What is Gross Domestic Product (GDP) with examples

Gross Domestic Product (GDP)

BY: MAH Kharal

Definition:

 Gross Domestic Product (GDP) is the best way to measure a country's economy. It includes everything produced by all the people and companies that are in the country. 

Gross Domestic Product (GDP) is the broadest quantitative measure of a nation's total economic activity. More specifically, GDP represents the monetary value of all goods and services produced within a nation's geographic borders over a specified period of time.

How to Calculate Gross Domestic Product:

The equation used to calculate GDP is as follows:

GDP = Consumption + Government Expenditures + investment + Exports - Imports

The components used to calculate GDP include:

Consumption:

-- Durable goods (items expected to last more than three years)

-- Nondurable goods (food and clothing)

-- Services

Government Expenditures:

-- Defense

-- Roads

-- Schools

Investment Spending:

-- Nonresidential (spending on plants and equipment), Residential (single-family and multi-family homes)

-- Business inventories

Net Exports of the year:

-- Exports are added to GDP

-- Imports are deducted from GDP

The GDP report also includes information regarding inflation:

-- The implicit price deflator measures changes in prices and spending patterns.

-- The fixed-weight price deflator measures price changes for a fixed basket of over 5,000 goods and services.

Measured by Current Dollar

GDP is calculated both in current dollars and in constant dollars. Current Dollar GDP involves calculating economic activity in present-day dollars. This, however, makes time period comparisons difficult due to the effects of inflation.

Measured by Constant Dollar

 By comparison, Constant Dollar GDP factores out the impact of inflation and allows for easy comparisons by converting the value of the dollar in other time periods to present-day dollars.

Types:

There are many different ways that a country's Gross Domestic Product is measured. It's important to know all the different types, and how they are used.

Nominal: 

 In 2014, US,GDP was $17.616 trillion. This is known as nominal GDP, which is the raw measurement that leaves price increases in the estimate.

Real:

 To compare Gross Domestic Product from one year to another, it's important to take out the effects of inflation. To do this, calculates real. It does this by using a price deflator, which tells you how much prices have changed since a base year. Multiplies the deflator by the nominal GDP. To do this, makes these three important distinctions:

1.      Income from U.S. companies and people from outside the country are not included, so the impact of Exchange rate and trade policies don't muddy up the number.

2.      The effects of inflation are taken out.

3.      Only the final product is counted.

Growth Rate:

 The GDP GROWTH RATE is the percent increase in the economy's output 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.

GDP per Capita:

 This is the best way to compare GDP between countries. That's because some countries have a large economic output because they have so many people. To get a more accurate picture, it's helpful to use GDP per Capita (per body). This divides Gross Domestic Product by the number of people, and measures the country’s standard.

You've probably already guessed that the best way to compare Gross Domestic Product by year and to other countries is with the real GDP. This takes out the effect of inflation, exchange rates and differences in population.

What It Tells You about the Economy?

Nominal Gross Domestic Product tells you the absolute output of any country. Real GDP allows you to compare countries. In comparing the economy of two different countries, you've got to take out the effects of inflation and exchange.

The growth rate measures if 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. 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 2-3%.

How It Affects You

Investors look at the growth rate to see if the economy is changing rapidly so they can adjust their asset allocation. In addition, investors compare country growth rates to decide where the best opportunities are. Most investors like to purchase shares of companies that are in rapidly growing companies.

If growth slows down, or is negative, then you should dust off your resume. Slow economic growth usually leads to layoffs and unemployment in country, but it can take several months. Declining growth means business revenues are down. It can take a while before executives can put together a layoff list and package. If you follow current GDP, you can be better prepared.

This would help you determine whether you should invest in, say, a tech-specific mutual vs a fund that focuses on agribusiness. It can also help you find training in sectors that are growing.

Why It Matters:

When GDP declines for two consecutive quarters or more, by definition the economy is in a recession. Meanwhile, when GDP grows too quickly and fears of inflation arise, the Federal Reserve often attempts to stimulate the economy by raising interest rates.