Question

What is GNP? Explain the methods of calculating GDP.

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Answer 1

Gross national product (GNP) is an estimate of total value of all the final products and services turned out in a given period by the means of production owned by a country's residents. GNP is commonly calculated by taking the sum of personal consumption expenditures, private domestic investment, government expenditure, net exports and any income earned by residents from overseas investments, minus income earned within the domestic economy by foreign residents. Net exports represent the difference between what a country exports minus any imports of goods and services.

GNP is related to another important economic measure called gross domestic product (GDP), which takes into account all output produced within a country's borders regardless of who owns the means of production. GNP starts with GDP, adds residents' investment income from overseas investments, and subtracts foreign residents' investment income earned within a country.

Gross Domestic Product (GDP) can be measured by 3 methods :

1. Income Approach :

· The income approach starts with the income earned from the production of goods and services. Under income approach we calculate the income earned by all the factors of production in an economy.

· Factors of production are the inputs which goes into producing final product or service. Thus, the factors of production for a business are – Land, Labour, Capital and Management within the domestic boundaries of a country.

· In this approach, we calculate income from each of these Factor of production which includes the wages got by labour, the rent earned by land, the return on capital in the form of interest, as well as business profits earned by management. Sum of All these incomes constitutes national income and is a way to calculate GDP.

· Formula : Net National Income = Wages + Rent + Interest + Profits

· To make it gross, we need to do two adjustments – Add depreciation of capital & Add Net Foreign Factor Income. NFFI is (income earned by the rest of the world in the country – income earned by the country from the rest of the world)

· GDP (Factor Cost) = Wages + Rent + Interest + Profits+ Depreciation + Net Foreign Factor Income

· This basically is the sum of final income of all factors of production contributing to a business in a country before tax.

· Now if we add taxes and deduct subsidies, then it become GDP at Market cost.

· GDP (Market Cost) = GDP (Factor Cost)+ (Indirect Taxes – Subsidies)

Expenditure Approach :

· Second approach is converse of Income approach as rather than Income, it begins with money spent on goods & services. This measures the total expenditure incurred by all entities on goods and services within the domestic boundaries of a country.

· Mathematically, GDP (as per expenditure method) = C + I + G + (EX-IM)

Where,

1. C: Consumption Expenditure, ie when consumers spend money to buy various goods and services. For example – food, gas bill, car etc.

2. I: Investment Expenditure, ie. when businesses spend money as they invest in their business activities. For eaxmple, buying land, machinery etc.

3. G: Government Expenditure, ie. when government spends money on various development activities and

4. (EX-IM): Exports minus Imports, that is, Net Exports. ie. we include the exports to other countries in calculation of GDP and subtract the imports from other countries to our country.

· The calculation of GDP from the above methods gives us the nominal GDP of the country. We will consider the difference between the Nominal and Real GDP in the coming article.

· Mostly GDP is calculated with both approaches and calculations are done in such a way that the values from both approaches should come almost equivalent.

3. Output (Production) Approach :

· This measures the monetary or market value of all the goods and services produced within the borders of the country.

· In order to avoid a distorted measure of GDP due to price level changes, GDP at constant prices or Real GDP is computed.

· GDP (as per output method) = Real GDP (GDP at constant prices) – Taxes + Subsidies.