What Is GDP and Why Is It So Important to Economists and Investors? (2024)

Gross domestic product (GDP) is one of the most widely used indicators of economic performance. Gross domestic product measures a national economy's total output in a given period and is seasonally adjusted to eliminate quarterly variations based on climate or holidays. The most closely watched GDP measure is also adjusted for inflation to measure changes in output rather than changes in the prices of goods and services.

Annual GDP totals are frequently used to compare national economies by size. Policymakers, financial market participants, and business executives are more interested in changes in the GDP over time, which are reported as an annualized rate of growth or contraction. This makes it easier to compare annual and quarterly rates.

Real (inflation-adjusted) U.S. GDP increased by 1.3% on an annualized basis for the first quarter of 2024 compared to an increase of 3.4% in the fourth quarter of 2023.

Key Takeaways

  • Gross domestic product tracks the health of a country's economy.
  • It represents the value of all goods and services produced over a specific time period within a country's borders.
  • Economists can use GDP to determine whether an economy is growing or experiencing a recession.
  • Investors can use GDP to make investment decisions—a bad economy often means lower earnings and stock prices.

Understanding Gross Domestic Product (GDP)

GDP measures the monetary value of goods and services produced within a country's borders in a given time, usually a quarter or a year. Changes in output over time as measured by the GDP are the most comprehensive gauge of an economy's health.

GDP figures are reported in the United States every month by the Bureau of Economic Analysis (BEA) both in nominal as well as real, or inflation-adjusted, terms. One month after the end of each quarter, the BEA releases an advance estimate of the previous quarter's GDP. In the two succeeding months, the second and third estimates are released. This information incorporates previously unavailable data.

While it is possible to deconstruct the GDP in various ways, the most common is to view it as the sum of a country's private consumption, investment, government spending, and net exports (or exports less imports).

The consumption and investment components of the GDP tend to be more reliable economic indicators than government spending or net exports. The 1.3% annualized increase in the first quarter of 2024 was linked to an increase in consumer spending, government spending, and nonresidential fixed investment.

The U.S. was the world's largest economy in 2024 according to the International Monetary Fund (IMF). It was followed by the economies of China and Germany.

Nominal vs. Real GDP

GDP can be expressed in nominal or real terms. Nominal GDP is calculated based on the value of the goods and services produced as collected, so it reflects not just the value of output but also the change in the aggregate pricing of that output. In other words, in an economy with a 5% annual inflation rate nominal GDP will increase 5% annually as a result of the growth in prices even if the quantity and quality of the goods and services produced stay the same.

1.3%

U.S. real GDP growth rate (annualized) during the fourth quarter of 2023, compared to an annualized increase of 3.4% in the first quarter of 2024.

In contrast, real GDP is adjusted for inflation. This means that it factors out changes in price levels to measure changes in actual output. Policymakers and financial markets focus primarily on real GDP because inflation-fueled gains aren't an economic benefit.

To estimate real GDP, the BEA constructs chain indexes that allow it to adjust the value of the goods and services to the change in prices of those goods and services.

Measuring GDP

There are three primary ways of calculating GDP: first, by adding up what everyone earned (known as the income approach) or by adding up what everyone spent in a year (the expenditure method). Logically, both measures should arrive at roughly the same total.

The income approach, which is sometimes referred to as GDP(I), is the sum of the aggregate compensation paid to employees, business profits, and taxes less subsidies. The expenditure method already discussed is the more common approach and is calculated by adding private consumption and investment, government spending, and net exports.

Finally, GDP can be measured based on the value of the goods and services produced (the production or output approach). Because economic output requires expenditure and is, in turn, consumed, these three methods for computing GDP should all arrive at the same value.

In general, the following simplified equation is often employed to calculate a country's GDP via the expenditure approach:

BEA's estimates of U.S. GDP are based on national income and product accounts (NIPAs) for sectors including businesses, households, nonprofit organizations, and governments. NIPAs are compiled from seven summary accounts tracing receipts and outlays for each of those sectors. Detailed NIPA data also forms the basis for BEA GDP reports by state and industry.

BEA's GDP estimates omit illegal activities, care of own children, and volunteer work for lack of reliable data. A BEA researcher estimated counting illegal activities would have increased nominal U.S. GDP by more than 1% in 2017. At the same time, the GDP figures include BEA estimates of what homeowners would have paid to rent equivalent housing so that the GDP does not increase every time an owner-occupied home is rented.

GDP for Economists and Investors

GDP is an important measurement for economists and investors because it tracks changes in the size of the entire economy. In addition to serving as a comprehensive measure of economic health, GDP reports provide insights into the factors driving economic growth or holding it back.

Economic health, as measured by changes in the GDP, matters a lot for the prices of financial assets. Because stronger economic growth tends to translate into higher corporate profits and investor risk appetite, it is positively correlated with share prices. Conversely, stronger GDP growth can hurt fixed-income investments, like bonds, by making their returns less attractive on a relative basis.

While GDP reports provide a comprehensive estimate of economic health, they are not a leading economic indicator but rather a look in the economy's rear-view mirror. Markets track GDP reports in the context of those that preceded them, as well as other more time-sensitive indicators relative to consensus expectations.

What Is Real and Nominal GDP?

Real and nominal GDP are two different ways to measure the gross domestic product of a nation. Nominal GDP measures gross domestic product in current dollars; unadjusted for inflation. Real GDP sets a fixed currency value, thereby removing any distortion caused by inflation or deflation. Real GDP provides the most accurate representation of how a nation's economy is either contracting or expanding.

