GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.
The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people’s total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors (“producers,” colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers’ incomes.
Example: the expenditure method:
GDP = private consumption + gross investment + government spending + (exports − imports), or
Note: “Gross” means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. “Domestic” means that GDP measures production that takes place within the country’s borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).
Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending. Two advantages of dividing total consumption this way in theoretical macroeconomics are:
- Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption.
- If separated from endogenous private consumption, government consumption can be treated as exogenous, so that different government spending levels can be considered within a meaningful macroeconomic framework.
The production approach is also called as Net Product or Value added method. This method consists of three stages:
- Estimating the Gross Value of domestic Output in various economic activities;
- Determining the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services; and finally
- Deducting intermediate consumption from Gross Value to obtain the Net Value of Domestic Output.
Gross Value Added = Value of output – Value of Intermediate Consumption.
Value of Output = Value of the total sales of goods and services + Value of changes in the inventories.
The sum of Gross Value Added in various economic activities is known as GDP at factor cost.
GDP at factor cost plus indirect taxes less subsidies on products is GDP at Producer Price.
For measuring gross output of domestic product, economic activities (i.e. industries) are classified into various sectors. After classifying economic activities, the gross output of each sector is calculated by any of the following two methods:
- By multiplying the output of each sector by their respective market price and adding them together and
- By collecting data on gross sales and inventories from the records of companies and adding them together.
Subtracting each sector’s intermediate consumption from gross output, we get sectoral Gross Value Added (GVA) at factor cost. We, then add gross value of all sectors to get GDP at factor cost. Adding indirect tax less subsidies in GDP at factor cost, we get GDP at Producer Prices.
Another way of measuring GDP is to measure total income. If GDP is calculated this way it is sometimes called Gross Domestic Income (GDI), or GDP(I). GDI should provide the same amount as the expenditure method described above. (By definition, GDI = GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.)
This method measures GDP by adding incomes that firms pay households for the factors of production they hire- wages for labour, interest for capital, rent for land and profits for entrepreneurship.
The US “National Income and Expenditure Accounts” divide incomes into five categories:
- Wages, salaries, and supplementary labour income
- Corporate profits
- Interest and miscellaneous investment income
- Farmers’ income
- Income from non-farm unincorporated businesses
These five income components sum to net domestic income at factor cost.
Two adjustments must be made to get GDP:
- Indirect taxes minus subsidies are added to get from factor cost to market prices.
- Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product.
Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is:
GDP = compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production and imports
GDP = COE + GOS + GMI + TP & M – SP & M
- Compensation of employees (COE) measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.
- Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.
- Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.
The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor (basic) prices. The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I).
Total factor income is also sometimes expressed as:
Total factor income = Employee compensation + Corporate profits + Proprieter’s income + Rental income + Net interest
Yet another formula for GDP by the income method is:
GDP = R + I + P + SA + W
where R : rents
I : interests
P : profits
SA : statistical adjustments (corporate income taxes, dividends, undistributed corporate profits)
W : wages
Note the mnemonic, “ripsaw”.
In economics, most things produced are produced for sale, and sold. Therefore, measuring the total expenditure of money used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP. Note that if you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Sweater-knitting is a small part of the economy, but if one counts some major activities such as child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of production. Similarly, if there is a long term shift from non-market provision of services (for example cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then this trend toward increased market provision of services may mask a dramatic decrease in actual domestic production, resulting in overly optimistic and inflated reported GDP. This is particularly a problem for economies which have shifted from production economies to service economies.
Components of GDP by expenditure
Components of U.S. GDP
GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M).
Y = C + I + G + (X − M)
Here is a description of each GDP component:
- C (consumption) is normally the largest GDP component in the economy, consisting of private (household final consumption expenditure) in the economy. These personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses but does not include the purchase of new housing.
- I (investment) includes business investment in equipments for example and does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment. In contrast to its colloquial meaning, ‘Investment’ in GDP does not mean purchases of financial products. Buying financial products is classed as ‘saving’, as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or stocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products.
