Gross Domestic Product (GDP) is an important measure of the economic health of a country. It represents the total value of goods and services produced within a country's borders during a specific time period.
GDP is most often used for discussing individual countries, but may also be calculated for regions (eg, southeast Asia), trading blocs (eg, the European Union), or areas within a country.
GDP is used to gauge the size and growth of a country's economy, as well as its overall health. It is an essential tool for policymakers, investors, and businesses to understand the economic landscape and make informed decisions. A GDP growth indicates a strong economy, while falling GDP can signal a recession or economic downturn.
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Therefore, it is crucial to monitor GDP to ensure the stability and growth of a country's economy.
How is GDP calculated?
GDP is calculated in three ways. The production or output approach is the sum of all the value added through producing goods and providing services (ie, the market value of what’s produced minus the costs of producing it). The income approach is the sum of all the income earned by companies and individuals from offering the same goods and services. The expenditure approach is the sum of everything spent on finished goods and services. In theory, all three should produce exactly the same result, but the difficulties of collecting data means that they may not.
Expenditure is normally the most useful way to analyse what makes up GDP. The equation is GDP (represented by a Y) = consumption (C) + investment (I) + government spending (G) + exports (X) – imports (M). As the last two terms make clear, GDP is based only on what’s produced within the borders of a country. If you’re looking at how much is produced by businesses owned by residents of the country – whether production takes place at home or elsewhere in the world – the equivalent statistic is gross national product (GNP) or gross national income (GNI).
Larger countries can have a bigger GDP than smaller ones and still be poorer in terms of living standards, so we often look at GDP per capita (GDP divided by population). In addition, comparing GDP calculated at market exchange rates – known as nominal GDP – may not reflect differences in the cost of goods and services between countries. So we also look at GDP per capita at purchasing power parity (PPP), which adjusts the exchange rate to account for differences in living costs.
See Tim Bennett's video tutorial: What is GDP?
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He has achieved the CFA UK Certificate in Investment Management, Chartered Institute for Securities & Investment Investment Advice Diploma and Chartered Institute for Securities & Investment Private Client Investment Advice & Management (PCIAM) qualification.
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