One of the most important economic indicators that is used in fundamental analysis is the gross domestic product otherwise known as GDP.
This measure or indicator is used in so many different evaluations. From the evaluation of its impact on various financial markets, including the stock market, the foreign exchange market (Forex), or even the real estate market, all the way to being one of the most crucial indicators of how well an economy is doing and how powerful it actually is.
Given the breadth of importance of this indicator, we want to discuss the gross domestic product in this article, see what it really is, how it impacts different markets, what are the different types of GDP, and how it is calculated.
What Is the Basic Definition Gross Domestic Product?
First and foremost, let’s go through the most basic definition of GDP.
GDP or gross domestic product is the total value in terms of fiscal value of the totality of products and services generated in a given economy during a specific time window. This time window is usually taken to be an annual time frame.
In many ways, the average joe can compare the GDP of a country to the market cap of a company – i.e. total liquidized assets and value of a company. But that is both right and wrong.
It can be right because it is indeed a good analogy. But it can also be wrong, because there is just so much more to the gross domestic product.
As was mentioned above, the most important use of the GDP is to function as an indicator for the health and strength of any economy. So economies release data relating to gross domestic product periodically. As mentioned, this period is usually annual, but it can also be quarterly.
For instance, the reports and data related to the GDP of the United States are published on a yearly basis and they are also published for each quarter.
So to recap, gross domestic product provides an all-in-one report that can measure the well-being of an economy because it is the aggregation of the monetary value of the entire products and services generated in that economy.
But this was only a basic definition of GDP. Let’s dive deeper.
A Closer Look at the Details of Gross Domestic Product
In this section, we should first refer to just how broad gross domestic product is.
What does GDP entail?
In actuality, GDP involves all the products and services generated both by public and private sectors in an economy, and all that is consumed through all these sectors. GDP also entails all the exports and deducts from that figure all the imports.
In the following sections, we will analyze how GDP is really calculated. But even with this simple glance, you can see how broad GDP actually is.
But given all the factors that are involved in the calculation and evaluation of gross domestic product, not all of them carry the same weight.
Trade deficit is the most important factor in measuring an economy’s GDP.
This means, in a quite straightforward manner, when the value of all the goods and services that are produced in an economy and then exported to a foreign economy outweigh the goods and services produced in a foreign economy and then imported, then the GDP of the first country would increase – and of course vice versa.
So when we talk about the total consumption through all the public and private sectors, the consumption of imported goods and services can really put a serious dent in the GDP of any economy.
But if GDP is a mere number, it can even be misleading, don’t you think?
If a country’s GDP was $3 trillion in 2018 and $5 trillion in 2023, does it mean the country’s economy has outperformed itself by $2 trillion?
The answer to that question is both yes and no.
To find the real answer, we need to discuss the different types of gross domestic product first.
Different Types of Gross Domestic Product
Various factors can be involved in the calculation of GDP. When we look at it from different perspectives and take into account different factors, we get to different types of GDP.
Nominal Gross Domestic Product
Nominal GDP is the simplest form of the Gross Domestic Product, where it is calculated based on the country’s currency and takes into account the total value of all the products and services generated in that economy at their currency cost and value. This means it doesn’t take into consideration factors such as inflation.
Real Gross Domestic Product
Real GDP is exactly like nominal GDP but with an added feature. Real Gross Domestic Product takes into account an important factor, i.e. inflation.
It is nominal GDP but adjusted in accordance with the rate of inflation. This is why an economy’s nominal GDP could rise through the years, but it would not actually make up for growth in that economy. Because looking at it through an inflation adjusted rate, it might turn out that there has been indeed a decrease and not an increase.
Gross Domestic Product Per Capita
GDP per capita is the amount of Gross Domestic Product per each person living in that economy. GDP per capita can be put forth in terms of nominal or even the inflation adjusted version which is the real GDP.
So in the calculation of GDP per capita, we can take any of those amounts and then divide it by the number of people in that country. Then what we get is GDP per capita.
This figure is used to provide a measurement with regard to standard of living above all.
Gross Domestic Product Growth Rate
This form of GDP is merely a type of comparative Gross Domestic Product that is used to compare the GDP of an economy based on a repeated recurrence.
So, for instance, there could be a comparison based on quarterly or annually Gross Domestic Product rates. Then these comparisons are used to measure how much growth there has been in that economy. The growth rate of GDP is calculated in terms of percentages.
Gross Domestic Product Purchasing Power Parity
Product Purchasing Power Parity (PPP) is yet another comparative form of the GDP. But this comparison is not carried out inside the economy. However, PPP takes the GDP of economies and calculates the difference among the various currencies in order to bring it up to an international and globalized dollar. This way the GDP of different economies and countries can be compared with one another.
Gross domestic product is the most important measure of the strength and health of any economy. GDP can be calculated and then reported in many different forms, including nominal, real, per capita, etc. each of which has its own applications.
The rates for gross domestic product are released by all countries around the world on an annual or even quarterly basis. They are also hugely impactful on various financial markets, including the forex market. So, for instance, the GDP announced by the United States can be very effective in how prices move in the foreign exchange market. This is why traders always keep a look out for the release of such information.