How Is Real GDP Calculated?

Real GDP is calculated by using a price deflator. A price deflator is the difference between prices in the current year that GDP is being measured and some other fixed base year. For example, if prices rose by 8% from the base year, the price deflator would be 1.08. The nominal GDP would then be divided by this deflator to reach real GDP.

What Is the Real GDP?

The real GDP of the U.S. as of the fourth quarter of 2023 was 1.3%. That's compared to an increase of 3.4% in the first quarter of 2024.

The Bottom Line

A single GDP number, whether an annual total or a rate of change, conveys a minimum of useful information about an economy. In context, it's an important tool used to assess the state of economic activity.

What Is GDP and Why Is It So Important to Economists and Investors? (2024)

FAQs

What Is GDP and Why Is It So Important to Economists and Investors? ›

Gross domestic product tracks the health of a country's economy. It represents the value of all goods and services produced over a specific time period within a country's borders. Economists can use GDP to determine whether an economy is growing or experiencing a recession.

What is GDP and why is it so important to economists and investors? ›

GDP measures the total market value (gross) of all U.S. (domestic) goods and services produced (product) in a given year. When compared with prior periods, GDP tells us whether the economy is expanding by producing more goods and services or contracting due to less output.

What is GDP in economics? ›

Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country's economic health.

Why is investment so important to GDP? ›

The Bottom Line. Businesses make capital investments in real estate, facilities, computers, and equipment. An increase in capital spending helps improve economic growth, as measured by GDP. Economic growth in the United States is driven by consumer spending and capital investment.

Why do economists think it's important to calculate GDP per capita? ›

Governments can use GDP per capita to understand how their economies are growing along with their populations. GDP per capita analysis on a national level can provide insights into a country's domestic population influence.

What is GDP and how is it useful? ›

Understanding Gross Domestic Product (GDP)

GDP measures the monetary value of goods and services produced within a country's borders in a given time, usually a quarter or a year. Changes in output over time as measured by the GDP are the most comprehensive gauge of an economy's health.

Which GDP is more important? ›

Real GDP is often favored over nominal GDP as it accounts for the effects of inflation. Thus, if nominal GDP grew at 4% in a given year, but the inflation rate was 5%, it actually shrunk by 1% in real (constant-dollar) terms.

Why is the GDP an important economic measurement? ›

GDP is important because it gives information about the size of the economy and how an economy is performing. The growth rate of real GDP is often used as an indicator of the general health of the economy. In broad terms, an increase in real GDP is interpreted as a sign that the economy is doing well.

What is GDP in one word answer? ›

GDP stands for "Gross Domestic Product" and represents the total monetary value of all final goods and services produced (and sold on the market) within a country during a period of time (typically 1 year).

What is the best definition of GDP? ›

gross domestic product (GDP), total market value of the goods and services produced by a country's economy during a specified period of time.

What is the relationship between GDP and investment? ›

Agrawal and Khan (2011) Impact of FDI on GDP: A Comparative Study of China and India They found that 1 per cent increase in FDI would result in 0.07 per cent increase in GDP of China and 0.02 per cent increase in GDP of India. They also found that China's growth is more affected by FDI as compared to India's growth.

Why investors can use GDP to make investment decisions? ›

At a high level, GDP reports tell you if the U.S. economy is expanding or contracting and why. Companies and the Federal Reserve often base decisions on GDP trends, so investors should understand the data and be ready to adjust their portfolios accordingly.

Who has the strongest economy in the world? ›

The United States of America is in the first place in the world GDP rank.

Who is the richest country in the world? ›

Luxembourg

Why is GDP per capita important? ›

Sustained economic growth increases average incomes and is strongly linked to poverty reduction. GDP per capita provides a basic measure of the value of output per person, which is an indirect indicator of per capita income. Growth in GDP and GDP per capita are considered broad measures of economic growth.

Why do economists use real GDP? ›

Real GDP is nominal GDP adjusted for inflation. Real GDP is used to measure the actual growth of production without any distorting effects from inflation. Real GDP is useful in setting public policy, analyzing inflation, and making business decisions.

Why is it important for economists to determine factors influencing real GDP? ›

As an economist, it is important to determine the influences on a nation's real GDP in order to understand and analyze the overall health and performance of the economy. By identifying these influences, economists can gain insights into the factors that drive economic growth and make informed policy recommendations.

What does GDP tell economists about business cycles? ›

It shows that economies go through periods of increasing and decreasing real GDP, but that over time they generally move in the direction of increasing levels of real GDP. A sustained period in which real GDP is rising is an expansion; a sustained period in which real GDP is falling is a recession.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Manual Maggio

Last Updated:

Views: 5683

Rating: 4.9 / 5 (69 voted)

Reviews: 84% of readers found this page helpful

Author information

Name: Manual Maggio

Birthday: 1998-01-20

Address: 359 Kelvin Stream, Lake Eldonview, MT 33517-1242

Phone: +577037762465

Job: Product Hospitality Supervisor

Hobby: Gardening, Web surfing, Video gaming, Amateur radio, Flag Football, Reading, Table tennis

Introduction: My name is Manual Maggio, I am a thankful, tender, adventurous, delightful, fantastic, proud, graceful person who loves writing and wants to share my knowledge and understanding with you.