- G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.
- X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations’ consumption, therefore exports are added.
- M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
A fully equivalent definition is that GDP (Y) is the sum of final consumption expenditure (FCE), gross capital formation (GCF), and net exports (X – M).
Y = FCE + GCF+ (X − M)
FCE can then be further broken down by three sectors (households, governments and non-profit institutions serving households) and GCF by five sectors (non-financial corporations, financial corporations, households, governments and non-profit institutions serving households). The advantage of this second definition is that expenditure is systematically broken down, firstly, by type of final use (final consumption or capital formation) and, secondly, by sectors making the expenditure, whereas the first definition partly follows a mixed delimitation concept by type of final use and sector.
Note that C, G, and I are expenditures on final goods and services; expenditures on intermediate goods and services do not count. (Intermediate goods and services are those used by businesses to produce other goods and services within the accounting year.
According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, “In general, the source data for the expenditures components are considered more reliable than those for the income components [see income method, below].”
Examples of GDP component variables
C, I, G, and NX(net exports): If a person spends money to renovate a hotel to increase occupancy rates, the spending represents private investment, but if he buys shares in a consortium to execute the renovation, it is saving. The former is included when measuring GDP (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP.
If a hotel is a private home, spending for renovation would be measured as consumption, but if a government agency converts the hotel into an office for civil servants, the spending would be included in the public sector spending, or G.
If the renovation involves the purchase of a chandelier from abroad, that spending would be counted as C, G, or I (depending on whether a private individual, the government, or a business is doing the renovation), but then counted again as an import and subtracted from the GDP so that GDP counts only goods produced within the country.
If a domestic producer is paid to make the chandelier for a foreign hotel, the payment would not be counted as C, G, or I, but would be counted as an export.
GDP real growth rates for 2010
A “production boundary” that delimits what will be counted as GDP.
“One of the fundamental questions that must be addressed in preparing the national economic accounts is how to define the production boundary–that is, what parts of the myriad human activities are to be included in or excluded from the measure of the economic production.”
All output for market is at least in theory included within the boundary. Market output is defined as that which is sold for “economically significant” prices; economically significant prices are “prices which have a significant influence on the amounts producers are willing to supply and purchasers wish to buy.” An exception is that illegal goods and services are often excluded even if they are sold at economically significant prices (Australia and the United States exclude them).
This leaves non-market output. It is partly excluded and partly included. First, “natural processes without human involvement or direction” are excluded. Also, there must be a person or institution that owns or is entitled to compensation for the product. An example of what is included and excluded by these criteria is given by the United States’ national accounts agency: “the growth of trees in an uncultivated forest is not included in production, but the harvesting of the trees from that forest is included.”
Within the limits so far described, the boundary is further constricted by “functional considerations.” The Australian Bureau for Statistics explains this: “The national accounts are primarily constructed to assist governments and others to make market-based macroeconomic policy decisions, including analysis of markets and factors affecting market performance, such as inflation and unemployment.” Consequently, production that is, according to them, “relatively independent and isolated from markets,” or “difficult to value in an economically meaningful way” [i.e., difficult to put a price on] is excluded. Thus excluded are services provided by people to members of their own families free of charge, such as child rearing, meal preparation, cleaning, transportation, entertainment of family members, emotional support, care of the elderly. Most other production for own (or one’s family’s) use is also excluded, with two notable exceptions which are given in the list later in this section.
Nonmarket outputs that are included within the boundary are listed below. Since, by definition, they do not have a market price, the compilers of GDP must impute a value to them, usually either the cost of the goods and services used to produce them, or the value of a similar item that is sold on the market.
