GDP (Gross Domestic Product) is usually touched upon by either sweaty, coked up so-called “analyst” on CNBC, or in economics classes by the professors. Either way, both situations make GDP seem intimidating, like women. But, like all intimidating things, you can make them less intimidating by understanding them (except in the case of women...they’re a mystery) So in this episode of Lofty Economics, I’m going to tear apart GDP, like I did to my Econ class, and try to get scared about something else, like Chinese Mexican restaurants.
For starters, what exactly is GDP? GDP stands for Gross Domestic Product. In basically, it’s how much an entity (usually a Country or industry sector) worth. This worth is the total value of the products or services provided by that entity. Usually it’s expressed as a year-to-year percentage change or by per-capita (per person involved in said entity).
So how does one actually measure GDP? Well there are mainly two methods; the income approach and the expenditure method. If using the income approach, one must add up the gross income (how much you made without considering your costs), compensation to employees, and taxes (including tax benefits). The expenditure method is combining the gross income, total expenses, and total investments. The expenditure method is more commonly used, when compared to the income method, mainly because it’s easier to obtain the information needed.
As stated above, GDP can be used to describe not only a country but also an industry. GDP can be helpful in determining the overall health of the entity it is describing. Any change in GDP affects the economy. And some changes could have multiple meanings. For example, a rapid rise/fall in GDP may seem healthy/unhealthy upfront, but it raises some concerns. What is causing this rapid rise/decline? Will this trend continue? What will counteract this trend? You see what I’m saying? The economy is like a spilled gasoline, and GDP is the match. The match could be lit, it could be dim, and it could be used. But, it doesn’t matter, throwing the match into the gas will get some reaction (the severity of the reactive depends on the state of the match).
So time for some real world examples. For a country, I’m going to use Armenia because…well why not. The GDP of Armenia (2013) is around 3,500 per capita (per-person officially accounted for Armenia). This is a 3.5% change from the GDP of 2012. Now let’s say that Armenia stumbled upon graphene deposits (rare form of carbon used for batteries). Armenia not only processed the graphene, but also created batteries using the material. They sold this new product to world at a very high price, but also invested heavily into the infrastructure needed for this industry. As a result, the GDP of Armenia increased around 3.4% in 2014. On the surface, it seems that Armenia’s growth is slowing, but if you look into the details the story changes. Armenia invested around $75 billion into the graphene industry. Once it was up and running, the Armenians began to churn some income, around $50 billion, from graphene that year. Armenia is still $25 billion in the hole, but makes that up with growth in other industries. Next year, will still be in need and Armenia will still be one of the main producers. That means that we should expect growth for next year if everything goes well. This is because the $25 billion will be covered and whatever is left over will go towards the net income.
Now let’s talk about GDP in terms of sectors. The GDP of the world is about $72 Trillion. Now since this is Lofty Economics, not 101, we’re going to use a sector that many don’t consider to be real. The illegal drug trade! The street pharmacy industry made about $600 billon in profits last year. If you do the math, it turns out that the illegal drug trade accounts for about 1% of the worlds GDP. For reference, agriculture accounts for about 6%, industry about 30%, and service 64%. Now 1% may not seem like a ton, but if you were to eliminate the drug industry completely, you would pull around $600 billion out of the world’s economy. Likewise, let us say that the drug industry increased to 2%. With the legalization of Marijuana people needed something illegal to tickle fancy, so they moved to other forms of mental recreation. That 2% would be worth about $1.2 trillion. That’s more than the GDP of Poland, Saudi Arabia, and the UAE combined. All from a 1% percent change.
So what am I trying to get at here? GDP, like interest, is very dependent on the percent. A 1%, 2% change is significant! It will affect the economy, and there are multiple circumstance surrounding that change.