What is Gross Domestic Product? What Is Its Use?

Various metrics or indicators are used to track and affirm the health of a nation’s economy. However, very few come close to what Gross Domestic Products indicates as it functions as a comprehensive scorecard for evaluating any given economy’s health.

What is GDP?

Gross Domestic Product is an economic metric that shows the value of all finished goods and services produced in a country over a specific period of time. The economic metric provides a snapshot of a country by estimating its size as well as growth rate.

Whenever economists talk of the economy expanding or contracting, they are essentially referring to GDP increasing or decreasing. A nations GDP is calculated by taking into consideration the final value of the products and services produced within the borders. The figure does not take into consideration the value of the various parts used to produce the final goods and services.

GDP is calculated using expenditures production or incomes incurred and generated. In most cases, it is adjusted for inflation and population, thus providing deeper insights into living standards in a country.

The foreign balance of trade has the biggest impact on the final GDP value. Countries which export more than they import tend to have a much bigger GDP. In this case, an economy is said to be in a trade surplus.

Understanding GDP

Gross Domestic Product can exist in different forms depending on how it is calculated. Conversely, there are two main types of GDP are

  • Nominal GDP
  • Real GDP

Nominal GDP is the raw GDP calculated by taking into consideration price increases. It is often referred to as current GDP as it is calculated using current market prices in either local currency or U.S dollar.

Real GDP, in contrast, does take into consideration price increases. Instead, it is calculated by first removing inflation’s effects on the final value of products and service. In this case, it is a more reliable figure for comparing an economy’s health at different times as prices of goods and services are held constant between the two periods.

GDP Growth Rate

GDP growth rate is simply the rate at which an economy grew over a given period mostly from quarter to quarter. A negative, growth rate signals economic contraction and could be early warning sign for recession.

It is one of the most-watched metric of the GDP as it is connected to policy targets such as inflation and unemployment.

In addition, if the growth rate is too high, there is always an increased risk of increased inflation.

Gross Domestic Products Per Capita

Gross Domestic Per capita is an important metric that provides an effective and reliable way of comparing two economies. The metric divides the total GDP value with the total number of people in a country conversely providing a measure of ascertaining the standard of living in a given country.

GDP Per capita signals the amount of output or income per person in an economy. Likewise, it can indicate the average productivity or living standards.

Gross Domestic Product Impact

Foreign Investment

Gross Domestic Product affects various aspects of the economy differently. For instance, foreign investors are likely to invest in a currently whose Gross Domestic Product is growing at an impressive rate as it signals expansion in the economy. Likewise, a country with a solid GDP growth rate is likely to see capital inflows in companies at the heart of fuelling the economic growth.

Interest Rates

Policymakers in the form of central banks adjust interest rates which affect various facets of the economy based on the GDP value. For instance, if the GDP is growing at an astronomical rate triggering increased inflation levels, a central bank can increase interest rates.

An increase of the base interest rate would essentially cause interest on mortgages to personal loans to increase conversely reducing the amount of money in circulation. Similarly, whenever the GDP Growth rate is declining, the central bank could cut interest rate to reduce the cost of borrowing, allowing people to borrow in a bid to fuel economic activities.

GDP Inefficiencies

GDP does not provide an accurate picture of the health of an economy, in part because it leaves out some factors. The figure does not factor in the impact of unpaid services on the economy. For instance, unpaid child care or voluntary work goes a long way in impacting the economy in one way or another, but never factored in the final GDP value.

Likewise, GDP shrugs off the black economy, which in most cases impacts societies as well as other economic activities. For instance, some people receive income from illegal activities but use the same amount to fuel various economic activities.

Ruchi Gupta

Ruchi Gupta covers various beats from finance to technology and from lifestyle to hobbies. She has an MBA in Finance. Ruchi enjoys writing on celebrities and political news. She likes traveling and exploring places.

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