- Goods and services provided by governments and non-profit organisations free of charge or for economically insignificant prices are included. The value of these goods and services is estimated as equal to their cost of production. This ignores the consumer surplus generated by an efficient and effective government supplied infrastructure. For example, government-provided clean water confers substantial benefits above its cost. Ironically, lack of such infrastructure which would result in higher water prices (and probably higher hospital and medication expenditures) would be reflected as a higher GDP. This may also cause a bias that mistakenly favors inefficient privatizations since some of the consumer surplus from privatized entities’ sale of goods and services are indeed reflected in GDP. Goods and services produced for own-use by businesses are attempted to be included. An example of this kind of production would be a machine constructed by an engineering firm for use in its own plant.
- Renovations and upkeep by an individual to a home that she owns and occupies are included. The value of the upkeep is estimated as the rent that she could charge for the home if she did not occupy it herself. This is the largest item of production for own use by an individual (as opposed to a business) that the compilers include in GDP. If the measure uses historical or book prices for real estate, this will grossly underestimate the value of the rent in real estate markets which have experienced significant price increases (or economies with general inflation). Furthermore, depreciation schedules for houses often accelerate the accounted depreciation relative to actual depreciation (a well built house can be lived in for several hundred years – a very long time after it has been fully depreciated). In summary, this is likely to grossly underestimate the value of existing housing stock on consumers’ actual consumption or income.
- Agricultural production for consumption by oneself or one’s household is included.
- Services (such as chequeing-account maintenance and services to borrowers) provided by banks and other financial institutions without charge or for a fee that does not reflect their full value have a value imputed to them by the compilers and are included. The financial institutions provide these services by giving the customer a less advantageous interest rate than they would if the services were absent; the value imputed to these services by the compilers is the difference between the interest rate of the account with the services and the interest rate of a similar account that does not have the services. According to the United States Bureau for Economic Analysis, this is one of the largest imputed items in the GDP.
GDP vs GNP
GDP can be contrasted with gross national product (GNP) or gross national income (GNI). The difference is that GDP defines its scope according to location, while GNP defines its scope according to ownership. In a global context, world GDP and world GNP are therefore equivalent terms.
GDP is product produced within a country’s borders; GNP is product produced by enterprises owned by a country’s citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNP non-identical. Production within a country’s borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNP; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNP but not its GDP.
To take the United States as an example, the U.S.’s GNP is the value of output produced by American-owned firms, regardless of where the firms are located. Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.
Gross national income (GNI) equals GDP plus income receipts from the rest of the world minus income payments to the rest of the world.
In 1991, the United States switched from using GNP to using GDP as its primary measure of production. The relationship between United States GDP and GNP is shown in table 1.7.5 of the National Income and Product Accounts.
The international standard for measuring GDP is contained in the book System of National Accounts (1993), which was prepared by representatives of the International Monetary Fund, European Union, Organization for Economic Co-operation and Development, United Nations and World Bank. The publication is normally referred to as SNA93 to distinguish it from the previous edition published in 1968 (called SNA68) 
SNA93 provides a set of rules and procedures for the measurement of national accounts. The standards are designed to be flexible, to allow for differences in local statistical needs and conditions.
Within each country GDP is normally measured by a national government statistical agency, as private sector organizations normally do not have access to the information required (especially information on expenditure and production by governments).
Main article: National agencies responsible for GDP measurement
Net interest expense is a transfer payment in all sectors except the financial sector. Net interest expenses in the financial sector are seen as production and value added and are added to GDP.
Nominal GDP and Adjustments to GDP
The raw GDP figure as given by the equations above is called the Nominal, or Historical, or Current, GDP. When comparing GDP figures from one year to another, it is desirable to compensate for changes in the value of money – i.e., for the effects of inflation or deflation. To make it more meaningful for year-to-year comparisons, it may be multiplied by the ratio between the value of money in the year the GDP was measured and the value of money in some base year. For example, suppose a country’s GDP in 1990 was $100 million and its GDP in 2000 was $300 million; but suppose that inflation had halved the value of its currency over that period. To meaningfully compare its 2000 GDP to its 1990 GDP we could multiply the 2000 GDP by one-half, to make it relative to 1990 as a base year. The result would be that the 2000 GDP equals $300 million × one-half = $150 million, in 1990 monetary terms. We would see that the country’s GDP had, realistically, increased 50 percent over that period, not 200 percent, as it might appear from the raw GDP data. The GDP adjusted for changes in money-value in this way is called the Real, or Constant, GDP.
