Let’s take a deep dive into GDP.
GDP = Gross Domestic Product
It’s a monetary (or market) value that is compromised of the goods and services produced within a country’s borders. It’s a mechanism used to assess the health of a nation’s economy and to identify if a country’s economy is growing, or shrinking. In Australia, we calculate GDP on a quarterly basis.
The calculation includes both public and private consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade.
What is the balance of trade, you ask? (Well, we can’t hear you, but we assume that’s what you’re asking)
It’s the difference between the value of a country’s exports and the value of a country’s imports. It’s a separate formula that is used to measure the general strength of the economy.
- A positive balance occurs when exports are higher than imports (trade surplus)
- A negative trade balance occurs when exports are lower than imports (trade deficit).
But don’t let certain words fool you, a positive balance doesn’t always = a healthy economy. It can be more complex than that, but this is a general rule of thumb.
Here’s where it gets a little confusing, there are different types of GDP.
Real GDP: The calculation of GDP using the previous year’s prices as a base and typically used for tracking economic growth. It’s adjusted for inflation and considered the most accurate portrayal of a country’s economy and economic growth rate.
Actual GDP: A measure of the value of economic activities at a specific time and interval, and typically used to calculate the current GDP.
Nominal GDP: A measure of the value of all final goods and services produced within a country’s borders at current market prices.
Potential GDP: A calculation of the best possible scenario for the economy, and how the economy would look if employment across all sectors was at 100%, with stable production prices, and a stable currency.
Why is this even important?
Because it gives us an understanding of how each country’s economy is performing, as well as a representation of economic production and growth. Real GDP is often used as the measure of the general health of the economy.
If the GDP rate is positive and continuing to grow, that is the sign of a healthy economy. However if that growth is exponential and quick, this could be an indicator to economists that the country could run the risk of inflation. By knowing this information, governments can make policy decisions to try to slow down the economy.
On the other side, if the GDP growth rate is negative (opposite to what we said above), this signals a recession (like what Australia experienced in 2020 due to the pandemic). With this signal we get from GDP, governments are then able to make decisions to encourage economic activity (like lowering interest rates).