To establish an economic and financial profile, one has to learn basic economic terminologies well. GDP, being one the most essential terms frequently used in economic literature, needs a clear understanding. Many terminologies (Nominal GDP and GNP, GDP per capita) associated with GDP are used to assess a country’s economic health. People often confuse these terms because they lack clear understanding; although these terms are interrelated, they have different connotations and calculation methods.
1. What is GDP (Gross Domestic Product)?
Gross Domestic Product is the fundamental economic indicator of all the indicators to gauge the economic profile of a country. It includes the value of all the goods and services produced and consumed within a country in a specified period, usually one year. Every year, countries release reports on their economic performance, and the most important in those reports are GDP size and the growth in the GDP. For example, China has a GDP size of $17.78 trillion and a growth rate of 5.2% in 2023.
There are three methods used to calculate GDP.
a. Production Approach
This method calculates GDP by summing up all the produced goods and services in that year. All the expenses that occurred during the production phase are also added.
b. Expenditure Approach
GDP is calculated by summing all the expenditure on the final goods and services by residents of a country. This includes household consumption, business investment, government spending on goods and services, and net exports (exports – imports).
c. The Income Approach
Another way of calculating GDP is by using the income approach. This method adds all types of income by individuals, businesses, governments, or any other entity. This includes wages, salaries, profits, rents, and taxes, less any subsidies.
2. What is nominal GDP (Gross Domestic Product)?
There are many ways to estimate a country’s economic health, including inflation, unemployment, industrial production, etc, out of which nominal GDP is one of the common indicators to assess a country’s economic health. GDP stands for gross domestic product, defined as the total value of all goods and services produced within the boundary limits of a country in a specific period. If GDP is evaluated at current market prices, it is called nominal GDP.
There are two approaches to calculate nominal GDP: the expenditure approach and the income approach. The expenditure approach calculates GDP by adding up the total spending on goods and services in the economy. The other method used to calculate nominal GDP is by using the real GDP and GDP price deflator.
A. Through Expenditure Approach:
To calculate nominal GDP through the expenditure approach, we need to know some parameters like consumer spending (C), investment (I), government spending (G), and total net exports (X-M). Consumer spending (C) is the amount households spend on goods and services. Investment (I) refers to the amount businesses pay on goods such as machinery, buildings, and equipment. Government spending (G) refers to the government’s spending on goods and services such as defense, education, and healthcare. Finally, total net exports (X-M) is the difference between the net value of a country’s exports and imports.
To calculate nominal GDP using the expenditure approach, we add these four components: GDP = C + I + G + (X-M). After knowing the values of these figures, just put these values below the formula to get nominal GDP.
It’s important to note that changes can influence nominal GDP in the price level. If prices increase, nominal GDP will also increase, even if the number of goods and services produced remains the same. Therefore, it is essential to consider inflation when interpreting nominal GDP data.
B. The GDP deflator Approach:
It calculates Real GDP by adjusting the nominal GDP for inflation, which means that it considers the price changes over time. On the other hand, the GDP price deflator is a measure of inflation that reflects the average price change for all the goods and services produced in an economy.
Using this method, we must first calculate real GDP and GDP price deflator to calculate nominal GDP. Once we have these values, we can put them in the given formula to obtain the nominal GDP.
3. What is GNP (Gross National Product)?
Gross national product (GNP) is the total value of all goods and services produced in a specific period by a country’s residents across the globe. It measures the total monetary value of the country’s residents’ production (output). It means that any output produced by any foreigner within the country must not be counted in GNP; similarly, any output produced by a country resident outside the country’s border must be included in GNP.
Mathematically, it can be represented as;
GNP = GDP + Net output produced (income inflow) from residents outside the country (overseas) – Net output produced (income outflow) to foreign countries
Calculating GNP is vital because it helps understand an economy’s health and growth. It also helps make policies; governments and policymakers use this data to assess economic trends. Furthermore, GNP provides an in-depth view of market size, which helps investors and businesses make decisions.
4. What is GDP Per Capita?
GDP per capita means the GDP allocated to every citizen of a country. It is calculated by summing all the goods and services produced, including taxes, and dividing it by a country’s population in the middle of a fiscal year. GDP per capita is considered a more accurate scale to measure a country’s human development and well-being. For Instance, the GDP of Switzerland in 2023 is 870 billion USD, and the per capita GDP is 98,800 USD, whereas the GDP of India in 2023 is estimated to be 3,730 billion USD, and the per Capita GDP is 2,610 USD.
GDP per Capita = GDP/ Total population of the country
5. What is the Difference Between GDP and GNP?
a. Scope of Measurement:
GDP measures the total amount of output produced within the geographical boundary irrespective of the producer’s nationality. GNP measures the total economic output produced by a country’s residents, domestically and abroad.
b. Geographical Limitation:
GDP only considers output that takes place within a country’s borders and does not include the income of people living abroad. GNP consists of the income of people living in the country and working abroad.
c. Calculation Method:
GDP is calculated by summing up consumption, investment, government spending, and net exports (exports minus imports) within a country during a specified period. GNP includes GDP, adds net income earned from foreign investments, and subtracts net income earned by foreign residents domestically.
d. Ownership of Production:
GDP focuses on the production in a country, whether from domestic production or production from foreign sources. GNP represents the income of people living in the country, regardless of the area where the income is generated.
e. International Transactions:
GDP does not consider income from a country’s residents abroad. GNP accounts for income earned by residents, whether domestically or internationally.
f. Sensitivity to International Factors:
Compared to GDP, which primarily reflects domestic production, GNP is more sensitive to changes in a country’s international capital and foreign earnings.
Both GDP and GNP are used as indicators of economic performance. Still, GNP also includes the income of people living abroad, which can provide a more comprehensive view of the country’s financial affairs.
Bottom Line
GDP is the most common term used to indicate the health of a country’s or region’s economy. GDP and terms related to it are essential in economic literature. However, many people often confuse these terms and use them interchangeably. Still, there is a clear difference between GDP and GNP and other allied concepts as a concept and in the calculation method.
