GDP: The Total Value of Goods and Services of a Nation

What is GDP?

GDP, or gross domestic product, is the measurement of an economy’s overall health and well-being. In other words, it’s the monetary value of all the finished goods and services produced within a country’s borders – its total output – during a given period. It takes into account all the goods and services produced, imports and exports, and government spending.

How do GNP and GNI relate to GDP?

Gross national product (GNP) and gross national income (GNI) are two other ways to quantify a country’s economic strength.

• GNP: Like GDP, GNP is the total value of a country’s goods and services. Whereas GDP represents all production – foreign or domestic – within a country’s borders, GNP represents all production by a country’s citizens or national corporations, whether domestic or abroad.
• GNI: GNI represents the total income of a country’s nationals or corporations. Like GNP, it takes nationality, not geography, into account. As the world becomes increasingly globalized and geography becomes more critical, GNI is seen as a more relevant indicator than GDP.   

What is GDP per capita?

GDP per capita is production “per head,” or per person. It’s calculated by dividing GDP by the country’s population. GDP per capita is helpful because it allows for meaningful comparisons between countries of different population sizes.

What does GDP say about the economy?

GDP is the most closely watched economic indicator. Domestically, it determines whether the economy has grown or contracted since the previous quarter. For example, when the GDP drops for at least two consecutive quarters, the economy is considered to be in a recession. GDP is also used to compare the size and growth rate of economies worldwide.

What is the GDP formula?

GDP is the sum of four components:

• Private consumption (C)
• Government consumption (G)
• Investment (I)
• Net exports (NX)

The calculation of GDP, then, is represented by the following formula:

C + G + I + NX = GDP

Here’s a deeper look at each component:

• C represents private consumption expenditures, aka consumer spending. This is the amount of money consumers spend on goods and services. Thus, consumer confidence and GDP are closely related.
• G represents government consumption expenditures and gross investment. This is the amount of money the government spends, including employee payroll and infrastructure. [Learn more about how payroll works.]
• I represents private domestic investment, or capital expenditures. This is the money businesses invest in inventory, property and other physical assets, such as machinery.
• NX represents net exports, or total exports minus total imports. Total exports include anything produced domestically, even if the company is based somewhere else. If a country imports more than it exports, net exports are negative.

How is GDP calculated?

There are three methods for determining GDP: expenditure, production (value added) and income. While the mathematical approaches are different, all yield the same final figure when done correctly.

• Expenditure approach: This is the most common approach, represented by the formula above. It’s a summation of the four components: private consumption, government consumption, investment and net exports.
• Production approach: Also known as “value added,” this method calculates GDP by measuring the value of all final goods in an economy. A “final goods” approach (the value of all goods in the economy minus the value of intermediate goods) is used to prevent double counting. For example, the cost of the grain would be deducted from the value of bread, and the cost of labor would be deducted from the value of petroleum.
• Income approach: The income approach calculates GDP by adding up all the income earned. In addition to wages, this includes rent earned by land, return on capital (interest) and corporate profits, with depreciation subtracted.

What’s not included in GDP calculations?

Not all production that takes place within a nation’s borders is accounted for in GDP. Unpaid work or activity in the underground economy, or “black market” – where illegal drugs; weapons; pirated music, movies and games; and exotic animals are bought and sold – is considered when calculating GDP.

GDP also does not include unpaid household labor, such as sewing or food production. As a result, some see GDP as flawed, as this exclusion disproportionately affects agrarian societies, where much of the production is done at home.

What is real vs. nominal GDP?

Whereas nominal GDP represents the raw calculation, real GDP adjusts for inflation. Since inflation is the decrease in the value of currency, inflation will cause prices to rise and thus GDP to artificially rise, even if the value of goods and services remains the same. For that reason, real GDP more accurately measures changes in an economy during periods of inflation.

In the United States, GDP is measured by the Bureau of Economic Analysis and publicly reported each quarter. Real GDP is calculated by setting a base year and adjusting the GDP in the following years with a GDP price deflator to reflect the value of consumer goods in the base year. For example, if prices inflate by 10% from the base year, the nominal GDP would be divided by the price deflator 1.10 to yield the real GDP.

Most stand-alone GDP figures will be nominal GDP since real GDP varies depending on the base year. Real GDP is used for comparison over time. 

What’s the relationship between GDP and employment?

Employment represents one factor of a country’s economy, whereas GDP measures total economic performance. This means that while employment alone does not drive GDP, employment levels and GDP are historically correlated. The relationship between unemployment and GDP is known as Okun’s law, after economist Arthur Okun.

The exact correlation in Okun’s law has changed over time, but roughly, a 1% fall in the unemployment rate yields a 3% rise in GDP.

How long has GDP been around?

Economist Simon Kuznets first introduced GDP measurements in the U.S. in the 1930s. In a report to Congress, Kuznets proposed a single economic indicator to measure a country’s economic output.

However, it wasn’t until 1944, following the establishment of the International Monetary Fund and the International Bank for Reconstruction and Development, that GDP was used as the standard economic measurement worldwide.

Historically, the U.S. GDP Growth Rate has averaged 3.2%. GDP reached an all-time high of 17.2% in 1950 and a low of -10.4% eight years later.

When reviewing its accomplishments in 1999, the U.S. Department of Commerce declared the GDP to be one of the greatest inventions of the 20th century.

Why does GDP matter to small business owners?

GDP provides an overall snapshot of the economy’s health, which can help business owners make projections. When GDP is high, consumers are more likely to feel flush and be ready to spend. For many companies, that may be the right moment for expansion and business growth. When GDP is low, retrenchment may be a more appropriate strategy.

However, some businesses are countercyclical; they are more likely to succeed when the economy is doing poorly. Financial advisors, companies associated with home and auto repair, grocery stores, and discount stores tend to fare better when consumers feel pinched.

Savvy business owners understand GDP

There is no one-size-fits-all approach for businesses to respond to new GDP numbers, but thoughtful business owners know what changes mean for them. Taking the time to understand how GDP affects your industry allows you to shift your strategy accordingly when new GDP figures are announced, helping you recession-proof your business.

Ross Mudrick and Chad Brooks contributed to the writing and reporting in this article.