National Product and Domestic Product
A modern economy produces literally thousands of different goods and services. Some of these goods and services such as rice, wheat, shirts, shoes, cooking gas, doctor's services, electricity, passenger transport, etc. are directly consumed by the population; some such as steel, fertilizers, raw cotton, cement, heavy chemicals, etc. enter as inputs in the production of other goods which may be directly used or further processed; finally some goods such as machine tools, furnaces, railway wagons, factory buildings, etc. augment the productive capacity of the economy. Intermediate goods such as steel and cement are not desired in themselves but only as inputs in producing other goods. The ultimate aim of all economic activity is to make available goods and services for consumption now and for augmenting productive capacity so that consumption in future can be maintained or increased. Gross National Product (GNP) and Gross Domestic Product (GDP) and other variants are measures of aggregate production of all goods and services which either afford consumption now or add to productive capacity.
Obviously, since there are thousands of such goods and services we cannot simply add their physical outputs (10 liters of milk plus 20 pairs of chappals plus 10 kilograms of rice plus 2 consultations with a doctor plus 10 trips to work on a city bus.... will be a highly inconvenient aggregate to deal with). They can all be converted to monetary units by multiplying their quantities by their market prices and then by adding together to get a single measure. GNP and GDP are such measures.Let us briefly mention some problems. Some goods such as electricity are both consumer goods when directly consumed by households and intermediate goods when used by industry. What do we do about these? What about services such as police force, defense, use of public roads and parks, government administration, etc. which all of us 'consume' but there are no explicit prices attached to them? Obviously, they must be included but how to value them? What about goods and services which are produced and consumed within a household without ever entering a market? For example, you paint your own house or repair your own scooter. We will see in the next chapter that some of these difficulties can be resolved with varying degrees of approximation while some simply have to be ignored.Notice that we have been talking about two distinct concepts, GNP and GDP, in the same breath. Though for some purposes the distinction is not very important there is a difference. It will be clarified later.There is another way of looking at GNP and GDP. Every productive process involves transformation of raw materials and intermediate inputs into finished products with the help of services of labor - blue collar and white collar - managers, and services of capital - machinery, equipment, structures, and working capital. The value of the finished product can be decomposed into value of raw materials and intermediates on the one hand and the value added by labor and capital. The agents who contribute to this value addition - workers and managers (who supply various types of labor services) shareholders and creditors (who supply capital), owners of buildings and structures - are compensated in the form of wages, salaries, profits, interest and rent.Thus, value added in a productive process equals the incomes paid out to suppliers of these inputs which economists call primary factors of production. If we put together the value added in all the productive activities carried out in an economy during a certain period of time we will get a measure of aggregate factor incomes generated in production. Under certain conditions this aggregate must equal GDP/GNP as defined earlier because the goods and services whose market value enters GDP are purchased by suppliers of primary inputs out of their incomes. Thus, for instance, households purchase consumer goods out of their wage and non-wage incomes, firms purchase capital goods out of their own savings (retained profits) and out of borrowed funds which in turn come out of savings of income earners. The qualification 'under certain conditions' will become clear later.Thus whichever way we look at it, GNP and GDP are measures of total economic activity (i.e. total money value of all goods and services produced) during a period as it contributes to current and future consumption. The size of national product or income (Y) in a country is very important because it influences the level of employment, the level of output and people's standard of living. Usually an increase in Y will mean more jobs, more output and a better standard of living. A fall in Y will have the opposite effect.
Y is determined by the level of aggregate demand (AD) in the economy. An economy is in equilibrium (i.e. all opposing forces in balance and all things remaining equal, there is no need to change) when:Y = ADThis is when the supply or output of goods and services produced in the economy is equal to the demand for these goods and services from various segments of the economy - household, corporate sector, government sector and external sector. If AD is greater than Y, Y will have to rise. If Y is greater than AD, Y will have to fall. The economy will eventually have to end up at equilibrium.Finally, note that changes in GDP over time can come about because of changes in physical volume of goods and services produced and changes in their prices. For many purposes we are interested in the former and would like to remove the effect of price changes. In the next lesson we will discuss how this can be done using the concepts of real and nominal GDP.