Gross Domestic Product (GDP)
What It Is:
Gross Domestic Product (GDP) is the broadest quantitative measure of a nation's total economic activity. More specifically, GDP represents the monetary value of all goods and services produced within a nation's geographic borders over a specified period of time.
How It Works/Example:
The equation used to calculate GDP is as follows:
GDP = Consumption + Government Expenditures + Investment + Exports - Imports
The components used to calculate GDP include:
-- Durable goods (items expected to last more than three years)
-- Nondurable goods (food and clothing)
-- Nonresidential (spending on plants and equipment), Residential (single-family and multi-family homes)
-- Business inventories
-- Exports are added to GDP
-- Imports are deducted from GDP
The GDP report also includes information regarding inflation:
-- The implicit price deflator measures changes in prices and spending patterns.
-- The fixed-weight price deflator measures price changes for a fixed basket of over 5,000 goods and services.
GDP is calculated both in current dollars and in constant dollars. Current Dollar GDP involves calculating economic activity in present-day dollars. This, however, makes time period comparisons difficult due to the effects of inflation. By comparison, Constant Dollar GDP factors out the impact of inflation and allows for easy comparisons by converting the value of the dollar in other time periods to present-day dollars.
Why It Matters:
When GDP declines for two consecutive quarters or more, by definition the economy is in a recession. Meanwhile, when GDP grows too quickly and fears of inflation arise, the Federal Reserve often attempts to stimulate the economy by raising interest rates.