We know that GDP growth from one period to the next is an indication of a healthy macroeconomy. However, GDP and GNP can also be used to help us compare growth from one nation to another, making international comparisons.
Both GDP and GNP measure the final value of all goods and services in an economy, so in this respect, they are very similar. The only difference is how "in an economy" is defined.
GDP, since it is gross domestic product, focuses on domestic production. It is concerned with where that production is occurring, or the location of the production. GDP represents everything produced in a country's borders. It does not matter who is doing the producing, or who owns the capital producing it.
GNP, or gross national product, on the other hand, focuses on production by nationals. It is concerned with who is doing the producing. GNP represents everything produced by a nation's people, and it does not matter where the producing is occurring.
Therefore, you can see that the phrase "in an economy" depends on whether it is concerned with who is doing the producing, or where the producing is occurring.
EXAMPLEWhen Hershey, which is an American company, produces chocolate in factories located in Mexico, the value of this chocolate counts for Mexico GDP, because it is occurring in Mexico. However, it counts for United States GNP, because it is occurring by an American-owned company.
Notice in the previous examples, we had production occurring outside of our country offset by another country producing here, so the difference between GDP and GNP was not significant.
However, there are countries where there is a significant difference.
GDP will actually be less than GNP in countries who have a lot of production by their residents occurring in other nations. like Hershey in Mexico, but they do not have other foreign nations producing domestically to offset that production elsewhere (like Honda producing in Ohio, domestically).
In this case, GDP may not be a good indication of the actual health or strength of an economy.
Now, the opposite can also occur, where GDP can be greater than GNP.
This occurs in countries who have a lot of other nations producing domestically, known as foreign direct investment, but they do not have a lot of their own companies producing overseas.
In these cases, GDP may be overstated, as much of the profits are leaving the country in the form of foreign direct investment. Therefore, GDP is not a great indicator of economic strength.
Despite some of these issues, GDP is still widely used today as a standard way of comparing economies internationally.
As we would expect, developed countries enjoy much greater GDP growth than developing or less developed countries.
In developed, strong economies, we find that when there is a lot of foreign investment domestically, the domestic economy still tends to benefit, as citizens in those strong countries have the wealth and income to consume the goods and services being produced.
Although real GDP, as mentioned, 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?
No, not necessarily.
First of all, real GDP does not measure any non-market activities, referring to those activities that people do for themselves, such as:
There is no way to measure those kinds of activities; they are non-market.
In addition, GDP does not completely measure the quality of life or well-being of a population.
EXAMPLEFor example, the economy might be "growing" according to GDP, but perhaps it is because everyone is working much longer hours and sacrificing leisure time. This, then, is not necessarily measuring quality of life. We might have more stuff, but are people really better off? It also doesn't measure things like pollution emitted from all this production, or crime, etc.
Finally, it is important to note that when we measure GDP per person, called GDP per capita, we need to understand that it is an average.
So, if GDP per capita rises, we can certainly say that our standard of living has improved, but this is an average. Does it mean that everyone is better off?
It could simply mean that income disparity is growing. Perhaps all of the gains to our GDP per capita have actually been realized by the most wealthy, and not by the middle class or lower classes, which is very important to keep in mind.
Source: Adapted from Sophia instructor Kate Eskra.