What is GDP and GDP Growth and Why is it Important?

Gross Domestic Product (GDP) is a metric that helps us understand the overall health of a nation’s economy and its residents.

Nearly everything around you is part of your country’s GDP. For example, when you eat in a restaurant, the tables, equipment in the kitchen, light fixtures, the employees’ income from working in the restaurant, and even your plate of food are part of your nation’s GDP.

GDP measures the total value of all finished goods and services in a country in a year. In the United States, which is the world’s largest economy, the GDP is about $19 trillion.

Finished goods are things that will not be resold. For example, the flour, eggs, and butter bought by a deli to make cookies are not part of GDP because they will be combined to make cookies, which are sold to customers. The cookies are part of the GDP and considered finished goods. The flour, eggs, and butter purchased to make cookies at home are part of the GDP because the cookies will not be sold.

How we calculate GDP

Economists use varying methods to calculate GDP. One well-known equation is:

Consumption + Investment + Government Spending + Net Exports = GDP

Consumption: This number represents consumer spending on physical goods like the food you buy at a restaurant or on services like the money you spend on a haircut. In developed countries, consumer spending typically makes up over half of the GDP. 

Investment: This is how much money businesses spend on property, including buildings and land and their spending on equipment. It also includes money that consumers spend on major investments like buying a home. When the economy is suffering, this part of the GDP equation typically shrinks because businesses and individuals tend to limit their large purchases during tough financial times. 

Government Spending: This is the money that national and local government entities spend on things like schools, roads, and defense. Government spending varies a lot between countries. 

Net Exports: This number represents a country’s exports minus their imports. Many countries actually have a negative net export number. For example, in the United Kingdom, about $1 billion worth of coffee comes into the country each year but they export only $315 million worth of coffee. This leaves them with a negative net export of coffee. 

GDP and a country’s overall financial health

Countries collect data on the factors that contribute to their GDP, making this a universal measurement as countries compare their performance worldwide.

If an economy is healthy, there’s generally an upward trend in its GDP over the years. When an economy is suffering, GDP contracts. When GDP falls for two consecutive quarters or longer, economists identify the trend as a recession.

GDP growth

GDP is measured quarterly by the Bureau of Economic Analysis (BEA). It’s the number many people use to determine a country’s overall financial health and success. When GDP increases from one quarter to the next, economists consider it an indication that the country is financially stable.  

For example, in late 2008, U.S. GDP contracted four consecutive quarters which meant the GDP Growth was negative for four consecutive quarters. This was the most dramatic GDP decline since the Great Depression in the United States.

Why are GDP and GDP growth important?

GDP and GDP growth matter because these numbers help us understand a nation’s financial health. When GDP increases, business and personal income grows, as well. When GDP contracts, businesses wait to hire new employees and individuals put off big purchases. This causes even further declines in GDP growth. 

GDP and GDP Growth plays a big role in how the government and the Federal Reserve (FED) make decisions that affect ordinary Americans. 

The government watches GDP growth closely and uses that information to inform policy and tax changes. For example, they cut taxes and increased their spending to stimulate the economy after The Great Depression. In the 1970s, the government limited spending, limited growth in money supply, and resisted tax cuts to combat inflation. 

The Fed uses GDP when it makes decisions about whether to raise interest rates. These decisions influence the economy in an important way. For example, when GDP growth is negative or slow, the Fed may decrease interest rates. As a result, businesses and individuals may be more willing to borrow money to make large purchases, which stimulates the economy and causes GDP to grow. When the GDP is on the rise, the Fed typically raises interest rates, which controls inflation and causes GDP growth to slow.

GDP doesn’t measure everything

One potential fault with GDP growth calculations that economists like to draw attention to is that GDP doesn’t give enough weight to money spent on services and the digital economy. For example, digital music allows individuals to purchase a subscription to a service that allows unlimited access to nearly any song. In the past, accessing music meant purchasing individual albums, which would have possibly contributed a greater amount of money overall to GDP than a small monthly digital subscription. 

GDP also does not measure the well-being and economic equality of individuals living in the country. So, a country like Nigeria, which had a GDP of $397,720 million with a per capita breakdown of $2,028, doesn’t show the huge disparity between groups of people living in the country. Many people in Nigeria live in extreme poverty and a few are very wealthy, so the average isn’t a correct representation of how a regular person lives in Nigeria. 

While GDP is an important indicator of a country’s overall financial health, but it doesn’t necessarily translate to the financial health of the people living in the country. 

At Facts First, we allow you to compare GDP Growth by U.S. President and the data is updated every quarter when the latest GDP numbers come out.