Analysis of Economy: Output of Goods and Services (GNP), and GDP on Economic success
Every nation must account for its economy over a specified period of time. This is vital in planning for and allocating funds to different ministries for the period. The existing government uses the Gross Domestic Product (GDP) and Gross National Product (GNP). GDP can be defined as the value of finished internal goods and services for a nation over a specific time length. It is related, but with a different metric to the GNP; the value of all finished products (goods and service) whose ownership belong to the residents of a country within a specified period.
GDP and GNP are the most common metrics used to measure a country’s economy. It takes into account private and public businesses within and without the country. They both represent the market value of all goods and services produces over the period. The country must look into these two metrics. And even though both are used, there are differences between how each defines the scope of the economy. Besides, interpretation of GDP and GNP brings varying understandings among parties. The differences comes in terms of geographical restrictions, where GDP limits the interpretation of a country’s economy to the borders of the country. GNP, on the other hand, extends to include economy from overseas from activities owned by its citizens.
- A country must account for its economy over a given period of time. GDP and GNP are both vital measures used in understanding the nation’s aggregate output economically.
- GPD focuses on the value of products produced in confinement to the country’s borders, from both citizens and non-citizens.
- GNP combines a country’s products from both citizens within its borders and those operating from overseas. It seeks to understand the overall performance of any business related to the country.
- Many countries apply the use of GDP in calculating their gross economy. For instance, the USA dropped using GNP in 1991 and focused on GDP to make a more stable compared with other economies of the world.
Understanding Gross Domestic Products
As stated above, many economies apply GDP in calculating their health and strength. It involves thorough scrutiny of the overall market value of the goods and services from domestic sources within a country. It is a critical parameter because it tells whether the economy is growing, stagnant, or contraction.
The GDP Formula
There are four critical components involved in the calculation of GDP. They include Consumption (C), Investment, (I), and Net Exports (N.P.), which are imports without the inclusion of exports. Taking this account, the formula for calculating GDP (Y) is Y= C + G + N.X. Let’s take the example of the U.S. in 2019. The country recorded a GDP of 70% personal consumption, 18% business investment, 17% government spending, and -5% net exports.
We can, therefore, divide GDP into four general categories for easy understanding.
1. Personal consumption
A country’s citizens can spend to buy and use goods and services. In all states, it amounts to the largest GDP. As seen above, consumer spending in the USA in 2019 was 70%, close to the total production of the country, in which case it was $13.28 trillion. To understand GDP from all these perspectives, it is vital to use real value, which is rounded up to the nearest Billion. Personal consumption expenditures are further sub-divided into goods and services.
These are simply tangible objects that can be bought and used physically. Products form the most significant part of the personal consumption needs of a country. And they come in two forms:
- Durable goods. As the name suggests, these are goods that stay and can be used for a long time without the need to replace them. For instance, furniture, autos, electronics, mattress, and similar goods can offer a useful life of three years and above.
- Non-durable goods. Also known as perishables, these are goods that cannot be used for a long time. They include fuel and clothing. These goods are needed on a day to day basis, and more are produced to cater to the increasing demand.
In the case of goods, the retailing industry stands as one of the most important components of the economy. This is because it delivers the products directly to the consumer. One can easily say retailers are the most important link between producers and consumers. And they deal directly with both durable and non-durable goods.
Service is often defined together with goods because they are all similar products in the end. However, services are non-tangible. They include paid aid, help, or information. But some definition also includes commodities that cannot be kept or consumed when bought. Services contribute to 45% of GDP. In the USA case, in reference to this article, it recorded the lowest GDP of 30% in the 1960s. Ever since, it has been the major contributor, courtesy of expansion in the banking and health care sectors. Most services consumed within many countries and difficult to export.
Services can be defined as part of retails sales services. In this case, the latest retail sales statistics are used as the data source for GDP calculation. The report comes out monthly, hence giving a preview of the component of the quarterly report.
Personal consumption makes the largest part of a country’s economy. Why is this so? Considering the USA case, we can say that America is lucky enough to have a very large domestic population within a geographic location with easy accessibility. Hence, it can consider a huge market for new products where businesses tend to know better what consumers want and strive to offer.
This is a similar case in many growing economies. Consumer-based GDP is the largest contributor to their economies, leading to more locally produced goods. When a country is independent of too many exports, it has a higher chance of growing its economy. Also, it gives consumers easy access to the products while ensuring lower prices for the said goods. Things like non-durable goods that should be consumed within a short period become a huge boost to the economy where they are not outsourced.
