Whether you’re an investor, business leader or policymaker, few numbers are as important to understand as gross domestic product (or GDP), the broadest measure of a nation’s economic output. A quick glance at this figure can give you a sense of an economy’s size and, when compared to past data, indicate whether it’s growing or shrinking.
To determine GDP, a country’s economy is broken down into three components: consumption, investment and exports minus imports. Consumption includes all purchases made by citizens, including items like retail goods and rent, and is usually the largest component of GDP. Investment, meanwhile, is comprised of money spent on building new establishments or purchasing equipment that will provide future benefits, such as a new factory or office building. Finally, exports minus imports tells you what the net value of the nation’s goods and services is.
Because countries use different currencies, comparing GDPs across nations requires conversion. There are two main ways to do this: using market exchange rates and purchasing power parity, or PPP, equivalent exchange rates. The latter are based on the number of units of one country’s currency that would need to be traded for a single unit of another country’s currency.
Many things can impact a country’s GDP, from government spending on war to the destruction of natural resources. But there are also growing concerns that GDP doesn’t necessarily reflect a nation’s overall well-being, as it emphasizes material production without taking into account the social costs of that production.