The factor used to convert GDP from current to constant values in this way is called the GDP deflator. Unlike the Consumer price index, which measures inflation or deflation in the price of household consumer goods, the GDP deflator measures changes in the prices of all domestically produced goods and services in an economy–including investment goods and government services, as well as household consumption goods.
Constant-GDP figures allow us to calculate a GDP growth rate, which tells us how much a country’s production has increased (or decreased, if the growth rate is negative) compared to the previous year.
Real GDP growth rate for year n = [(Real GDP in year n) − (Real GDP in year n − 1)] / (Real GDP in year n − 1)
Another thing that it may be desirable to compensate for is population growth. If a country’s GDP doubled over some period but its population tripled, the increase in GDP may not be deemed such a great accomplishment: the average person in the country is producing less than they were before. Per-capita GDP is the measure compensated for population growth.
GDP (PPP) share of world / per capita per nation 1980–2015, Source: International Monetary Fund (WEO April 2011)
The level of GDP in different countries may be compared by converting their value in national currency according to either the current currency exchange rate, or the purchase power parity exchange rate.
- Current currency exchange rate is the exchange rate in the international currency market.
- Purchasing power parity exchange rate is the exchange rate based on the purchasing power parity (PPP) of a currency relative to a selected standard (usually the United States dollar). This is a comparative (and theoretical) exchange rate, the only way to directly realize this rate is to sell an entire CPI basket in one country, convert the cash at the currency market rate & then rebuy that same basket of goods in the other country (with the converted cash). Going from country to country, the distribution of prices within the basket will vary; typically, non-tradable purchases will consume a greater proportion of the basket’s total cost in the higher GDP country, per the Balassa-Samuelson effect.
The ranking of countries may differ significantly based on which method is used.
- The current exchange rate method converts the value of goods and services using global currency exchange rates. The method can offer better indications of a country’s international purchasing power and relative economic strength. For instance, if 10% of GDP is being spent on buying hi-tech foreign arms, the number of weapons purchased is entirely governed by current exchange rates, since arms are a traded product bought on the international market. There is no meaningful ‘local’ price distinct from the international price for high technology goods.
- The purchasing power parity method accounts for the relative effective domestic purchasing power of the average producer or consumer within an economy. The method can provide a better indicator of the living standards of less developed countries, because it compensates for the weakness of local currencies in the international markets. For example, India ranks 11th by nominal GDP, but fourth by PPP. The PPP method of GDP conversion is more relevant to non-traded goods and services.
There is a clear pattern of the purchasing power parity method decreasing the disparity in GDP between high and low income (GDP) countries, as compared to the current exchange rate method. This finding is called the Penn effect.
For more information, see Measures of national income and output.
Per unit GDP
GDP is an aggregate figure which does not consider differing sizes of nations. Therefore, GDP can be stated as GDP per capita (per person) in which total GDP is divided by the resident population on a given date, GDP per citizen where total GDP is divided by the numbers of citizens residing in the country on a given date, and less commonly GDP per unit of a resource input, such as GDP per GJ of energy or Gross domestic product per barrel. GDP per citizen in the above case is pretty similar to GDP per capita in most nations, however, in nations with very high proportions of temporary foreign workers like in Persian Gulf nations, the two figures can be vastly different.
Standard of living and GDP
GDP per capita is not a measurement of the standard of living in an economy. However, it is often used as such an indicator, on the rationale that all citizens would benefit from their country’s increased economic production. Similarly, GDP per capita is not a measure of personal income. GDP may increase while real incomes for the majority decline. The major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely, and consistently. It is measured frequently in that most countries provide information on GDP on a quarterly basis, allowing trends to be seen quickly. It is measured widely in that some measure of GDP is available for almost every country in the world, allowing inter-country comparisons. It is measured consistently in that the technical definition of GDP is relatively consistent among countries.
