GNP: An Alternative Measure of Output

While GDP represents the most commonly used measure of an economy’s output, economists sometimes use an alternative measure. Gross national product (GNP) is the total value of final goods and services produced during a particular period with factors of production owned by the residents of a particular country.

The difference between GDP and GNP is a subtle one. The GDP of a country equals the value of final output produced within the borders of that country; the GNP of a country equals the value of final output produced using factors owned by residents of the country. Most production in a country employs factors of production owned by residents of that country, so the two measures overlap. Differences between the two measures emerge when production in one country employs factors of production owned by residents of other countries.

Suppose, for example, that a resident of Washington owns and operates a watch repair shop in Canada. The value of watch repair services produced at the shop would be counted as part of Canada’s GDP because they are produced in Canada. That value would not, however, be part of U.S. GDP. But, because the watch repair services were produced using capital and labor provided by a resident of the United States, they would be counted as part of GNP in the United States and not as part of GNP in Canada.

Because most production fits in both a country’s GDP as well as its GNP, there is seldom much difference between the two measures. The relationship between GDP and GNP is given by

GDP + net income received from abroad by residents of a nation = GNP

 

Key concepts

· GDP is the sum of final goods and services produced for consumption (C), private investment (I), government purchases (G), and net exports (X _n). Thus GDP = C + I + G + X _n.

· GDP plus net income received from other countries equals GNP. GNP is the measure of output typically used to compare incomes generated by different economies.

· GDP can be viewed in the context of the circular flow model. Consumption goods and services are produced in response to demands from households; investment goods are produced in response to demands for new capital by firms; government purchases include goods and services purchased by government agencies; and net exports equal exports less imports.

· Total output can be measured two ways: as the sum of the values of final goods and services produced and as the sum of values added at each stage of production.

 

Unit 2.2 Measuring Total Income

Learning objectives

1. Define gross domestic income and explain its relationship to gross domestic product.

2. Discuss the components of gross domestic income.

3. Define disposable personal income and explain how to calculate it from GDP

 

We saw in the last section that the production of goods and services generates factor incomes to households. The production of a given value of goods and services generates an equal value of total income. Gross domestic income (GDI) equals the total income generated in an economy by the production of final goods and services during a particular period. It is a flow variable. Because an economy’s total output equals the total income generated in producing that output, GDP = GDI. We can estimate GDP either by measuring total output or by measuring total income.

The Components of GDI

Employee compensation is the largest among the components of factor income. Factor income also includes profit, rent, and interest. In addition, GDI includes charges for depreciation and taxes associated with production. Depreciation and production-related taxes, such as sales taxes, make up part of the cost of producing goods and services and must be accounted for in estimating GDI. We will discuss each of these components of GDI next.

Employee Compensation

Compensation of employees in the form of wages, salaries, and benefits makes up the largest single component of income generated in the production of GDP. In the second quarter of 2008, employee compensation represented 57% of GDI.

The structure of employee compensation has changed dramatically in the last several decades. In 1950, virtually all employee compensation—95% of it—came in the form of wages and salaries. The remainder, about 5%, came in the form of additional benefits such as employer contributions to retirement programs and health insurance. In 2008, the share of benefits was roughly 19% of total employee compensation.

Profits

The profit component of income earned by households equals total revenues of firms less costs as measured by conventional accounting. Profits amounted to 15.6% of GDI, or $2,226.7 billion in 2008, down sharply from five decades earlier, when profits represented about 25% of the income generated in GDI.

Profits are the reward the owners of firms receive for being in business. The opportunity to earn profits is the driving force behind production in a market economy.

Rental Income

Rental income, such as the income earned by owners of rental housing or payments for the rent of natural resources, is the smallest component of GDI (less than 0.5%); it is the smallest of the income flows to households. The meaning of rent in the computation of GDI is the same as its meaning in conventional usage; it is a charge for the temporary use of some capital asset or natural resource.

Net Interest

Businesses both receive and pay interest. GDI includes net interest, which equals interest paid less interest received by domestic businesses, plus interest received from foreigners less interest paid to foreigners. Interest payments on mortgage and home improvement loans are counted as interest paid by business, because homeowners are treated as businesses in the income accounts. In 2008 net interest accounted for 6.3% of GDI.

Depreciation

Over time the machinery and buildings that are used to produce goods and services wear out or become obsolete. A farmer’s tractor, for example, wears out as it is used. A technological change may make some equipment obsolete. The introduction of personal computers, for example, made the electric typewriters used by many firms obsolete. Depreciation is a measure of the amount of capital that wears out or becomes obsolete during a period. Depreciation is referred to in official reports as the consumption of fixed capital.

Depreciation is a cost of production, so it represents part of the price charged for goods and services. It is therefore counted as part of the income generated in the production of those goods and services. Depreciation represented about 13% of GDI in 2008.

Indirect Taxes

The final component of the income measure of GDI is indirect business taxes.Indirect taxes are taxes imposed on the production or sale of goods and services or on other business activity. (By contrast, a direct tax is a tax imposed directly on income; the personal income and corporate income taxes are direct taxes.) Indirect taxes, which include sales and excise taxes and property taxes, make up part of the cost to firms of producing goods and services. Like depreciation, they are part of the price of those goods and services and are therefore treated as part of the income generated in their production.

Table GDP and GDI shows the components of GDI in 2008. Employee compensation represented the largest share of GDI. In principle, GDP and GDI should be equal, but their estimated values never are, because the data come from different sources. Output data from a sample of firms are used to estimate GDP, while income data from a sample of households are used to estimate GDI. The difference is the statistical discrepancy shown in the right-hand column of Table.

Table GDP and GDI, 2008

Gross domestic product	$14,420.5	Gross Domestic Income	$14,260.0
1. Personal Consumption Expenditures	10,169.5	1. Compensation of Employees	8,089.8
2. Gross Private Domestic Investment	2,013.6	2. Profits	2,226.7
3. Government consumption expenditures and gross investment	2,943.9	3. Rental income of persons	63.1
4. Net exports of goods and services	–706.5	4. Net interest	903.8
		5. Taxes on production and imports	1,076.9
		6. Consumption of fixed capital (depreciation)	1,899.7
		Statistical discrepancy	160.5

 

The table shows the composition of GDP and GDI in the third quarter of 2008 (in billions of dollars at an annual rate). Notice the rough equality of the two measures. They are not quite equal because of measurement errors; the difference is due to a statistical discrepancy and is reduced significantly over time as the data are revised.