What Is Gross Domestic Product and Why Is It Important?

Gross domestic product (GDP) is the value of finished services and goods within a country. This economic indicator tells economists how healthy or poor a nation’s economy is and gives insight into areas of growth or shrinkage. Depending on GDP reporting and approach, economists can gather data to gain a holistic view of economic health.

Economists?use many abbreviations when discussing various topics related to domestic revenue, banking and economics. However, to individuals unfamiliar with these concepts, the abbreviations may be confusing. One such abbreviation is GDP, which stands for gross domestic product.

But what is GDP and why does it matter? In this article, we’ll cover the definition of GDP and what it means to the market (as well as the average consumer).?

What Is Gross Domestic Product?

Gross domestic product is a way to measure the market value of goods and services manufactured and sold (output) during a specific period in a country or region.

GDP indicates income earned from production and the total monetary amount spent on final goods and services.

Not all product or service activity counts toward the GDP. For example, volunteer work (or other types of unpaid work,?like household production ) might be challenging to measure in various industries, so accurately indicating these productive actions' value is difficult since they are not in the marketplace.

Why Does GDP Matter?

GDP provides much of the essential information that economists use all the time. It emphasizes the health of national or global economies and provides information about the size of an economy or any changes in performance.?

The effects of the economy directly impact consumers as well, making GDP reports important to our day-to-day lives. Different economic factors, such as inflation, employment or interest rates all come from various measurements of the economy.

This goes to show that how much people spend (and what they spend it on) directly impacts how well or poorly their regional economy performs. GDP gives real insight into this impact.?

History of GDP

The U.S. experienced an economic boom following World War I and quickly developed one of the world’s strongest economies. However, there was no standard to understand how well the economy was doing or how accurate mixed speculations about the stock market and wealth assets were.?

The collapse of the flourishing stock market that followed made it clear that the U.S. needed a tool to measure a country’s economic activity and strength.?

Following the Great Depression, the U.S. Senate hired Simon Kuznets. His job was to determine how badly the economy fared. Kuznets, an expert statistician and economist that emigrated to the U.S. in the early 1920s, developed the method of measuring the gross national product (GNP) . Following this, Kuznets then created the GDP, which has become one of the main tools for economic measurement worldwide.?

What Are the Types of GDP?

There are several types of GDP reporting that economists use depending on the information they need. The types of GDP are:

• Nominal
• Real
• Growth rate
• Per capita
• Purchasing power parity?

Nominal

Nominal GDP ?is the assessment of production in an economy, including current prices. All goods and services counted within nominal GDP reflect the actual sale value for that year. Typically, nominal GDP is useful when comparing different quarters of output in the same year.?

Real

Real GDP reflects the number of goods and services an economy produces in a year adjusted for inflation or deflation. By adjusting for price changes, this type of GDP presents an accurate picture of productivity growth in a region. Real GDP is useful when comparing different quarters of output in different (or multiple) years since inflation impacts pricing.?

Growth Rate

GDP growth rates look at yearly or quarterly changes in a country’s output to see how fast that country’s economy grows or shrinks. This is a popular metric for economic policymakers because GDP growth often connects to policy priorities , such as unemployment or inflation rates.?

Per Capita

GDP per capita measures the GDP per person within a country’s population . This type of GDP may indicate how productive the country is on average based on the amount of output per person in an economy. For reporting purposes, economists may showcase GDP per capita data in nominal, real or purchasing power parity terms.?

Purchasing Power Parity

Purchasing power parity (PPP) is not a direct measurement of GDP. Still, economists use this to compare a country’s GDP and standard of living to other countries’ GDPs and standards of living. Therefore, this is a popular metric for analysts to?compare countries’ currencies and productivity levels .?

How GDP Relates to Other Economic Measurements

There are several tools that economists use when assessing the economy that offer different measurements. While GDP, GNI and GNP are all similar acronyms, they aren’t the same economic terms. Here are these acronyms broken down:

• GDP: Gross domestic product
• GNI: Gross national income
• GNP: Gross national product?

The GDP measures the value of goods and services produced within a country, while the GNP shows how many goods and services citizens of a country produced. Therefore, the GDP considers domestic goods and services produced within a country’s borders, but the GNP will consider the value of all goods and services manufactured by that country’s citizens (even if finished outside of the country ).

Conversely, the GNI is?the total income a country’s people and businesses earn . While GDP and GNP focus more on productivity and finished goods or services, GNI looks specifically at income levels. However, both the GNI and GNP rely on the GDP’s data.?

Ways to Measure GDP

There are three methods economists use to measure GDP: output, expenditure and income approaches.

Output Approach

Also called the production approach, the output approach measures the market value of goods and services produced within a country.?

Real GDP (GDP at constant prices ) – taxes + subsidies = output approach GDP

Expenditure Approach?

With the expenditure approach, the focus is on money used for goods and services. This approach measures the expenses sustained on goods and services within a country.?

C + I + G + (EX-IM) = expenditure approach GDP

• C = Consumption expenditure (consumers buy goods and services)
• I = Investment expenditure (businesses invest in their business activities)
• G = Government expenditure (government spends money on development activities)
• EX-IM = Exports minus imports

Income Approach?

The GDP income approach formula calculates income earned by various production factors in an economy. Factors of production are components that go into creating a finished good or service. This approach comes from the thought that all expenditures in an economy should equal the income generated by production .

Total income + sales taxes + depreciation + net foreign factor income = income approach GDP

Final Thoughts on the GDP

The GDP does not necessarily measure socio-economic welfare — it strictly measures a country's production and consumption capacity. However, it is an excellent instrument to use, in conjunction with other economic tools, to see a holistic picture of an economy.?

Consumers care about the GDP because the nation’s economy impacts many things that directly affect their lives, including pricing and inflation .?

Additionally, the more consumers there are in an economy, the?more goods or services they will consume , driving demand. At the same time, if people have more money, they will spend more money, but this relies on?employment rates ?and job outlooks for various industries.?

Simply put, multiple parts of the economy closely tie together (as proven by GDP measurements), which shows just how vital the everyday consumer's role is in impacting how a nation’s economy grows or shrinks.?

Top Takeaways?

What is gross domestic product and why is it important?

• GDP is the monetary value of finished goods and services within a nation in a set period.?
• The need for different measurement tools to track the economy grew following the Great Depression and World War II.
• Economists use different types of GDP reporting to gain various pieces of information related to a country’s economy.
• Consumer spending and habits drive a significant part of the GDP, especially in the U.S.

(Reporting by NPD)