Gross domestic product definition
/What is Gross Domestic Product?
Gross Domestic Product (GDP) is the total value of goods manufactured and services provided within a country over a period of time. It includes all production and services within the country, even if they are provided by entities owned by foreigners. GDP is a high-level indicator of the economic health of a country.
How to Calculate Gross Domestic Product
The calculation of GDP is as follows:
+ Personal consumption expenditures
+ Gross private domestic investment
+ Government spending
+ Exports
- Imports
= Gross domestic product
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This basic calculation is called nominal GDP, because it does not include an adjustment for price inflation. When the amount is reduced for price inflation, it is called real GDP.
GDP is typically measured on a trend line, to plot changes in a country’s GDP over time. The most common measurement reported from this trend line is quarterly changes in GDP, though the changes can also be calculated on an annual basis. GDP is also measured on a per capita basis, to determine the average GDP per person; doing so eliminates the effect of highly populous countries that report high aggregate GDP, but which have low GDP on a per-person basis.
Components of the Aggregate Expenditure Equation
It is worth delving into each component of the aggregate expenditure equation in somewhat more detail, which we have done in the following sub-sections.
Personal Consumption Expenditures
This is the total market value of household purchases, which is comprised of durable goods, nondurable goods, and services. Durable goods have a shelf life of at least three years, such as motor vehicles, kitchen appliances, and jewelry; since these purchases are expensive, they tend to be volatile. Nondurable goods have a shorter shelf life, such as food and prescription drugs. Services comprise about two-thirds of all consumption expenditures, including restaurant purchases, health care, movies, and airline tickets. In general, when spending in this category falls, it is quite probable that a recession is looming.
Gross Private Domestic Investment
This is the aggregate amount of capital spending by businesses, plus net changes in inventory, and residential housing. Of the two types of investment, capital spending by businesses comprises about 80% of the total, and so is more closely watched. This is especially important, because company managers will not invest unless they anticipate good times ahead, so this measure is also somewhat of an opinion indicator. Inventory levels are a good indicator of business sentiment, since managers tend to build up inventory levels when they expect increased demand, and scale back when they foresee the reverse.
Government Spending
This is comprised of all government expenditures in the country, covering such items as highway construction and maintenance, military expenditures, employee compensation, and research. About two-thirds of this number involves spending at the state and local levels, where expenditures are more likely to be targeted at road construction, utilities, police services, and so forth. This tends to be quite a stable proportion of total GDP, though spending may rise sharply in time of war or when it is spending extra to pull the economy out of a recession.
Value of Exports and Imports
This is the net difference between the value of the goods and services exported to other countries and the amount imported from them. This figure has been negative for the United States for an extended period of time, which reduces the total amount of GDP for the country.