States. Only the value of the shoe gets counted. The shoelace does not.

Real GDP is lower than nominal. In 2017, it was $18.051 trillion. The BEA provides it using 2012 as the base year in the Interactive Tables, Table 1.1.6. Real Gross Domestic Product-Chained Dollars.

Growth Rate: The GDP growth rate is the percentage increase in GDP from quarter to quarter. It tells you exactly whether the economy is growing quicker or slower than the quarter before. Most countries use real GDP to remove the effect of inflation.

If the economy produces less than the quarter before, it contracts and the growth rate is negative. This signals a recession. If it stays negative long enough, the recession turns into a depression. As bad as a recession is, you also don't want the growth rate to be too high. Then you'll get inflation. The ideal growth rate is between 2 percent and 3 percent.

The BEA calculates the U.S. GDP growth rate. It provides current U.S. GDP statistics monthly. In 2017, it was 2.2 percent. The U.S. GDP has changed each year since 1929 depending on the phase of the business cycle.

GDP per Capita: GDP per capita is the best way to compare gross domestic product between countries. This divides gross domestic product by the number of residents. It’s a good measure of the country's standard of living. Some countries have enormous economic outputs only because they have so many people. The 2017 U.S. GDP per capita was $59,500.

The best way to compare gross domestic product by year and between countries is with real GDP per capita. This takes out the effects of inflation, exchange rates, and differences in population. In 2007, the United States lost its position as the world's largest economy.

How It Affects You

The GDP impacts personal finance, investments, and job growth. Investors look at the growth rate to decide if they should adjust their asset allocation. They also compare country growth rates to decide where the best opportunities are. Most investors like to purchase shares of companies that are in rapidly growing countries.

The Federal Reserve uses the growth rate to decide whether to implement an expansionary monetary policy to ward off recession or contractionary monetary policy to prevent inflation. Its primary tool is the federal funds rate.

For example, say the growth rate is speeding up. The Fed raises interest rates to stem inflation. In this case, you would want to lock in a fixed-rate mortgage. You know that an adjustable-rate mortgage will start charging higher rates next year.

If growth slows or becomes negative, then you should dust off your resume. Slow economic growth leads to layoffs and unemployment. That can take several months. It takes time for executives to compile the layoff list and exit packages. 

You could use the GDP report from the BEA to look at which sectors of the economy are growing and which are declining.

You can apply for jobs in growing sectors. Even during the 2008 financial crisis, health care industries continued to add jobs. This report also helps you determine whether you should invest in, say, a tech-specific mutual fund versus a fund that focuses on agribusiness.

Difference From GNP

For the value of everything produced by a country's citizens, no matter where they are in the world, you should look at gross national product. The World Bank now calculates gross national income instead, but the differences are insignificant.

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