Gross Domestic Product (GDP) is an important indicator that measures the overall health of an economy. In this Wiki, we will take a look at what GDP is and its various components.
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Gross Domestic Product
Gross Domestic Product, or GDP for short, is the total of all economic activity in one country regardless of who owns the productive assets (the things that generate the money). For example, if a Japanese-owned company is making cars inside of the United States then this economic activity will count in the U.S. GDP calculation.
Because GDP is the main measure of total economic activity this makes it very important. It’s the monetary value of all the finished goods and services produced within a country's borders during the specific time period being measured. It includes all private and public consumption, government outlays, investments, and exports minus imports that occur within a country. Put simply, GDP is a broad measurement of a nation’s overall economic activity and health.
GDP is most commonly used as an indicator of the economic health of a country. It’s also used as a gauge of a country's standard of living for its citizens. Since the way of measuring GDP is fairly similar from country to country, GDP can be used to compare the productivity of various countries with a fairly high degree of accuracy.
A nation’s GDP from any time period can be measured as a percentage relative to previous years or quarters. When traders measure GDP in this way, it can be tracked over long periods of time and used in measuring a nation’s economic growth (or lack of growth). It can also help in determining if an economy is in a recession or if it is growing in a way that increases the standard of living for the nation’s people.
Real GDP
Real gross domestic product is an “inflation-adjusted” measure that reflects the value of all goods and services produced by an economy in a given year. This is expressed in base-year prices, and is often referred to as "constant-price," "inflation-corrected GDP” or "constant dollar GDP."
Unlike nominal GDP, real GDP can account for changes in price levels and provide a more accurate figure of economic growth. This represents the total economic activity in constant prices.
It’s significant because it’s useful for tracking how an economy is developing over time. Real GDP reveals changes in economic output after adjusting for inflation. So, if regular GDP was 4% but inflation was 2% for the same time period, then real GDP is actually 2% (4% - 2% = 2%).
This is typically viewed in the context of the overall economic cycle and becomes more significant at certain points within the economic cycle.
Nominal GDP
Nominal GDP is gross domestic product, or total economic activity, measured at current market prices.
Nominal GDP differs from real GDP in that it includes changes in prices due to inflation. Basically, Nominal GDP tells us the overall increase or decrease in price levels. It’s significant because it describes the total level of production or economic achievement within a nation.
Per Capita GDP (GDP per Head)
Per capita GDP measures the output on a per-person basis. The equation is GDP divided by the population size of the nation being measured.
It’s significant because it’s used as an indicator of overall economic welfare. Output per head can be used as a good guide to understanding the living standards of the nation’s people. If real GDP per head increases it indicates an improvement in the overall economic well-being because people have more money and can therefore increase their standard of living.
Per capita GDP is especially useful when comparing one country to another because it shows the relative performance of each country being measured. A rise in per capita GDP signals growth in the economy and tends to reflect an increase in productivity and economic welfare.
Productivity GDP
This measures the output for one unit of labour or capital. It’s significant because it indicates the “efficiency” and the “potential” of total economic output.
Productivity is highly cyclical since employment and capital are less flexible and change at a slower rate than supply and demand. If you think about it, demand for certain products can dry up virtually overnight but the manufacturing and employees making the products don’t catch wind of this event until much later because there is a time lag.
GDP Deflators
“Deflators” measure the difference between the current and constant price GDP and its individual components. For example, if GDP increases by 4% in nominal terms but increases by 1% in real terms then the implied economy-wide rate of inflation is 3% (4% - 1% = 3%). This is an attempt to smooth out inflation readings.
Deflators are valuable for identifying trends and obtaining advanced warning of price changes which is what makes them valuable to monitor for economists
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