Chapter 5 - Introduction to fundamental analysis
What Is Gross Domestic Product (GDP)?
Gross Domestic Product (GDP) is one of the most common indicators used to track the health of a country's economy. It includes a number of different factors such as consumption and investment. It is also a major factor in using Taylor's rule. In this short article, we look into the reason why Gross domestic product (GDP) is an important economic factor, and what it means for both economists and investors.
It represents the total Dollar for all goods and services produced during a specific time period, often indicated by the size of the economy. GDP is usually expressed compared to the previous quarter or year.
- The gross domestic product tracks the health of the country's economy.
- It represents the monetary value of all goods and services produced during a specific time period within the country borders.
- Economists can use GDP to determine whether an economy is growing or stagnating.
- Investors can use GDP to make investment decisions; A bad economy means lower profits and lower stock prices.
Gross Domestic Product (GDP) Definition
GDP is used primarily to measure the health of a country's economy. It is the monetary value of all the finished goods and services that are produced within the country borders in a specific time period and includes anything that produced by the country citizens and foreigners within its borders.
GDP is calculated by adding:
Personal and public consumption
- Public and private investment
- Government spending
- Exports - imports
This number is generally expressed as a percentage. In the United States, this number is calculated on a quarterly basis in the United States by the Office of Economic Analysis (OAE). While quarterly growth rates are a periodic measure of how the economy is performing, annual GDP figures are often considered a measure of the overall size of the economy.
Nominal Vs. Real Gross Domestic Product (GDP)
GDP can be expressed in two different ways, that are : nominal and real GDP. Nominal GDP takes into account current market prices without taking into account inflation or deflation. This figure looks at the natural movement of prices and tracks the gradual increase in the value of an economy over time.
This is in contrast to the real GDP that leads to the inflation factor or the overall rise in price levels. Economists generally prefer to use real GDP as a mean to compare a country's economic growth rate. It is calculated using the price deflator, which is the difference in prices between the current year and the base year, which is the reference year. Thus, economists can see if there has been any real growth from year to year.
Gross Domestic Product (GDP) Measurement
This can be complicated. However, in its simplest form, the calculation can be done in one of two ways: either by collecting what each person earns per year (income approach) or by adding what each person spends per year (expenditure method). Logically, both procedures should reach roughly the same sum.
The income approach, sometimes referred to as gross domestic product (I), is calculated by adding total remuneration to employees, total profits for listed and unregistered companies, and taxes minus any subsidies. Expenditure approach is the most common method and is calculated by adding total consumption, investment, government spending, and net exports.
GDP for Economists and Investors
As one might imagine, both economic production and growth “representing GDP” have a major impact on almost everyone in this economy. For example, when the economy is healthy, there is usually a decrease in unemployment rates and an increase in wages as companies are asked to work to meet the growing economy. Economists look into the positive GDP growth to determine the economy boom. Conversely, they can use negative GDP growth to determine if the economy is in recession.
The significant change in GDP, whether up or down, usually has a major impact on the stock market. It is not difficult to understand why; A bad economy usually means lower profits for companies. This is , in turn, translated into lower stock prices. Investors are often concerned with both positive and negative GDP growth when evaluating an investment idea or devising an investment strategy, but keep in mind, given that GDP is the measure of the economy in the previous quarter or year, it can help explain how it affects stocks and your investments. Therefore, it should not be used as a way to predict how the market will move.