Gross Domestic Product (GDP) – definition and meaning
Gross domestic product (GDP) is probably the most important economic measure of the state of a nation’s economy. With just one figure, one can tell whether a country’s economy has grown, remained the same or shrunk compared to a past time, such as last year or the previous quarter.
GDP is the net value of all goods and services that an economy produces during a specific period, while accounting for taxes, and subsidies.
GDP figures allow economists to record and analyze the economic output of a region or country over a specific period (yearly, quarterly, and even monthly).
Patterns of GDP growth are used to help pinpoint when an economy may be headed in the wrong direction and determine whether a nation is in recession, allowing those in charge to change monetary policies.
According to the European Union, an economy is officially in recession if it experiences two successive quarters of GDP contraction.
There are three main ways of calculating GDP:
Output: includes the value of goods and services produced by all sectors of the economy.
Expenditure: the value of all goods and services purchased by consumers (households), the government, plus investment in machinery and buildings. It also includes total exports minus imports.
Income: the value of income, i.e. mainly wages and profits.
In theory, if the calculations are done correctly, all three approaches should produce the same total.
How to calculate GDP:
GDP = C + G + I + NX
C = an economy’s net private consumption and consumer spending.
G = net government spending
I = a country’s businesses spending on capital
NX = total net exports.
The importance of GDP
GDP is one of the most commonly used and referenced indicators of the current economic situation of a country, and is often used to determine a nation’s standard of living.
It can also be used to determine a specific industry’s relative contribution, because GDP is based on the total ‘value added’ compared to just sales numbers and each firm’s value is added. In economics, value added refers to an industry’s contribution to total GDP.
GDP has a considerable impact on practically everyone in a country. When an economy is experiencing healthy economic growth, unemployment rates decline, salaries rise, and there is an increase in businesses demand for labor.
Changes in GDP (be they increases or declines) also have an effect on a nation’s stock market – when GDP changes the income for businesses change too, which in turn push stock prices in different directions.
The book ‘System of National Accounts’, published in 1993, is currently the international standard for measuring GDP.
The publication, which was prepared by representatives of the United Nations, the International Monetary Fund, the European Union, and the World Bank, is also referred to as SNA93 – lays out the procedures for measuring national accounts.
The shadow economy – work and business activities that operate ‘below the radar’ – in which taxes on income, sales and profits are not paid, are not included in GDP computations. This means that countries are probably considerably wealthier that official figures suggest.