Economics 101 - What is GDP?

The growth of an economy is measured in terms of an increase in the size of a nation’s economy. A broad measure of an economy’s size is its output. The most widely-used measure of economic output is the Gross Domestic Product, abbreviated GDP.

GDP is generally defined as the market value of the goods and services produced by a country. It is one of the primary indicators used to gauge the health of a country’s economy. Strictly defined, GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a period of time. In short, everything produced by all the companies and all the people in a given country (i.e. the United States).

There are three important concepts to note with regard to this definition:
• GDP is a number that expresses the worth of the output of a country in local currency.
• GDP tries to capture all final goods and services as long as they are produced within the country, thereby assuring that the final monetary value of everything that is created in the country is represented in the GDP.
• GDP is calculated for a specific period of time, usually a year or a quarter of a year.

While there are many ways to calculate GDP, the most common approach to measuring and understanding GDP is the expenditure method:

GDP = consumption + investment + (government spending) + (exports – imports)

Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.

As you can imagine, economic production and growth, what GDP represents, has 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: a bad economy usually means lower profits for companies, which in turn means lower stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession.

How does GDP affect the US economy?

Investors look at GDP growth to see if the economy is changing rapidly so they can adjust their asset allocation. In addition, investors compare country GDP growth rates to decide where the best opportunities are. The Federal Reserve (Fed) uses the GDP growth rate as one of the indication of whether the economy needs to be restrained or stimulated.

How does GDP affect real estate?

If the GDP growth rate is speeding up, the Fed may raise interest rates to stem inflation. In this case, homeowners would want to lock in a fixed-rate mortgage, because they know that an adjustable-rate mortgage will start charging higher rates next year.