Gross domestic product commonly known as GDP measures the monetary value of goods and services purchased by consumers in a country within a certain timeframe. Another way to define GDP is that it calculates most of the output or productivity that goes on within a country.
There are many professionals and organizations who can benefit from GDP including policy makers, economists, entrepreneurs and investors.
Uses Of GDP
GDPcan provide countries an estimate of the size and growth of their economies. Notable bodies who use GDP include the White House, The Federal Reserve, congress, businesses, as well as state and local governments. Some ways GDP can be used include:
The White House and Congress use it to help plan spending and form tax policies
The Federal Reserve uses GDP to set monetary policies
Economists use GDP to see how fast the economy is growing, compare economic growth between states, or see how different industries are performing
Business professionals can use GDP to make decisions about jobs and expansion
Additionally, investors can use GDP to guide their investment decisions. When GDP is rising, it indicates strong economic growth. This can mean companies performing well, stock prices going up, and positive investment returns. The reverse can be said when a country’s GDP is on a downward slope.
Real GDP Vs Nominal GDP
There are two primary types of GDP-nominal and real. The main difference between the two is that nominal GDP doesn’t take inflation into account, but real GDP does. The latter is adjusted for both inflation and deflation so we can see whether the value of output is increasing because production has gone up or because prices have gone up. Oftentimes, real GDP is a more accurate reflection of what’s going on in the economy.
There are two other types of GDP, which include actual and potential. Actual GDP is the real-time measurement of outputs. Potential GDPrequires near perfect conditions such as 100% employment across all sectors and stability in currency and product prices.
Calculating GDP
GDP is usually calculated annually but can also be calculated quarterly. In the United States, the annualized GDP estimate is calculated every fiscal quarter and annually. There are multiple ways to calculate GDP but three of the most common are by expenditure, income, and production.
Expenditure
A sum of all money spent by consumers, businesses, governments, and net exports.
The equation for calculation GDP by expenditures is:
GDP = C + G + I + X-M
C: All private consumer spending in the economy
G: Total government expenditure
I: Sum of investments spent in a country or business investments
X: Exports
M: Imports
Income
The total sum of income that is generated as a result of production. An example of this is employee salaries.
Equation:
GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income
Production
Total sum of purchases made on final goods and services
Equation:
Gross Value Added = Gross Value of Output – Value of Intermediate Consumption
GDP vs GNP
We’ve established that GDP is the total value of goods and services within a country. Another way to measure the economic health of a country is through Gross National Product or GNP. Unlike GDP, GNP is used to calculate the value of goods and services produced by the residents of a country despite their geographical location. For instance, if an American citizen was working as an expatriate in England, their economic activity would be calculated within the United States’ GNP. As long as they’re a resident of the United States, their production counts towards the country’s GNP.
That said, if a British citizen started a company manufacturing and selling goods in the U.S. their production would count towards the United States’ GDP, but count towards England’s GNP.
GNP can help paint a picture of the total economic output of a country beyond its geographical borders, but is not the best measure for how an economy is performing. It’s also not very helpful if you want to compare the economies of different countries.
To calculate GNP, you add GDP plus the net income citizens make from assets abroad and subtract any production by foreign companies that produce goods or render services in the U.S.
As a formula, this looks like:
GNP = GDP + income made by firms/citizens abroad – production by foreign firms/nationals
Understanding how GDP and GNP work as an investor can be helpful when you’re investing within the U.S. and internationally. To begin your investing journey or expand your portfolio, reach out to someone from our team today.
