GDP – Napkin Finance

# What is Gross Domestic Product (GDP)?

The gross domestic product, or GDP, represents the total value of a country’s economy. It is used as a way to measure the success of a given economy compared with those of other nations.

The GDP is expressed in billions of dollars for the United States because we have a large economy. Other countries have GDPs expressed in smaller units due to their smaller size. So, yes, size does matter!

## Importance

The GDP is often used to measure a country’s productivity or prosperity. If a nation’s GDP is high and growing, it indicates that the country’s economy is healthy.

The size of a nation’s GDP, however, is not the most important factor. Smaller, less powerful nations naturally have smaller GDPs and are still perfectly healthy. Instead, economists look at whether the GDP increases or decreases over time.

## Measurement Methods

Although GDP formulas are complicated, two different methods are generally used to calculate this figure:

1. Income
• Adds up the total amount of money earned by a country, including:
• Salaries earned by individuals
• Profits earned by corporations
• Taxes collected by the government

The argument for the Income Method states that when people, companies, and governments have more money they spend more money, which stimulates the economy. The higher the GDP under this method, the more money the nation, as a whole, has to buy things, expand businesses, and invest in improvements.

1. Expenditures
• Adds up the total amount of money spent by a country, including:
• The amount spent by individuals, corporations, and the government
• Investments
• Net exports
• This represents the amount of money spent by other countries on American goods and services minus any amount spent by the U.S. on foreign products, called “” If the U.S exports more than it imports, the GDP goes up.

Spending money is what directly stimulates the economy. When you spend money, you create demand for products and services that must be provided or created by companies, which then must hire workers to meet that demand. For this reason, the Expenditure Method is more common, but both methods should arrive at roughly the same figure since the economy is largely cyclical—money earned is money spent.

## GDP Growth

The difference between the GDP year to year or quarter to quarter, called “GDP Growth,” is an important metric to economists. No piece of data is useful on its own, so economists look at the change in a country’s GDP over time to determine the economic trends. This growth rate is expressed as a percentage:

#### GDP Growth = (GDP This Period – GDP Last Period) / GDP Last Period

For example, the GDP of the United States was \$17,393 billion in 2014 and grew to \$18,037 billion in 2015. The GDP Growth for this one-year period is:

#### GDP Growth 2014-2015 = (\$18,037 – \$17,393) / \$18,037 = 0.0357, or 3.57%

*Since both GDP figures are expressed in billions, we are able to drop the extra zeroes to simplify the math.

This tells us that the U.S. economy “grew” by more than 3% in one year, but GDP Growth can be negative in times of economic decline.

One good example of this occurred during the 2008 crisis when the GDP of the U.S. declined by more than 2% between 2008 and 2009.

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## Fun Facts:

• While the U.S. tops the list of countries ranked by GDP with \$18,569 billion in 2016, the tiny island nation of Tuvalu has the lowest GDP in the world with just over \$34 million.
• The GDP of the entire world is a whopping \$75,544 billion.
• According to the International Monetary Fund, the U.S. economy made up nearly 25% of the global GDP in 2016.

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