What Is GDP? What is GNP? A Basic Guide to Understanding Economic Terms

Updated on January 25, 2018
Chris M Thompson profile image

Experience working in and with businesses from around the world, Japanese and international business major, and classical guitarist.

Measuring Our Economies

What is GDP or GNP? They both are an acronym for, "Gross Domestic Product," and, "Gross National Product." We often hear it mentioned in the news especially associated with times of economic growth or hardship, but many people often do not understand the meaning. In short, they are our current ways of measuring our economy's output. They are considered imperfect systems, (I will get to that after a more in-depth explanation), which are often critiqued by economists. Despite this, they are still regarded as useful tools of measurement.

Source

Nominal GDP

It's important to first note that there are two types of GDP: nominal and real. For the sake of simplicity, we will start with nominal GDP. Nominal GDP is the measurement of the amount of final goods produced and sold during the period of a year. This is usually evaluated at the market value it sold for in that year. A final good is a good that is sold to its final user. For example, if an apple is sold to a brewery to make apple cider, it is not considered a final good; however, when the apple cider is sold, it is added to the GDP, as it has now become a final good. Since the value of the apple is included in the apple cider, (or else the business would be losing money), if we counted it in the first transaction, it would be counted twice in the GDP!

Also note that GDP will include private consumption, government spending (except for welfare), gross investment, and exports minus imports. The mathematical formula is written like this: GDP=C+I+G+(X-M)

Real GDP

Real GDP is our nominal GDP but adjusted for inflation. Just because our nominal GDP goes up doesn't mean our production is going up. Instead, prices might be what is rising. In order to calculate real GDP, we must have a base year to set the standard. Basically, we take the quantity our final goods sold of our current year and multiply it by the prices of an earlier year. This will reflect how the GDP's quantity, the actual output, has changed over time.

Solving for Real GDP

First Year Qtty. and Price
Second Year Qtty. and Price
Second Year Final Goods Total
100 - 2$
110 - 600$
220$
50 - 1$
40 - 20$
40$
10 - 5$
5 - 100$
25$
In this example, to find the real GDP we are using the first year as the base year. Basically, we take the first year's prices and multiply them by the second year's quantities in order to find the second years real GDP final good totals. GDP = 285$

Problems Associated With GDP

GDP is known to have some inefficiencies that are often critiqued by economists. One major one being the fact that government spending towards things like helping people recover after a disaster is also included. It also fails to cover the value of leisure time, and only measures the health of the economy rather than people's actual well being. Just because production might be higher doesn't mean people are happier. Also, often times when GDP is used as a measurement on the news to compare political candidates, it can be skewed in the sense that they switch between nominal GDP and real GDP in order to switch the measurement in favor or in detriment to the political person/party being discussed. For measurement of well being, GDP again fails in the sense that it doesn't include underground production, because it can't. If it's not reported on tax, it's probably not reported in the GDP. This means that things like homemade baked goods, drug deals, and other non-taxed things are not included.

Basic Overview of GNP

GNP is short for Gross National Product. Yet again, it is another method of measuring a countries output of final goods. The difference is, it only counts productions/operations owned by the countries residents. For example, A General Motors plant in the US would count, but a Toyota plant would not since it is a Japanese company. However, a General Motors plant in Japan would be counted in the United States' GNP. When compared to GDP, it's basically the same thing only with foreign operations in domestic territory removed, but domestic operations in foreign territory included.

In Conclusion

Now, when you hear these terms again you will likely have a basic understanding of what they are talking about. There is obviously more to this subject, but this explanation is intended more for people who just want a basic understanding of what these terms mean. With this knowledge, you have a basic understanding of the way to determine economic health of different countries, or even your own.

GDP Video Explanation

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      mark 

      3 months ago

      thank you

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