2. Capital investments by businesses
Every company operating with the borders of a country needs raw materials to produce their goods. In this case, they have to purchase and invest in different channels to deliver consumer goods. And these are called business investment. However, not every purchase by the company is counted. For example, if a purchase in only intended to replace an existing item, it does not add value to the GDP, hence it is not counted. It is only when a producer creates new consumer goods that it can be counted for GDP calculation purposes.
In America, 2019 saw businesses spending $3.42 trillion, which is 18% of the GDP. And it was double the same expenditure in 2009, where it was only %1.5 trillion. It picked by $2.3 trillion in 2004. Business investments can be divided into two sub-groups.
- Fixed Investment
Fixed investment is categorized as a non-residential investment, which includes primarily of business equipment. In other words, investments that businesses do to grow themselves, such as software, capital goods, and manufacturing items. Bodies that calculate GDP, like the BEA, get such data from the monthly report of durable goods a company orders, and it is among the leading economic indicator in the USA.
Commercial real estate construction is a small but very crucial aspect of non-residential investment. It is counted and added to the overall commercial invention, with exclusion on resales. The BEA includes them to the GDP of the construction year.
Fixed investment also combines residential constructions. In other words, new single-family homes, condos, and townhouses are considered part of the growing economy of a nation. And just like real estate, house resales do not feature in fixed investments, hence do not count in GDP calculation. In 2019, new home buildings accounted for $594 billion, 3% of the US GDP. Commercial and residential constructions together accounted for $1.11 trillion, 5.8 of the GDP.
One important factor to note is that the general economy of a country determines investment in housing. This is why the 2008 financial crisis was a big blow to the housing industry. In 2005, America was enjoying $872, 6.1% of the GDP residential construction income, which dropped to $382 billion; 2.6%.
- Business inventory change
A company may wish to add the inventories of the goods they plan to sell by a specific percentage. This figure is measure by a change in private inventory. In other words, if the stocks increase, it means the business is receiving orders for products they don’t have at the moment; hence they order in excess to have enough on stand-by. And a company must have enough inventories so that they don’t disappoint or chase away potential customers. When private inventory increases, it positively affects GDP.
And when there is a drop in inventory orders, it means business is having a slow time, as demands are decreased. This may lead to production cut back, potentially followed by layoffs. Hence, any change in private inventories is taken very seriously, as a leading indicator. Even though it contributed to less than 1% of the US GDP in 2018, it is still a vital aspect.
A government has to spend on different areas. In 2019, the government spent $3.30 trillion in the USA, which accounts for 17% of the GDP, which was down from 19% in 2006. This is evidence that the government was spending more before the economic relapse of 2008. The federal government used $1.28, where more than 60% went to the military. The contribution of state and local governments rose a bit to 11%, compared to 2017.
Every sector of the economy contributes to the GDP calculation. And government expenditure in things like infrastructures and other developments are key points to note. They all indicate how fast the economy of a country is growing.
Imports and exports all have a role to play in GDP. Import affects GDP negatively as it subtracts where exports add, hence contributing positively.
In the USA, imports are more than exports, creating a deficit. The country still depends on a lot of petroleum even though it has gained in domestic shale oil production.
Services are not easy to export, and in some cases, totally impossible. In 2019, important ate up $3.49 trillion, perhaps a bit more than the previous years, while exports contributed positively by $2.53 trillion. And this is why the international trade subtracted $950 billion from the GDP.
A country that exports more goods than imports can see a larger GDP. And this is why it is among the major parameters for measuring economic growth.
Gross National Product
This another vital metric used to measure a nation’s economic health. GNP is the market value of goods and services provided by citizens, whether domestic or abroad. Whereas GDP focuses on the local economy and what is happening within its borders, GNP looks at how its nationals are contributing to economic growth. Hence, GNP focused on citizenship while overlooking geographical boundaries. However, note that GNP does not include the contribution of foreign nationals.
For instance, an English football player in Germany who sends his income home to England, or an American investor in Canada who transfers dividend income from shareholders in Canada to the USA, are both excluded from the GNP of the countries of residents. And if a Korean-based researcher sends their earning home while working in the U.S. or a French airline generates revenue from its abroad services, they are both adding their nation’s GNP.
GNP is found as the sum of consumption, government spending, business capital expenses, and net expenses and net earnings by individuals and businesses operating abroad, subtracted from the net earnings of foreign residents and businesses by domestic investment.
A country is measured by how powerful its economy is. And as you can see, every citizen has a role to play in this growth. Even though GDP and GNP are both important aspects of economic calculations, most countries prefer using GDP alone. The bottom line is, they are critical in the world of business and economics.
Author: James Hamilton