What is GDP and why is it such an important number?

What is GDP?

Gross domestic product (GDP) is used to estimate the size of the US economy. It is calculated as the value of all goods and services produced in the US. In 2019, GDP was $21.4 trillion.

GDP measures the amount of value added in the production process. There are two ways of measuring the production of a given product. We can look at the value at final sale or we can look at how much value was added at each stage of production. Imagine the production of a loaf of bread. A farmer produces the wheat and sells it to a bakery. The bakery takes the wheat and produces a loaf of bread that it sells to a grocery store. The grocery store then sells it to the final consumer. The loaf of bread may sell for $3 to the final consumer (and be counted as $3 in GDP), but the $3 can also be broken down at each of the production process. The $3 equals the total of the amount of value that was added at each stage of production.

What is the history of measuring GDP?

The measure was created in 1934 for a report to Congress by an economist at the National Bureau of Economic Research (NBER). It was then adopted internationally as the standard for measuring economies in the years during and following World War II.

Most governments track and publish GDP data through a national statistical agency. In the US, GDP is calculated by the Bureau of Economic Analysis, using data collected by various governmental and private sources, including the Census Bureau, Internal Revenue Service, Federal Reserve, and Bureau of Labor Statistics, among others.

While GDP estimates vary from various international agencies such as the International Monetary Fund, the World Bank, and the United Nations, the United States is generally regarded as having the largest GDP of any country in the world.

It’s not just the size of GDP that matters. Most economists are interested in the rate of growth. GDP growth tends to signal a positive economic outlook, while slowing growth may mean a recession is coming. Professionals are also interested in the changing mix of industries; for example, the decline in manufacturing’s contribution to GDP signals significant shifts in the US economy.

Why does the US government track GDP?

Tracking GDP allows policy makers, journalists, and researchers to understand how quickly the economy is growing or shrinking. It is used across government entities for planning purposes, including preparing federal budgets, setting monetary policy, and guiding economic research. For example, the White House uses GDP growth to generate tax revenue projections, which are then used to craft budget proposals.

In the private sector, GDP is a key measure used by a variety of professionals, including financial experts to make investments and CEOs to guide their long-term strategic planning.

While GDP is a commonly accepted measure of economic health, academics and researchers debate the specifics of the calculation and the resulting economic value that is or isn’t captured.

How do we know when a recession occurs?

The textbook definition of a recession is when GDP shrinks for two consecutive quarters. However, recessions are officially declared by NBER, the same agency that developed the calculation for GDP. NBER uses more measures than just GDP to determine the start and end dates for recessions and expansions.

The US has experienced eleven recessions since 1947.

What drives GDP growth?

Four components contribute to GDP. Consumer spending on goods (products like laptops and vegetables) and services (such as plumbers and hairdressers), business investments (such as a farmer buying a tractor), government spending (on things like infrastructure or the military), and trade (net exports).

The largest component is consumer spending on both goods and services (68% of GDP), followed by investments (17%) and government spending (17%). Currently, trade does not contribute to GDP; imports are larger than exports, resulting in -3% impact on GDP.

Which industries contribute the most to US GDP?

Three industries contributed 45% of GDP in 2018: finance, insurance, and real estate; professional and business services, and manufacturing.

The market value of goods and services is based on economic activity within the US. If components of a product are produced in another country and then imported to the US for final assembly, GDP only captures the value once it enters the US.

To avoid double-counting on products made within the US, GDP is calculated based on the final sale of goods and services, excluding the input of parts and labor. For example, while the sale of a table would be counted, the value of the labor to cut down a tree and the cost of the wood to produce the table would not.

Conclusion

GDP is one of the most cited measures of the economy. Tracked by policy makers, business professionals, and economists, GDP growth is a helpful tool to evaluate the health of the economy. For more economic indicators, check out USAFacts data on interest rates, median annual wages, and inflation.

Learn more from USAFacts and get the data directly in your inbox by signing up for our newsletter.