What Is Gross Domestic Product? How It Affects You
The Key to Understanding What a Country Is Good at Producing
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.
How to Calculate GDP
The components of GDP are:
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).
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.
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.
- Income from U.S. companies and people from outside the country are not included. That removes the impact of exchange rates and trade policies.
- The effects of inflation are taken out.
- 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 how fast a country's economy is growing. Most countries use real GDP to remove the effect of inflation. In 2017, it was 2.2 percent.
GDP per Capita: This is the best way to compare gross domestic product between countries. Some countries have enormous economic outputs because they have so many people. To get a more accurate picture, it's helpful to use GDP per capita. This divides gross domestic product by the number of residents. It’s a good measure of the country's standard of living. 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.
What It Tells Us About the Economy
The different measures of GDP are great tools for comparing the economies of other countries as well as how an economy changes over time. When economists talk about the “size” of an economy, they are referring to GDP. In 2007, the United States lost its position as the world's largest economy.
The growth rate measures whether the economy is growing more quickly or more slowly than the quarter before. If it 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 to 3 percent.
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 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 down or is negative, then you should dust off your resume. Slow economic growth usually leads to layoffs and unemployment. That can take several months. That's because 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.