Understanding GDP

# Gross Domestic Product and How It Affects You

Gross domestic product is the total value of everything produced in the country. It doesn't matter if it's produced by citizens or foreigners. If they are located within the country's boundaries, their production is included in GDP.

To avoid double-counting, GDP includes the final value of the product, but not the parts that go into it. For example, a U.S. footwear manufacturer uses laces and other materials made in the United States. Only the value of the shoe gets counted; the shoelace does not.

In the United States, the Bureau of Economic Analysis measures GDP quarterly. Each month, it revises the quarterly estimate as it receives updated data.

### Calculating GDP

The components of GDP include personal consumption expenditures plus business investment plus government spending plus (exports minus imports). Now that you know what the components are, it's easy to calculate a country's gross domestic product using this standard formula: C + I + G + (X - M).

When economists talk about the “size” of an economy, they are referring to GDP.

### Types

There are many different ways to measure a country's GDP. It's important to know all the different types and how they are used.

Nominal GDP: This is the raw measurement that includes price increases. In 2018, nominal U.S. GDP was \$20.494 trillion.

Real GDP: To compare GDP by year, the BEA removes the effects of inflation. Otherwise, it might seem like the economy is growing when really it's suffering from double-digit inflation. The BEA calculates real GDP by using a price deflator. It tells you how much prices have changed since a base year. The BEA multiplies the deflator by the nominal GDP. The BEA makes the following three important distinctions:

1. Income from U.S. companies and people from outside the country are not included. That removes the impact of exchange rates and trade policies.
2. The effects of inflation are taken out. For example, it counts the value of a new car engine only after it's assembled in the vehicle.
3. Only the final product is counted.

Real GDP is lower than nominal. In 2018, it was \$18.566 trillion. The BEA provides it using 2012 as the base year in the National Income and Product Accounts, Table 1.1.6. Real Gross Domestic Product-Chained Dollars.

Growth Rate: The GDP growth rate is the percentage increase in GDP from quarter to quarter. It tells you exactly whether the economy is growing quicker or slower than the quarter before. Most countries use real GDP to remove the effect of inflation.

If the economy produces less than the quarter before, it contracts and the growth rate is negative. This signals a recession. If it stays negative long enough, the recession turns into a depression.

As bad as a recession is, you also don't want the growth rate to be too high. Then you'll get inflation. The ideal growth rate is between 2 -3%.

The BEA calculates the U.S. GDP growth rate. It provides current U.S. GDP statistics monthly. In 2018, it was 2.9%. The U.S. GDP growth rate has changed each year since 1929 depending on the phase of the business cycle.

GDP per Capita: GDP per capita is the best way to compare gross domestic product between countries. This divides the gross domestic product by the number of residents. It’s a good measure of the country's standard of living. Some countries have enormous economic outputs only because they have so many people. In 2018 the U.S. GDP per capita was \$57,170.

The best way to compare GDP per capita by year or between countries is with real GDP per capita. This takes out the effects of inflation, exchange rates, and differences in population. In 2007, the United States lost its position as the world's largest economy.

### How GDP Affects You

GDP impacts personal finance, investments, and job growth. Investors look at a nations' growth rate to decide if they should adjust their asset allocation. They also compare country growth rates to find their best international opportunities. They purchase shares of companies that are in rapidly growing countries.

The U.S. central bank, the Federal Reserve, uses the growth rate to determine monetary policy. It implements expansionary monetary policy to ward off recession and contractionary monetary policy to prevent inflation. Its primary tool is the federal funds rate.

For example, if the growth rate is increasing then the Fed raises interest rates to stem inflation. In this case, you should lock in a fixed-rate mortgage. Your payments on an adjustable-rate mortgage will rise along with the fed funds rate.

If growth slows or becomes negative, then you should update your resume. Slow economic growth leads to layoffs and unemployment. That can take several months. It takes time for executives to compile the layoff list and prepare exit packages.

Use the GDP report from the BEA to determine which sectors of the economy are growing and which are declining.

You can apply for jobs in growing sectors. Even during the 2008 financial crisis, health care industries continued to add jobs. This report also helps you determine whether you should invest in, say, a tech-specific mutual fund versus a fund that focuses on agribusiness.

### Difference Between GNP and GNI

Gross national product measures the value of everything produced by a country's citizens, no matter where they are in the world. The World Bank now calculates gross national income instead, but the differences are insignificant.

### Problems With GDP

One of the biggest criticisms of GDP it that it doesn't count the environmental costs. For example, the price of plastic is cheap because it doesn't include the cost of pollution. GDP doesn't measure how these costs impact the well-being of society. A country will improve its standard of living when it factors in environmental costs.

Another criticism is that GDP doesn't include unpaid services. It leaves out child care and unpaid volunteer work. As a result, the economy undervalues these contributions to the quality of life.

GDP also does not count the shadow or black economy. GDP underestimates economic output in countries where a lot of people receive their income from illegal activities. These products aren't taxed and don't show up in government records. The government estimates, but cannot accurately measure, this output. Global Financial Integrity estimated the black market contributed up to \$2.2 trillion to the \$128 trillion global economy in 2017.

Likewise, societies only value what they measure. For example, Nordic countries rank high in the World Economic Forum's Global Competitiveness Report. Their budgets focus on the drivers of economic growth. These are world-class education, social programs, and a high standard of living. These factors create a skilled and motivated workforce. These countries also have a high tax rate. That slows GDP growth. But they use the revenues to invest in the long-term building blocks of economic growth.

Riane Eisler's book, “The Real Wealth of Nations,” proposes changes to the U.S. economic system by giving value to activities at the individual, societal, and environmental levels.