by Michael Lodge
Yesterday I got a message from a client asking me to explain what is the GDP so I promised her I would do a blog about it. Now the funny thing about my blogs is, if I do a blog on my travel to San Francisco I get thousands of readers, but if I do a blog on taxes or business, it seems to put people to sleep. But I am going to try to explain what the GDP and why do we look at this very important number.
So here goes Economics 101, go get a cup of coffee to keep you awake.
In economics the Gross Domestic Product or GDP, shows how much a country produces in some amount of time, usually looking at it on a yearly basis. The calculation can vary from country to country but it is just about the same. Here is how the GDP is calculated.
Consumer Spending (C), All investments (I), all government spending minus taxes (G), and the value of exports minus imports (X-M) that gets you to the GDP, or:
GDP = C = I – G – (X – M)
As of June 2016 report (http://www.bea.gov/) our GDP only grew by 1.2%, a very bad number. It shows that this nation over the last eight years has had a very slow growth in our economy. Wages in the United States grew by only 0.2% which is another bad number that wages are just not advancing with the cost of living. And that is why Americans are so angry. Basically eight years of nothing.
So why do we as a nation use this calculation? Because we want to know how healthy our country is, and to see how healthy other countries are. If our country, or another country, has a high value of the GDP we can say the country has a large economy. The biggest GDP in the world is the United States. Germany is the largest in Europe, Nigeria in Africa and China in Asia.
To make it even more boring we can explain GDP even more by saying there are different ways to calculate the GDP. Nominal GDP is the normal amount of money spent on all new and final goods in an economy, read GDP (adjusting for changes in prices) tries to correct this number for inflation. For example, if the prices rise by 2% (meaning, everything costs 2% more) and the nominal GDP grows by 5%, the real GDP growth is only increases by 3%.
GDP per capita is the total income of a country, divided by the number of inhabitants. It shows how rich people, on average, are.
VIDEO – UNDERSTANDING GDP (sorry from 2010 but it still is a good example of GDP)
Why does GDP mean to us as an average citizen? Mark Koba of CNBC wrote a great piece on this which is as follows:
How does the GDP affect the average citizen?
When the economy is healthy, there is usually low unemployment and wage increases, as businesses demand labor to meet the growing economy.
However, if the GDP growth rate is speeding up too fast, the Federal Reserve may raise interest rates to stem inflation—or the rising of prices for good and services. That could mean loans for cars and homes would be more expensive. Businesses too would find the cost of borrowing for expansion and hiring to be on the rise.
If GDP is slowing down, or is negative, it can lead to fears of a recession which means layoffs and unemployment and declining business revenues and consumer spending.
The GDP report is also a way to look at which sectors of the economy are growing and which are declining. It can also help gear workers toward training in those sectors that are growing.
How does the GDP affect investors?
Investors look at GDP growth to see if the economy is changing rapidly so they can adjust their asset allocation. A bad economy usually means lower profits for companies, which in turn means lower stock prices for some firms.
The GDP can help determine whether someone might invest in a mutual fund or stock because the health care industry is growing, versus a fund or stock that focuses on technology, which the GDP might say is slowing down.
Investors can also compare country GDP growth rates to decide where the best opportunities are for foreign investment. Most investors like to purchase shares of companies that are in rapidly growing countries.
So that in a nutshell is GDP. By now you should be done with your coffee and perhaps know just a little bit more about the GDP.
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