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3 Tutorials that teach International Comparisons
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International Comparisons

International Comparisons

Author: Kate Eskra
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This lesson covers the International Comparisons
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Tutorial

INTERNATIONAL COMPARISONS

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Hi. Welcome to macroeconomics. This is Kate. This tutorial is on international comparisons. As always, my key terms are in red, and examples are in green. So in this tutorial we'll look at how both GDP and GNP can be used to measure economic growth in a country. We'll talk about why there can be differences between these two measures. And finally, you'll understand the shortcomings of just using GDP as a measure of quality of life.

OK. So we know that GDP growth from one period to the next is an indication of a healthy macro economy. But GDP and GNP can also be used to help us compare growth from one nation to another. And that's what this tutorial is about. So we're making international comparisons.

So the big idea here is that both GDP and GNP attempt to measure all economic activity of a country in a year. So why do we have two measures? Both of them do this by measuring the final value of all goods and services in an economy. So they're very similar in that fact. The only difference is how this part of that definition is defined.

So what do they mean by in an economy? All right. Well GDP, since it's gross domestic product, focuses on domestic production. So it's concerned with where that production is occurring, or the location of the production. So it's everything produced in a country's borders. It doesn't matter in these cases who is doing the producing, or who owns the capital producing it.

GNP is different. It focuses on production by nationals. So it is concerned with who is doing the production, or the producing. So this is everything produced by a nation's people. And it doesn't matter where the producing is occurring. So you can see that in an economy, just depends on whether it's concerned with who's doing the producing, or where the production is occurring.

OK. So a couple examples to illustrate this. So when Hershey, which is an American company, decides to produce their chocolate in factories located in Mexico that will count for actually Mexico's GDP, because it's occurring in Mexico. But it counts for our, United States GNP, because it's occurring by an American-owned company.

When Honda cars are manufactured in Ohio, now that counts for the United States GDP. Because the production is occurring here in one of our states. But it counts for Japan's GNP, because Honda is owned by Japan.

All right. So the difference between GDP and GNP is not really significant for countries who have both domestic production and foreign production by their companies, and who have other, or foreign, nations producing domestically to offset their own nation's production elsewhere. Those examples I gave you where in one case we had production occurring outside of our country, but in another case we had another country producing here. Those things, in a way, kind of offset. So in that case, the difference between GDP and GNP isn't really that significant.

But there are countries where it is a significant difference. So let's talk about when GDP will actually be much less than GNP. That's going to occur for countries who have a lot of production by their residents occurring in other nations. Like the example I gave you, like Hershey in Mexico, but they don't have other foreign nations producing domestically to offset that production elsewhere. So they don't have companies like Honda producing in our country, domestically. OK. So in that case, GDP actually may not be a very good indication of the actual health or strength of an economy.

Now the opposite can also occur, where GDP can actually be greater than GNP. So this would be for countries who have a lot of other nations producing domestically. And that's known as foreign direct investment. But then they don't have a lot of their own companies producing overseas. So in these cases, GDP actually can be kind of overstated. And a lot of the profits, in reality, are leaving the country. Because it's in the form of this foreign direct investment. And so in those cases GDP really might not be a great indicator of economic strength for those countries.

So despite some of these issues though, GDP is still really widely used today as a standard way of comparing economies internationally. And as we would expect, overall developed countries enjoy much greater GDP growth than developing or less developed countries. So in developed strong economies, we find that when there is a lot of foreign direct investment, a lot of foreign investment domestically, the domestic economy actually still tends to benefit, as citizens in those strong countries have the wealth and income to consume the goods and services being produced there. So it's a little bit different.

So although real GDP, like we said, is used to compare quality of life between countries or standard of living, is it really a perfect measure of all economic activity or how people live in a country? We're going to go through a couple of reasons why it's not necessarily a perfect measure.

First of all, it does not measure any nonmarket activities. And nonmarket activities are things we do for ourselves, like cleaning our own homes, or caring for children, changing the oil on our own car. There's no way to measure those kinds of activities. They're nonmarket.

It also, in my opinion and in a lot of people's opinion, does not really measure quality of life or well-being of a population. So for example, the economy might be growing according to GDP. But maybe it's growing because everyone is working a lot longer hours, and they're sacrificing leisure time. To me, that's not necessarily measuring quality of life. We might have more stuff. But are people really better off? It doesn't measure things like pollution that could be emitted from all this production, or crime, or anything like that.

Finally, it's really important to note that when we measure, when we look at it per person, that's called GDP per capita. And we need to understand that that's an average. So certainly we can say our standard of living thing has improved in our country, if our GDP per person or per capita has gone up from one year to the next. But that's an average. Does that mean that everyone is better off? It could just mean that income disparity is actually growing. Maybe all of the gains to our GDP per capita have really been realized by the most wealthy and not by the middle class or lower classes. So that's also something very important to keep in mind.

The bottom line though is although it's not perfect for comparing quality of life, it does indicate and provide a way to compare consumption across nations very well.

So in this tutorial we looked at how both GDP and GNP are used to measure economic growth in a nation. When we're comparing nations, there can be differences between these two measures. Because GDP focuses on where that production is occurring, it's domestic production. And GNP is concerned with production by a nation's residents. And then finally we discussed a few of the shortcomings of GDP as a measure of quality of life. Thanks so much for listening. Have a great day.