The major disadvantage is that it is not a measure of standard of living. GDP is intended to be a measure of total national economic activity— a separate concept.
The argument for using GDP as a standard-of-living proxy is not that it is a good indicator of the absolute level of standard of living, but that living standards tend to move with per-capita GDP, so that changes in living standards are readily detected through changes in GDP.
Proponents of GDP as a metric of social well being argue that it is a value neutral measure and expresses what we can do, not what we should do. This is compatible with the fact that different people have different preferences and different opinions on what well-being is. Competing measures like GPI define well-being to mean things that the definers ideologically support. Therefore, they cannot function as the goals of a plural society. Moreover, they are more vulnerable to political manipulation
Gross National Product. GNP is the total value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-residents located in that country. Basically, GNP measures the value of goods and services that the country’s citizens produced regardless of their location. GNP is one measure of the economic condition of a country, under the assumption that a higher GNP leads to a higher quality of living, all other things being equal.
In order to count a good or service it is necessary to assign some value to it. The value that the measures of national income and output assign to a good or service is its market value – the price it fetches when bought or sold. The actual usefulness of a product (its use-value) is not measured – assuming the use-value to be any different from its market value.
Three strategies have been used to obtain the market values of all the goods and services produced: the product (or output) method, the expenditure method, and the income method. The product method looks at the economy on an industry-by-industry basis. The total output of the economy is the sum of the outputs of every industry. However, since an output of one industry may be used by another industry and become part of the output of that second industry, to avoid counting the item twice we use not the value output by each industry, but the value-added; that is, the difference between the value of what it puts out and what it takes in. The total value produced by the economy is the sum of the values-added by every industry.
The expenditure method is based on the idea that all products are bought by somebody or some organisation. Therefore we sum up the total amount of money people and organisations spend in buying things. This amount must equal the value of everything produced. Usually expenditures by private individuals, expenditures by businesses, and expenditures by government are calculated separately and then summed to give the total expenditure. Also, a correction term must be introduced to account for imports and exports outside the boundary.
The income method works by summing the incomes of all producers within the boundary. Since what they are paid is just the market value of their product, their total income must be the total value of the product. Wages, proprieter’s incomes, and corporate profits are the major subdivisions of income.
The output approach
The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces.
Because of the complication of the multiple stages in the production of a good or service, only the final value of a good or service is included in total output. This avoids an issue often called ‘double counting’, wherein the total value of a good is included several times in national output, by counting it repeatedly in several stages of production. In the example of meat production, the value of the good from the farm may be $10, then $30 from the butchers, and then $60 from the supermarket. The value that should be included in final national output should be $60, not the sum of all those numbers, $100. The values added at each stage of production over the previous stage are respectively $10, $20, and $30. Their sum gives an alternative way of calculating the value of final output.
The income approach
The income approach equates the total output of a nation to the total factor income received by residents of the nation. The main types of factor income are:
- Employee compensation (= wages + cost of fringe benefits, including unemployment, health, and retirement benefits);
- Interest received net of interest paid;
- Rental income (mainly for the use of real estate) net of expenses of landlords;
- Royalties paid for the use of intellectual property and extractable natural resources.
- The expenditure approach
The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output combines all the different areas in which money is spent within the region, and then combining them to find the total output.
GDP = C + I + G + (X – M)
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services
Note: (X – M) is often written as XN, which stands for “net exports”
The names of the measures consist of one of the words “Gross” or “Net”, followed by one of the words “National” or “Domestic”, followed by one of the words “Product”, “Income”, or “Expenditure”. All of these terms can be explained separately.
“Gross” means total product, regardless of the use to which it is subsequently put.
“Net” means “Gross” minus the amount that must be used to offset depreciation – ie., wear-and-tear or obsolescence of the nation’s fixed capital assets. “Net” gives an indication of how much product is actually available for consumption or new investment.
“Domestic” means the boundary is geographical: we are counting all goods and services produced within the country’s borders, regardless of by whom.
