Economy Explained: What Is the GDP – and What Does It Have to Do With You?
Gross domestic product, or GDP, represents the total value of all goods and services produced within a country during one year. Depending on the report, one year can be either one fiscal year or one calendar year. In some cases, these reports might be produced on a quarterly basis, such as the annualized quarterly GDP reports produced by the Bureau of Economic Analysis.
The figure that usually commands the most attention related to GDP is the rate of growth. Hence, you see that number right at the top of the BEA’s report. GDP doesn’t always capture all of the nuance seen with a large economy, especially one as large as the US economy. Nevertheless, GDP is generally seen as a measure of how well the economy is doing; if GDP is increasing, the economy is doing well and vice versa.
When calculating GDP, imports and exports have to be taken into account, too. In particular, exports increase GDP and imports decrease it. If exports exceed imports, you have a trade surplus. On the other hand, if imports exceed exports, it is known as a trade deficit.
When the GDP has two consecutive quarters of negative growth, by popular definition, that is a recession. However, the National Bureau of Economic Research doesn’t strictly follow this definition when declaring recessions.
Types of GDP
Further metrics have been developed in an attempt to account for inflation and other considerations. Here are some of them:
- Real GDP: Real GDP is the inflation-adjusted measure. Thus, it calculates GDP using inflation-adjusted prices of goods and services for each year against a constant dollar value (i.e., real GDP in 2012 dollars)
- Purchasing Power Parity (PPP): Purchasing power parity, or PPP, attempts to calculate the buying power of each country’s citizens. Because of this, it adjusts GDP for differences in things like income, cost of living, and living standards of each country.
- GDP Per Capita: GDP per capita shows the GDP on a per-person basis. It shows the amount of output per person, which helps identify local and regional differences in GDP.
How Should We Understand GDP?
GDP is a useful tool for understanding the overall health of a country’s economy. The International Monetary Fund (IMF) says, “GDP is important because it gives information about the size of the economy and how an economy is performing. When real GDP is growing strongly, employment is likely to be increasing as companies hire more workers for their factories and people have more money in their pockets.” Similarly, the IMF says that shrinking GDP may indicate shrinking employment, as has been true during the COVID-19 pandemic.
Thus, while there are some finer details, especially at the state local levels that GDP may not identify, it remains a useful tool to quickly gauge the overall health of a country’s economy.
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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