What Is GDP?
Gross Domestic Product (GDP) is a quantitative measure of how much an economy produces. It includes the monetary value of both goods and services within a specific nation’s borders.
From cars to machinery to your hairdresser’s services, GDP is an important factor for understanding the financial health of a country. Investors often use GDP to determine whether an economy is growing or in a recession, then make investment decisions based on that data.
GDP Formula: How to Calculate GDP
The formula for GDP is as follows:
To arrive at the final calculation, you must find each individual component in the formula. These include:
Durable goods (items expected to last more than three years)
Nondurable goods (food and clothing)
Public and Private Investment
Nonresidential (spending on plants and equipment)
Residential (single-family and multi-family homes)
Exports are added to GDP
Imports are deducted from GDP
Information on GDP is widely available. You do not need to track everything down yourself: The US Department of Commerce releases GDP data on a quarterly basis. The GDP report also includes information regarding inflation.
Gross Domestic Product Example
Using a recent GDP report provided by the US Department of Commerce, you can see each component used to calculate the GDP for each quarter and year.
|Gross domestic product (GDP)||21,427.7|
|Personal consumption expenditures||14,562.7|
|Gross private domestic investment||3,743.9|
|Net exports of goods and services||-631.9|
|Government consumption expenditures and gross investment||3,753.0|
|Gross domestic product||21,427.7|
Why Is GDP Important?
GDP is typically expressed as a comparison to the previous year’s GDP, as in the chart below:
When GDP declines for two or more consecutive quarters, the economy is in a recession. Meanwhile, when GDP grows too quickly and fears of inflation arise, the Federal Reserve often attempts to slow the economy by raising interest rates.
How GDP is Used in Investing
Investors often look to GDP to inform their investment decisions. This is because a significant change in GDP (up or down) will have an effect on the stock market.
If GDP moves up, it’s an indicator that the economy is more productive, creating more goods and more employment opportunities. In turn, consumers and companies have more confidence, and are spending more. This typically signals economic growth and causes the stock prices to rise (bull market). Conversely, if GDP moves down, it's because the economy is less productive, creating fewer employment opportunities and fewer goods. Thus, consumers and companies have less confidence and fewer funds. This leads to less spending, a lower GDP, and stock prices that drop (bear market).
GDP is not used as a means to predict how the market will move, but rather as an overview of trends.
The Limitations of GDP
GDP only measures products and services produced and sold. It’s an indicator for the health of an economy and does not account for the following:
Non-market transactions (For example, child care provided by mothers at home).
Whether the distribution of products and services (wealth) is fair. For example, a high GDP can be good for the economy, but may only benefit one portion of the population who has access to wealth.
Which Countries Had the Highest GDP in 2019?
With a GDP of more than $22 trillion, the United States was the world's largest economy in 2019. Although the rankings of national economies have changed considerably over time, the United States has maintained its top position since the 1920s.
As of October 2019, the International Monetary Fund Report reported that the top 10 economies by GDP were:
The five economies with the lowest GDP were:
GDP Explained on a Deeper Level
Let’s review the variations of GDP and how it compares to other quantitative measurements:
Nominal GDP vs. Real GDP - Adjusting for Inflation
Nominal GDP is the market value for goods and services unadjusted for inflation. It’s GDP in current dollars. You can see this as “Current Dollar Measures” at the bottom of the GDP report provided by the US Department of Commerce
Real GDP (constant-dollar GDP) is nominal GDP that’s been adjusted for inflation. This is why it’s called ‘real’ output for GDP since it accounts for the reality of inflation. Real GDP allows for easy comparisons by converting dollar value from other time periods into present-day value.
GDP Per Capita
GDP per capita is the measurement of the total economic output of a country divided by the number of people (and adjusted for inflation). It's used to compare the standard of living between countries.
The formula is as follows:
If you’re reviewing a specific point in time in a single country, use nominal GDP divided by the current population. Remember: “Nominal” means that GDP is measured in current dollars (and is unadjusted by inflation).
Example of GDP Per Capita
The GDP per capita is vastly different between China and the United States despite the fact that they occupy the top two positions for GDP overall. (See chart above)
According to the World Bank and the Organisation for Economic Co-operation and Development (OECD) National Accounts data, the United States GDP per capita is 62,794.6 and China’s GDP per capita is 9,770.8 (below several other countries). In this case, China’s vast population acts as an equalizing factor for GDP per capita and provides a better indicator of living standards across the country.
GDP vs. GNP
GDP is the market value of everything that’s produced within a country. Gross National Product (or GNP) is the value of goods and services produced by a country’s residents, no matter where they live.
For example, an American citizen living and working in Italy earns an income. She must report that income because she is still an American citizen. This is then factored into the United States’ GNP.
GDP vs. GNI
GDP measures production while Gross National Income (GNI) measures income earned outside of the country.
GNI equals GDP plus earned wages, salaries, and property income of citizens living abroad.
GDP Data Sources
The Bureau of Economic Analysis (BEA) in the US Department of Commerce collects data that contributes to the GDP calculation. However, the data used to calculate GDP is collected from outside the BEA. Most of it comes from other federal agencies (e.g. Census Bureau, Bureau of Labor Statistics, US Treasury).
Other data is a byproduct of government functions such as collecting taxes, paying Social Security benefits, or managing the federal budget.
Some GDP data may also come from the private industry: Trade groups and data companies provide specialized sales data on products like prescription drugs and cars.
The BEA obtains all of this information and the Department of Commerce releases GDP data for the US economy on a quarterly basis.
The History of GDP
The modern concept of GDP was developed by Simon Kuznets for a 1934 US Congress report on national income. GDP was used with other data as a way to warn against the use of welfare.
In 1944 at the Bretton Woods Conference (also known as the United Nations Monetary and Financial Conference), GDP was used as the main tool for measuring the economy across each country. At that time, GNP was the preferred data, measuring production by citizens at home and abroad.
According to Philipp Lepenies, GDP achieved singular status as an economic indicator during World War II. However, the complete switch from GNP to GDP as the US’ preferred quantitative measure wasn’t until the early 1990s. GDP retains its importance today as an indicator of national development and progress, pointing to trends that speak to the economic health of a nation.
In an attempt to keep up with technological advances, the international conventions that govern GDP data inclusion regularly change.
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