It’s the perennial question among investors.
What is gross domestic product?
Gross domestic product (GDP) is the monetary value of all the goods and services that a country produces within a certain time period, minus the goods and services used up in production. Measured quarterly and annually, GDP provides insight into the growth rate of a nation’s economy. There are two alternative ways of looking at GDP: nominal GDP, which includes inflation, and real GDP, which excludes inflation.
GDP is the broadest measure of a country’s economic growth and standard of living. Political leaders use GDP to prepare budgets and shape economic policy, and central banks use it to formulate monetary policy. Wall Street understands the direction of the economy by looking at GDP, and it is the most important indicator for corporate planning. It is used to compare the economic growth rates and standards of living of different countries.
GDP captures the value of products and services that are consumed by end users, and seeks to exclude the value of intermediate services and products that are inputs used up during production. The objective is a measure of output without counting items of value more than once. Also, GDP measures the value of production, not the revenue earned from selling goods and services. If a car is produced in one quarter and not sold until three quarters later, for GDP its value is counted in the quarter when it is made.
There are three different approaches for measuring GDP: production, expenditure, and income. The production approach is the most direct method: by totaling all output and subtracting input costs, you have GDP. The expenditure approach measures all spending in an economy, while the income approach totals all income earned in an economy.
The production approach, also called the output approach, measures the “value added” by all production in an economy after input costs, and is the most direct method for estimating GDP. The value added is the value of final production of all goods and services, less the value of the goods and services that are consumed in the process.
Production GDP = gross value of economic output – gross value of intermediate consumption
Under the expenditure approach, GDP is the sum of all expenditures by all end users. For goods and services that remain unsold at the end of the period being measured, the product is considered to have been bought by the producer. Simply put, the expenditure approach measures all spending by everyone participating in the economy.
Expenditure GDP = consumption expenditure + investment expenditure + government expenditure + (exports – imports)
The income approach is the flip side of the expenditure approach: all spending is just somebody else’s income. This approach provides a measure that is called gross domestic income (GDI). Ideally, it should produce a GDI figure that is identical to the expenditure approach, but in practice GDI and expenditure GDP often differ slightly due to differing ways for pricing goods and services. GDI is calculated by totaling the incomes that companies and households earn from economic activity: interest for capital, rent for land use, wages and salaries for labor.
GDI = employee compensation + profits from companies + (taxes – government subsidies)
Changes in GDP have a big impact on interest rates. Check out Bankrate’s to find out how you can get a better deal on your loans.
Gross domestic product example
In the U.S., the Bureau of Economic Analysis (BEA) calculates GDP using the expenditure approach. The BEA releases three estimates of GDP each quarter: the advance estimate, near the end of the first month after the end of the quarter being measured, then the second and third (or final) estimates, near the end of the second and third months after the end of the quarter being measured. The advance measure is incomplete and subject to substantial revision, while the second and third estimates are based on more detailed and comprehensive data.
In the first quarter of 2017, the advance estimate for real GDP (or GDP adjusted to remove the impact of inflation) was up 0.7 percent from the prior quarter. This was revised up to +1.2 percent in the second estimate, then revised up again to +1.4 percent in the second and final estimate. Meanwhile, nominal GDP (or GDP that leaves in the impact of inflation) gained 3.0 percent from the prior quarter. This figure was revised to 3.4 percent in the second reading, and was left at 3.4 percent in the third and final reading.