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GNP: An Alternative Measure of Output

24 April, 2015 - 16:47

While GDP represents the most commonly used measure of an economy’s output, economists sometimes use an alternative measure. Gross national product (GNP) is the total value of final goods and services produced during a particular period with factors of production owned by the residents of a particular country.

The difference between GDP and GNP is a subtle one. The GDP of a country equals the value of final output produced within the borders of that country; the GNP of a country equals the value of final output produced using factors owned by residents of the country. Most production in a country employs factors of production owned by residents of that country, so the two measures overlap. Differences between the two measures emerge when production in one country employs factors of production owned by residents of other countries.

Suppose, for example, that a resident of Bellingham, Washington, owns and operates a watch repair shop across the Canadian–U.S. border in Victoria, British Columbia. The value of watch repair services produced at the shop would be counted as part of Canada’s GDP because they are produced in Canada. That value would not, however, be part of U.S. GDP. But, because the watch repair services were produced using capital and labor provided by a resident of the United States, they would be counted as part of GNP in the United States and not as part of GNP in Canada.

Because most production fits in both a country’s GDP as well as its GNP, there is seldom much difference between the two measures. The relationship between GDP and GNP is given by

EQUATION 21.3

GDP+net income received from abroad by residents of a nation = GNP

In the third quarter of 2008, for example, GDP equaled $14,220.5 billion. We add income receipts earned by residents of the United States from the rest of the world of $805.8 billion and then subtract income payments that went from the United States to the rest of the world of $688.4 billion to get GNP of $14,538.0 billion for the third quarter of 2008. GNP is often used in international comparisons of income; we shall examine those later in this chapter.

KEY TAKEAWAYS

  • GDP is the sum of final goods and services produced for consumption (C), private investment (I), government purchases (G), and net exports (Xn). Thus GDP = C + I + G + Xn.
  • GDP can be viewed in the context of the circular flow model. Consumption goods and services are produced in response to demands from households; investment goods are produced in response to demands for new capital by firms; government purchases include goods and services purchased by government agencies; and net exports equal exports less imports.
  • Total output can be measured two ways: as the sum of the values of final goods and services produced and as the sum of values added at each stage of production.
  • GDP plus net income received from other countries equals GNP. GNP is the measure of output typically used to compare incomes generated by different economies.

TRY IT!

Here is a two-part exercise.
a. Suppose you are given the following data for an economy:

Personal consumption

$1,000

Home construction

100

Increase in inventories

40

Equipment purchases by firms

60

Government purchases

100

Social Security payments to households

40

Government welfare payments

100

Exports

50

Imports

150

 


Identify the number of the flow in Figure Figure 21.5 to which each of these items corresponds. What is the economy’s GDP?

b. Suppose a dairy farm produces raw milk, which it sells for $1,000 to a dairy. The dairy produces cream, which it sells for $3,000 to an ice cream manufacturer. The ice cream manufacturer uses the cream to make ice cream, which it sells for $7,000 to a grocery store. The grocery store sells the ice cream to consumers for $10,000. Compute the value added at each stage of production, and compare this figure to the final value of the product produced. Report your results in a table similar to that given in the Table 21.1.

Case in Point: The Spread of the Value Added Tax

Outside the United States, the value added tax (VAT) has become commonplace. Governments of more than 120 countries use it as their primary means of raising revenue. While the concept of the VAT originated in France in the 1920s, no country adopted it until after World War II. In 1948, France became the first country in the world to use the VAT. In 1967, Brazil became the first country in the Western Hemisphere to do so. The VAT spread to other western European and Latin American countries in the 1970s and 1980s and then to countries in the Asia/Pacific region, central European and former Soviet Union area, and Africa in the 1990s and early 2000s.

What is the VAT? It is equivalent to a sales tax on final goods and services but is collected at each stage of production.

Take the example given in Table 21.1, which is a simplified illustration of a house built in three stages. If there were a sales tax of 10% on the house, the household buying it would pay $137,500, of which the construction firm would keep $125,000 of the total and turn $12,500 over to the government. With a 10% VAT, the sawmill would pay the logger $13,200, of which the logger would keep $12,000 and turn $1,200 over to the government. The sawmill would sell the lumber to the construction firm for $27,500—keeping $26,200, which is the $25,000 for the lumber itself and $1,200 it already paid in tax. The government at this stage would get $1,300, the difference between the $2,500 the construction firm collected as tax and the $1,200 the sawmill already paid in tax to the logger at the previous stage. The household would pay the construction firm $137,500. Of that total, the construction firm would turn over to the government $10,000, which is the difference between the $12,500 it collected for the government in tax from the household and the $2,500 in tax that it already paid when it bought the lumber from the sawmill. The table below shows that in the end, the tax revenue generated by a 10% VAT is the same as that generated by a 10% tax on final sales. Why bother to tax in stages instead of just on final sales? One reason is simply record keeping, since it may be difficult to determine in practice if any particular sale is the final one. In the example, the construction firm does not need to know if it is selling the house to a household or to some intermediary business.

Also, the VAT may lead to higher revenue collected. For example, even if somehow the household buying the house avoided paying the tax, the government would still have collected some tax revenue at earlier stages of production. With a tax on retail sales, it would have collected nothing. The VAT has another advantage from the point of view of government agencies. It has the appearance at each stage of taking a smaller share. The individual amounts collected are not as obvious to taxpayers as a sales tax might be.

Good

Price

Value Added

Tax Collected

Tax Already Paid

Value Added Tax

Logs

$12,000

$12,000

$1,200

-$0

=$1,200

Lumber

$25,000

$13,000

$2,500

-$1,200

=$1,300

House

$125,000

$100,000

$12,500

-$2,500

=$10,000

Total

   

$16,200

-$3,700

=$12,500

 

ANSWER TO RY IT! PROBLEM

a. GDP equals $1,200 and is computed as follows (the numbers in parentheses correspond to the flows in Figure Figure 21.5):

Personal consumption (1)

$1,000

Private investment (2)

200

Housing

100

Equipment and software

60

Inventory change

40

Government purchases (3)

100

Net exports (4)

-100

GDP

$1,200

 


Notice that neither welfare payments nor Social Security payments to households are included. These are transfer payments, which are not part of the government purchases component of GDP.

b. Here is the table of value added.

Good

Produced by

Purchase by

Price

Value Added

Raw milk

Dairy farm

Dairy

$1,000

$1,000

Cream

Dairy

Ice cream maker

3,000

2,000

Ice cream

Ice cream manufacturer

Grocery store

7,000

4,000

Retail ice cream

Grocery store

Consumer

10,000

3,000

   

Final Value

$10,000

 
   

Sum of Values Added

 

$10,000