What is GDP? How does it affect me?

GDP and how it affects me

GDP is as country’s Gross Domestic Product, and is one of the primary indicators of a country’s economic health.  Simply put, this is the total economic output, or total level of production of the country over a given time period.  Often quoted in the news are the GDP figures for the year, or GDP figures for the quarter; and the numbers given are usually in comparison to the previous year or quarter.  For example, US GDP growth for 2013 was approximately 3.4% (world bank).  Sometimes the news will quote quarterly growth in annualized figures; for example “the UK grew at 3% in the fourth quarter” does not mean that in 3 months it grew by 3%, but rather it grew at a rate that if continued steadily would end up being a total of 3% growth for the year.

How Is Gross Domestic Product (GDP) Calculated?

How is the number calculated?  There are three methods of calculating the figure: the production approach, the income approach, and the expenditure approach; and they should all in theory add up to the same number.  The production approach is the sum total of market value of final goods and services produced in a country during 1 year.  In comparison, the income approach simply adds the sum total of all incomes of all individuals living in a country during that same year.  The most commonly used method however is the expenditure approach.  With the expenditure approach, we calculate the sum of all consumption, investment, government spending, and net exports (exports minus imports).

Whenever people talk about a “recession” or most recently the “great recession”, they are referring to a time where GDP did not grow for two consecutive quarters.  To address the question “are we in a recession?”, that every politician and news anchor wanting a good soundbite was asking in 2008… the word “recession” is simply a term coined by economists when looking back at past economic data to describe a period of time whereby GDP decreased instead of increased.

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In addition to GDP, we have terms like GNP (Gross National Product), Real GDP, various adjustments to GDP, taking into account externalities, purchasing power parity, etc.; all of which are debated by economists, though that is beyond the scope of this article.

This begs the question: what does it all mean for me, and how does it effect me?  Certainly these huge abstract numbers are the concern of governments and not the individual?…

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Unfortunately, this is not true. GDP numbers do have an impact on the individual. For example, GDP and the unemployment rate very often go hand in hand. Often some external factor that causes companies to lay off workers or go out of business themselves will then lead to less overall production in the economy and lower GDP. Conversely, external factors that cause a country to be less productive (simple example: a particularly damaging natural disaster or geopolitical/military conflict) lead to lower GDP numbers…which in turn leads to less investor confidence in a country and thus less capital inflows to the country. This leads to companies and/or governments having less capital to expand their businesses or provide services, and thus laying off or firing employees, or forcing employees to have part-time contract work rather than full-time with benefits. Active investors can also keep an eye on figures like GDP and unemployment in helping to determine how, when, and in which country, to best deploy their investment capital.

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Sources and Further Reading