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What is GDP and what happens when it drops?

What is GDP and what happens when it drops?
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The news is always going on about GDP and the economy. It also frequently reviews the impacts of a fast, slow and negative economy. There is an important reason why. A drop in GDP could affect your job, and it is important to understand how. But what is GDP?

Let’s take a closer look at what it is and how it affects you as a business owner, a citizen and an investor.

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What is GDP?

GDP stands for gross domestic product. It is one of the most significant ways of indicating how well or poorly an economy is performing.

It is a measure of the health or size of a country’s economy over time, usually one quarter (three months) at a time. Gross domestic product is also measured monthly or yearly, but the most widely watched is the quarterly figure.

How is GDP calculated?

The Office for National Statistics (ONS) is responsible for calculating GDP in the UK. It collects data from thousands of companies to determine three things:

  • Production/output – the total value of commodities and services produced by all sectors of the economy.
  • Expenditure – the total amount spent by households and the government when purchasing the commodities and services mentioned above.
  • Income – the total value of the income generated in wages and profits.

How is GDP interpreted?

Once the Office for National Statistics calculates the GDP value of a particular quarter, it compares it to the previous quarter to see whether there is an increase or a drop.

Economists, businesses, investors and politicians like to see a GDP value that is increasing steadily. This signifies that the economy is doing well – jobs are being created and employees are getting good pay.

A drop in GDP means that the economy is shrinking (negative economy or growth) – this is considered bad news for employees, businesses and investors. A progressive decline in GDP over two or more quarters in a row may indicate a recession. In such a situation, people could lose their jobs and there could be pay freezes.

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How GDP affects an average citizen

Following the news on GDP is in your best interest. When the economy is healthy, meaning the GDP is rising steadily, employment rates and wages increase. This is an excellent place to be because there is some level of certainty that your job is secure.

However, if GDP increases too quickly, the Bank of England (BoE) may step in and raise interest rates to stem inflation. Taking out a bank loan to buy a house or car could then become too expensive. Businesses would also find it too costly to hire or borrow for expansion.

How GDP affects investors

The GDP report highlights how different sectors of the economy are performing, helping investors identify growing and declining sectors. A prudent investor can purchase a growing industry’s stock while avoiding sectors that the GDP may indicate are slowing.

A negative economy lowers profits for companies and, in turn, stock prices fall. As an investor, you might need to determine whether this is the best time to buy a particular stock and hold it for the long term.

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