Gross Domestic Product (GDP) and Its Importance

If you listen to any of the many finical news stations, you have no doubt heard the term GDP. GDP is an acronym for Gross Domestic Product and according to many, a country's GDP is one of the most important measures of a country's health and standard of living that there is.

GDP represents the measure of several things and is not so easily determined. When analysts measure GDP they look at, all private and public consumption or spending, Government outlays or spending, total country investments, and finally total exports and imports. These areas of concern are sometimes represented as follows:

C = Consumer Spending

G = Government Spending

I = Business Spending

NX = Net Exports, which is Exports - Imports

The GDP number you may hear on the news is calculated on an annual basis and will be compared to the previous quarter or the previous year's GDP number. The GDP number is important as it represents a countries growth. So, if you hear that the latest GDP number is 2% then that means that the country's economic growth for the past quarter or year (depending on which measure is being used) was 2%.

When I was a stock broker I was always meeting people who were baffled by the GDP number as there are in fact two ways in which you can come up with it. The first is called the income approach and uses what everyone earns to come up with the number and the second way is called the expenditure approach, which uses what people spend as a measure.

No matter which measure is used though, the result should be around the same. The importance of the GDP number though is its significance to overall spending. Because recessions and depressions of countries are largely due to an overall drop in spending then logically, having a low level GDP number for an extended period of time is not a good thing, especially when the trend in GDP becomes negative. There are many other factors besides GDP that dictate recession or not, but many economists track the GDP number very closely for that reason.

While some experts say that GDP is a leading indicator of a county's overall health, others will say it is only a measure of [productivity. Whatever the case may be, knowing that the GDP number may in fact point to or from a recession makes the number worth paying attention to when it is announced on the news.

Source: Investopedia, Gross Domestic Product (GDP) Definition, Invesopedia.com