Few numbers convey as much information about the economy as gross domestic product, or GDP. It’s used by a wide range of people, from investors to policymakers, and it can tell you a lot about how well a state or country is doing. But what exactly is GDP, and how does it work?
GDP is the monetary value of all the goods and services produced in a country in a given period. The Bureau of Economic Analysis calculates it using public data on construction, manufacturing, trade flows and inventory reports. It also uses econometric methods to forecast GDP and its subcomponents. The first release of GDP, called the advance estimate, has the largest impact on markets. The second and third releases are usually minor revisions to the initial report.
The components of GDP are consumption, investment and government spending. Consumption represents the purchase of final goods and services by households and businesses. It’s normally the largest component of GDP and when it increases, that’s seen as a sign of a healthy economy. Investment is the purchase of equipment and other assets by businesses. And government spending is salaries for public servants, military expenditures and other investment by the federal, state and local governments.
Real GDP is a measure that’s adjusted for inflation, so changes in price levels are factored out to make sure the growth we see actually reflects actual output. This is important for policymakers because it allows them to distinguish between inflation-fueled gains that don’t benefit the economy and genuine gains that do.
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