“National” means the boundary is defined by citizenship (nationality). We count all goods and services produced by the nationals of the country (or businesses owned by them) regardless of where that production physically takes place.
The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal, but the National figures of France.
“Product”, “Income”, and “Expenditure” refer to the three counting methodologies explained earlier: the product, income, and expenditure approaches. However the terms are used loosely.
“Product” is the general term, often used when any of the three approaches was actually used. Sometimes the word “Product” is used and then some additional symbol or phrase to indicate the methodology; so, for instance, we get “Gross Domestic Product by income”, “GDP (income)”, “GDP(I)”, and similar constructions.
“Income” specifically means that the income approach was used.
“Expenditure” specifically means that the expenditure approach was used.
Note that all three counting methods should in theory give the same final figure. However, in practice minor differences are obtained from the three methods for several reasons, including changes in inventory levels and errors in the statistics. One problem for instance is that goods in inventory have been produced (therefore included in Product), but not yet sold (therefore not yet included in Expenditure). Similar timing issues can also cause a slight discrepancy between the value of goods produced (Product) and the payments to the factors that produced the goods (Income), particularly if inputs are purchased on credit, and also because wages are collected often after a period of production.
GDP and GNP
Main articles: GDP and GNP
Gross domestic product (GDP) is defined as “the value of all final goods and services produced in a country in 1 year”.
Gross National Product (GNP) is defined as “the market value of all goods and services produced in one year by labour and property supplied by the residents of a country.”
As an example, the table below shows some GDP and GNP, and NNI data for the United States:
National income and output (Billions of dollars)
|Gross national product|
|Net U.S. income receipts from rest of the world|
|U.S. income receipts|
|U.S. income payments|
|Gross domestic product|
|Private consumption of fixed capital|
|Government consumption of fixed capital|
- NDP: Net domestic product is defined as “gross domestic product (GDP) minus depreciation of capital”, similar to NNP.
- GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income.
National income and welfare
GDP per capita (per person) is often used as a measure of a person’s welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy. However, there are serious limitations to the usefulness of GDP as a measure of welfare:
- Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny’s income contributes to GDP, but an unpaid parent’s time spent caring for children will not, even though they are both carrying out the same economic activity.
- GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time. Similarly, the impact of economic activity on the environment is not measured in calculating GDP.
- Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming.
- GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime. This leads to distortions – for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured.
- GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population. See Gini coefficient.
Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used.
Difficulties in Measurement of National Income
There are many difficulties when it comes to measuring national income, these can be broadly classified into:
Conceptual Difficulties are related to the concepts of national income:
– Inclusion of Services; there has been some debate about whether to include services in the counting of national income, and if it counts as output. Marxian economists are of the belief that services should be excluded from national income, most other economists though are in agreement that services should be included.
-Identifying Intermediate Goods; the basic concept of national income is to only include final goods, intermediate goods are never included, but in reality it is very hard to draw a clear cut line as to what intermediate goods are. Many goods can be justified as intermediate as well as final goods depending on their use.
-Identifying factor Incomes; separating factor incomes and non factor incomes is also a huge problem. Factor incomes are those paid in exchange for factor services like wages, rent, interest etc. Non factor are sale of shares selling old cars property etc, but these are made to look like factor incomes and hence are mistakenly included in national income.
-Services of Housewives and other similar services; national income includes those goods and services for which payment has been made, but there are scores of jobs, for which money as such is not paid, also there are jobs which people do themselves like maintain the gardens etc, so if they hired someone else to do this for them , then national income would increase, the argument then is why are these acts not accounted for now, but the bigger issue would be how to keep a track of these activities and include the in national income.
-Unreported Illegal Income; sometimes, people don’t provide all the right information about their incomes to evade taxes so this obviously causes disparities in the counting of national income.
-Non Monetized Sector; in many developing nations, there is this issue that goods and servicesare traded through barter, i.e. without any money. Such goods and services should be included in accounting of national income, but the absence of data makes this inclusion very difficult.