The Gross Domestic Product, or GDP, is the total market value of all goods and services produced in a country within a year, including production of any foreign-owned companies operating inside that country. So, what they do is they take all the goods, all the services, and everything the country produces in a year, add up the value of all that and come up with one big number and that is the GDP.
Here in the United States, the GDP is recorded by the United States Department of Commerce, and it’s reported every three months.
Looking at a pie chart, you can see the GDP broken down.
Here in the United States we have the largest GDP in the world by far. In fact, we are about three times as big as Japan and four to five times as big as Germany, the third largest.
When there is an increase in the GDP, it means that people are spending more. This means companies must produce more, causing an increase in the workforce and a decrease in unemployment.
When the GDP decreases, people are spending less. This means companies must produce less, causing a decrease in the workforce and an increase in unemployment.
In fact, the definition of a recession is two back-to-back quarters of declining or contracting Gross Domestic Product.
GDP figures can be used to determine the health of the economy. When adjusted for inflation, the annual growth of the GDP can be used to indicate whether the economy is growing too slow, too fast, or at the correct level.
The GDP rate of growth is one of the factors used to determine what type of economic policies are needed, including changes in interest rates and government spending.
If the GDP is growing too slow or contracting, economists worrying about unemployment will recommend policies that will help increase growth, such as cutting interest rates or increasing spending.
If the GDP is growing too fast, economists worrying about inflation will recommend policies that will reduce growth, such as raising interest rates or reducing spending.
In addition, the GDP growth rate is often used to make comparisons between countries that have similar economies.
For the most part, the GDP includes three components to total spending: consumer spending, investment spending, and government spending.
Consumer spending, also called consumption, is the largest of the three components, accounting for roughly two-thirds of the Gross Domestic Product.
The most important gauge for consumer spending is income levels. If the GDP is rising, companies will produce more, meaning they will hire more, increasing total income, which will lead to more spending.
If the GDP is declining, companies will produce less, causing them to reduce the number of employees they have, reducing total income, which will lead to less spending.
After consumer spending, probably the next important part of GDP is investment spending. In this case, investment spending doesn’t refer to things like stocks and stuff like that. It refers to companies spending money to grow and expand by adding things like new equipment, new factories, new buildings.
When a company expands by adding new buildings or equipment, it adds to the production capability.
One interesting thing to point out is that, if you look at the graph, that residential investments, by people inside the U.S., is not as large as non-residential investments. In fact, if you look at the graph it’s about a 2-to-1 ratio.
The third component of the GDP is government spending. Approximately 20% of the U.S. Gross Domestic Product is government spending. That’s a huge number.
Since such a large percentage of GDP is government spending, government can increase or decrease the GDP by changing the amount of money it spends.
If the government feels inflation is a concern, it can reduce the Gross Domestic Product by reducing its own spending. If the government feels unemployment is a concern, it can increase GDP by increasing spending.
When the total level of spending is equal to the Gross Domestic Product, an equilibrium is hit. In other words, the total production of goods and services is equal to the total spending for goods and services.
Once the equilibrium level is hit, the GDP remains until the level of total spending changes.
Obtaining an equilibrium level of GDP is not always optimum. Rather, it is only desirable to have equilibrium GDP when the economy reaches full employment with minimal inflation.