What is GDP and how is it calculated?
December 8, 2022 5 min read
Gross domestic product (GDP) can be used as a kind of snapshot of a country’s economic performance. It’s a broad way to measure the value of the goods and services produced within a set time frame. GDP data can be extremely influential. It affects everything from policy decisions to interest rates.
Learn more about GDP, how it’s calculated and how it might impact your day-to-day life.
- Gross domestic product (GDP) is the total value of the goods and services produced by a country in a given period of time.
- GDP can give people a big-picture idea of how a country’s economy is performing.
- GDP data might be used to inform decisions about things like policy, hiring, investing, interest rates and more.
Gross domestic product, simplified
GDP, or gross domestic product, is the total market value of the goods and services produced in a country within a specific time period.
GDP data can provide some insights about a country’s economic well-being. In fact, according to the U.S. Department of Commerce, GDP is among the most influential economic measures.
So it’s no surprise that Congress, the Federal Reserve, state governments, businesses and the general public use GDP data to help make decisions about things like interest rates, policies, hiring, spending and investing.
What does GDP measure?
According to the Department of Commerce, GDP can be broken down into four categories: personal consumption expenditures, gross private domestic investment, net exports of goods and services, and government consumption expenditures and gross investment. And in case you’re not an economist, here’s what all that means.
Personal consumption expenditures
These are the goods and services that people who live in a given country spend money on. You might also hear it called “consumer spending.”
So what kinds of things does that cover? Here are some types of personal consumption expenditures that may be included in GDP calculations:
- Durable goods: Things that typically last longer than three years, like appliances, furniture, tires and electronics.
- Nondurable goods: Goods that last fewer than three years, like food, beverages and paper products.
- Services: Services provided by professionals like hairdressers, doctors, mechanics or bus drivers that aren’t tangible and can’t be stored.
Gross private domestic investment
This measures how much businesses spend and invest within their own country. It’s broken down into two subsections: fixed investments and change in private inventories.
- Fixed investments can include business assets such as land, buildings, equipment and intellectual property products.
- Change in private inventories refers to how the actual, physical volume of a business’s inventory has changed over a specific period of time.
Net exports of goods and services
This refers to the value of a country’s exports minus its imports. This calculation is needed for an accurate measurement of GDP, because net imports take away from a country’s GDP, while exports add to it.
Government consumption expenditures and gross investment
Government consumption expenditures cover government spending on public services. That might include things like government employee salaries, national defense spending, public schools and more.
Government gross investment is related to fixed assets, such as highways, buildings or equipment.
What doesn’t GDP measure?
GDP doesn’t measure all productive activity in a country. For example, unpaid work—like some child care and volunteer work—isn’t included in a country’s GDP. And any illegal financial activities are also excluded when measuring GDP.
Types of GDP
There are a few types of GDP. But the two main ones to know about are real GDP and nominal GDP. Here’s how they work:
- Real GDP: This measure of GDP is adjusted for inflation. Real GDP can help give a snapshot of a country’s economic growth that isn’t skewed by price changes caused by inflation.
- Nominal GDP: This is a way to measure GDP that looks at current prices and doesn’t adjust for inflation.
Real GDP and nominal GDP both measure the same total output of a country’s goods and services during a specific time. But real GDP might be more useful for looking at changes in the volume of goods and services produced, while nominal GDP can help when examining changes in their value.
How is GDP calculated?
There are a lot of ways to measure GDP. Some approaches look at income. Others focus on production. One method for calculating GDP that the U.S. Bureau of Economic Analysis highlights is the expenditure approach.
Using the expenditure approach, GDP is basically a country’s total consumer spending. That includes everything from consumers buying weekly groceries to companies investing in new equipment.
Here’s the formula for calculating GDP using the expenditure approach:
- C: Consumer spending on goods and services.
- I: Business investments in things like buildings and land plus individual home purchases.
- G: Federal, state and local government spending on things like public schools, road construction and maintenance, and defense.
- NX: This stands for a country’s net exports. That means the total value of a country’s exports minus the total value of its imports.
Why is GDP important?
GDP data can offer a big-picture indication of a country’s economic performance. And that can have real impacts on people’s day-to-day lives.
For example, GDP data can inform how the Federal Reserve sets monetary policies—like the country’s prime interest rate. And that can affect the total amount someone pays for a car loan, a mortgage or credit card purchases.
Businesses may also use GDP data to make hiring decisions, which can directly impact people who are trying to get a job. And speaking of job searches, people may also be able to use GDP data to learn about industries that are growing or declining.
GDP in a nutshell
GDP is one way to measure a country’s economic performance. GDP data can affect everything from policy decisions to an individual’s job prospects or investment choices.
So it can be helpful to have a basic understanding of how GDP works and how it might affect things like the job market and interest rates.
If you’re curious to dive deeper, you can learn more about how credit card interest works and how you might be impacted if the prime interest rate changes.