The U.S. government recently reported that the gross domestic product (GDP) grew 1.9% in the third quarter (July to September), down from the 2% gain in the previous three-month period. The market had expected a 1.6% expansion, which suggests that the national economy is not slowing down as much as markets fear. It may not be what it was prior to the U.S.-China trade war, but at least it is expanding.
What is the GDP?
With the data in the spotlight, now would be a good time to answer the question: What is the GDP?
The GDP is the total value of everything produced in a country, whether it is made by locals or foreigners. In this U.S., this figure is measured every quarter by the Bureau of Economic Analysis (BEA), which also revises its quarterly estimates when it receives updated data.
The GDP is calculated by looking at consumer spending (C), business investment (I), government spending (G), and exports (X) minus imports (M). Economists use a formula to determine the nation’s GDP, which goes: C + I + G + (X-M).
There are also different types of GDP, such as:
- Real: Value of economic output revised for price changes.
- Nominal: Raw measurement of the economy that includes price changes.
- Growth rate: Percentage increase in GDP from quarter to quarter.
- Per capita: GDP divided by the population. This is used to measure living standards. In the U.S., GDP per capita is around $58,000.
GDP is the main metric for markets and economists, followed by gross national product (which measures every item produced by the country) and gross national income (money earned by the country’s businesses and people).
Is the GDP a reliable measure? Let’s look at the pros and cons.
The GDP is a broad indicator of a country’s overall development, making it easy to measure growth. Since the data is easy to collect and simple to formulate, the GDP can serve as an instant gauge of whether economic policies are working or hurting. It is comparable to a snapshot of everything that has happened in the last three months.
Economists and the business media like to depend on the GDP because it can be split into several sub-metrics. The GDP can consider population, price inflation, and growth.
If you want to evaluate economies from around the world, then you can compare GDP rates.
The biggest drawback to GDP is that it does not determine the real value of goods and services that affect the country’s standard of living. For example, investors pooled resources to build a ship to fish for salmon, transport cargo, and offer sightseeing tours. The project required a lot of money to buy resources, like aluminum, cement, and lumber. Through this, the ship contributed to the national GDP as it was built, even though it did not yet did not catch fish, carry cargo, or have any passengers.
In 1990, the former Soviet Union’s GDP was roughly half of the U.S. GDP. This was surprising considering the widespread misery, suffering, and unhappiness in that country. The problem, however, was not the output but consumption. Russia smelted steel, but it was not used in construction or manufacturing. Russia paved roads, but they did not lead to anywhere.
The GDP also measures short-term jolts to the economy, such as wartime spending.
And, many economists now contend that GDP omits important household duties that do not produce financial value, like child-rearing and cleaning.
Buy or Sell?
Is there too much of a dependence on the GDP numbers every quarter? Financial markets hold their breath in the moments leading to the government releasing the latest data. Thankfully, we now have a treasure trove of data at our fingertips, so we no longer need to rely on just one metric.