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

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A:

The gross domestic product (GDP) is one of the primary indicators used to gauge the health of a country's economy. It represents the total dollar value of all goods and services produced over a specific time period, often referred to as the size of the economy. Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the Q3 2017 GDP of a country is up 3%, the economy of that country has grown by 3% over the third quarter. While quarterly growth rates are a periodic measure of how the economy is faring, annual GDP figures are often considered the benchmark for the size of the economy.

In the United States, real GDP increased at an annual rate of 2.6 percent in the fourth quarter of 2017, according to figures released by the Bureau of Economic Analysis. For all of 2017, GDP grew 2.3 percent. Current-dollar GDP increased 4.1 percent, or $762.3 billion, in 2017 to a level of $19,386.8 billion.

The countries with the largest GDP in descending order are 1. The United States, 2. China, 3. Japan, 4. Germany, 5. The United Kingdom, 6. France, 7. India, 8. Italy, 9. Brazil and 10. Canada.


Measuring GDP can be complicated, but at its most basic, the calculation can be done in one of two ways: either by adding up what everyone earned in a year (income approach) or by adding up what everyone spent (expenditure method). Logically, both measures should arrive at roughly the same total.

The income approach, which is sometimes referred to as GDP(I), is calculated by adding up total compensation to employees, gross profits for incorporated and nonincorporated firms, and taxes less any subsidies. The expenditure method is the more common approach and is calculated by adding total consumption, investment, government spending and net exports.


As one can imagine, economic production and growth – which GDP represents – have a large impact on nearly everyone within that economy. For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market. It's not hard to understand why; a bad economy usually means lower earnings for companies, which translates into lower stock prices. Investors often pay attention to both positive and negative GDP growth when assessing an investment idea or coming up with an investment strategy.

There are actually two types of GDPs that economists use to measure a country's economy. Nominal GDP refers to a country's economic output without an inflation adjustment, while Real GDP is equal to the economic output adjusted for the effects of inflation. Economists will look at negative GDP growth to determine whether an economy is in a recession.

For more on this topic, see Is real GDP a better index of economic performance than GDP?andMacroeconomic Analysis. To stay on top of the latest macroeconomic news and analysis, sign up for our free News to Use newsletter.


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