GDP, GNP and the gap between them
National income is measured through several yardsticks, the two headline ones being gross domestic product and gross national product.
A Japanese car maker's factory in Gujarat adds to India's GDP (produced inside the frontier) but the profit it remits belongs to non-residents. An Indian engineer's salary earned in Dubai adds to India's GNP (produced by a resident) but not to GDP. Net the two flows and you have net factor income from abroad, the bridge between the two totals.
Computing these numbers is a huge data collection and processing task, and it can be done three ways.
Three methods, one answer
GDP is the aggregated flow of goods and services from the economy's sectors: agriculture, industry and services. Economists total the money value of all final goods and services produced in a period. Final goods are those consumed by participants; goods used in further production, intermediate goods, are excluded to avoid double counting. The method works sector by sector, and total output is the sum of sector outputs.
National income is the aggregate income of individuals. The syllabus borrows Robert Kiyosaki's four categories of working people: employees earn wages and salaries, professionals earn income from their services, entrepreneurs earn profits (including undistributed corporate profits), and investors earn returns on their capital and rent on their land. The sum of all four for a period is national income.
Everything produced is bought by someone, so national income can be counted from the consumption end. Consumers are individuals, corporates and the government; exports (foreigners buying what the economy produces) and imports (residents buying what other economies produce) are adjusted for. Aggregate demand equals private consumption plus government spending plus gross capital formation plus net exports, and the syllabus notes aggregate demand is sometimes referred to as GNP.
In practice all three methods produce similar results with minor differences, statistical errors among the reasons.
The steel that goes into a car is an intermediate good; counting the steel and the car would count the steel twice. The product method counts only final goods and services. An option that includes intermediate goods in the product method is wrong.
What the statistics are used for
Savings, and the step that turns them into investment
Savings are income over expenses, computed separately for the economy's three constituents. Individuals' savings are personal savings; corporates' undistributed profits are corporate savings; the government's are public savings, which rarely exist because governments generally run budget deficits. Individuals and corporates together are private savings, and the sum of personal, corporate and public savings is national saving.
Savings become investment only when they are channelled to productive use: handed to corporates or the government to invest and generate further earnings. The channel is a financial instrument, equity, bonds, government securities and others, that carries funds from savers to the users who issue the securities. Governments and central bankers work to make that conversion easy by building efficient financial markets: a wide range of products, ease of conversion, simple transactions, safety, low cost and transparency. Higher savings and a higher conversion of savings into investment are both good for an economy.
- GDP is the market value of goods and services produced within a country's frontiers regardless of the producer's nationality; GNP is what a country's residents produce anywhere in the world. The difference is net factor income from abroad: income received by residents minus income paid to non-residents.
- Product method: money value of final goods and services by sector (agriculture, industry, services), never intermediate goods. Income method: wages of employees, service income of professionals, profits of entrepreneurs (including undistributed corporate profits), returns and rent of investors. Expenditure method: private consumption plus government spending plus gross capital formation plus net exports.
- Per capita income (national income divided by population) is the better measure of living standards; the service sector is about 60% of India's GDP at factor cost; the statistics guide fiscal and monetary policy.
- Savings are income over expenses: personal, corporate (undistributed profits) and public (rare, governments usually run deficits); personal plus corporate is private saving; all three make national saving. Savings are not investment until channelled into financial instruments, which efficient markets exist to make easy.