GDP is the most important measure of economic activity, and it’s followed closely by investors, economists, policymakers, and the media. A big release of new GDP data can move markets, and changes in inflation-adjusted GDP over time are a key indicator of whether a country is growing or not.
It’s important to understand what GDP can and cannot tell us, though. For one thing, it doesn’t capture things that might be deemed important to a society’s well being, like environmental damage or the use of non-renewable resources. In addition, GDP is an estimate, and there are limitations to how it’s calculated.
The first step in calculating GDP is to collect information about all the goods and services produced in a country. This information is then compiled into a database. A country’s national statistical agency is typically responsible for collecting this information. The resulting data is then analyzed and published by the statistical agency.
When comparing GDP between two countries, the value of the output must be converted to the same currency. This can be done using market exchange rates (those that prevail in the foreign exchange market) or purchasing power parity (PPP) exchange rates.
The next step is to calculate the change in output over a given period, usually a year or quarter. This is called real GDP because it takes into account the pace of price inflation by adjusting the nominal GDP figure for price changes using a statistical tool.