Gross Domestic Product and Gross National Product
Episode #4 of the course Introduction to macroeconomics by Doha Soliman, CFA
Good morning! Today, we’ll be discussing a concept we briefly introduced yesterday: the GDP. In particular, we’ll cover how it is calculated and the components it contains. The reason this technicality is of importance lies in what the GDP omits and why it is sometimes argued as an inadequate measure of an economy’s growth.
But let’s get back to the basics. The Gross Domestic Product (GDP) is a monetary measurement of the output of a region for a given period of time, usually expressed in domestic currency for a given quarter. The exact formula for the GDP is:
Y= C + I + G + (X – M)
Y = total output
C = consumption of the economy
I = investments
G = government spending
X = exports
M = imports
This equation summed up tries to explain all the money within an economy. Let’s simplify. As a consumer, all the money you earn, you either spend or save (C + I). The government also raises money and spends it on its economy (G). Now add all the goods we produce that get exported to other nations (X), and subtract all the goods we did not produce but imported from abroad (M). This sums up our entire output as a nation.
Shortcomings of the GDP
The problem with the GDP that many have brought forth is that it does not account for several large components of an economy that are difficult to quantify: black markets, illegal transactions, resale of products (e.g. a used car), and any products or services that do not have a monetary value, such as volunteer work.
Another problem the GDP ignores is the reason for the consumption, whether personal or governmental. For instance, if there is an epidemic or a natural catastrophe in a region, government spending, as well as personal spending, may increase. This would raise the GDP of the economy in question. While such disastrous events would not result in a prospering economy, the GDP would not distinguish the difference and would reflect an increase in GDP.
While the GDP as a measure of prosperity may be deemed simplistic, it is nonetheless the most ideal measure we currently have for measuring a country’s growth and output.
Gross National Product
Another measure of economic output sometimes used is the Gross National Product (GNP). It is a very similar measurement to the GDP, but the main difference is that the GNP accounts for all production supplied by the citizens of one country or region, whereas the GDP is based on the geographical region and is not concerned with the ownership or production means.
For instance, hypothetically, you are an American citizen, and you operate a business within the USA, as well as in Canada. The US GDP would only account for the production of your USA entreprise, whereas the GNP will reflect both your American and Canadian production in the calculation of its GNP. This would represent a more factual measurement, since you may have to pay taxes on your income earned in other countries, depending on your country’s tax laws.
Comparability of Growth Figures
When reading business news or listening to government officials, you may have noticed they don’t usually discuss the GDP or GNP, but rather GDP per capita and similarly, the GNP per capita. The reason for this added term is that the GDP/GNP of a nation with 300 million residents will differ greatly from that of a nation with a population of five million. Hence, dividing the measurement of choice by capita results in a comparable figure. The term per capita simply means dividing the figure by the number of people within a region.
As we wrap up our discussion of GDP and regional output, tomorrow, we’ll start looking at the concept of inflation and the role central banks play in the money supply.
Recommended book
GDP: A Brief but Affectionate History by Diane Coyle
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