GDP is the total market value of all domestically produced final goods and services for a particular year. Its five key factors are: market value, final goods and services, produced, within a country, during a specific time period.

• Only final goods and services count: GDP includes goods and services purchased by final users. Intermediate goods purchased for resale or for the production of another good or service are excluded, to avoid double-counting. Their value is embodied in the value of the goods purchased by the end user.

• GDP is a "flow" variable; it measures the market value of production that flows through the economy.

• Financial transactions and income transfers (e.g., social security and welfare payments) are excluded because they represent exchanges, not productions, of goods and services. GDP counts transactions that add to current production.

• GDP counts only goods and services produced domestically, whether by citizens or foreigners.

• It includes only goods produced during the current period. Thus, sales of used goods are not counted in GDP. However, sales commissions count toward GDP because they involve services provided during the period.

GNP is the total market value of all final goods and services produced by the citizens of a country. It measures the output that is produced by the "nationals" of a country. This figure is the output generated by the labor and capital owned by the citizens of the country, regardless of whether that output is produced domestically or abroad. Consider the case of the United States. GNP is the income earned by Americans, regardless of whether that income is earned in the United States or abroad. It omits the income foreigners earn in the United States, but counts the income that Americans earn abroad. It is equal to GDP minus the net income of foreigners.

GNP = GDP + Income received by citizens for factors of production supplied abroad - Income paid to foreigners for the contribution to domestic output

In short, GNP measures the worldwide output of a nation's citizens while GDP measures the domestic output of the nation.

• In general, the bulk of output is produced domestically using resources owned by nationals of the country. Thus, GDP often differs only slightly from GNP.
• These two measures differ substantially only when a country attracts a large number of foreign workers or investments (the country's GDP will exceed its GNP).
• If a relatively large number of a country's citizens work abroad, or its citizens have made substantial investments abroad, the country's GNP will exceed its GDP.

Practice Question 1

Which one should be counted toward U.S. GDP?

A. When a wholesale distributor sells steak to a restaurant, the restaurant owner pays $400 to the distributor.
B. An American purchases domestic stocks at NYSE.
C. A stockbroker helps an investor buy a portfolio of stocks for $100,000, receiving $800 as commission.

Correct Answer: C

A: The steak is still an intermediate good. Only the final purchase price paid by the patron of the restaurant for the steak dinner should be counted.

B: Financial transactions are excluded from GDP since they don't involve production. They merely transfer ownership from one party to another.

C: The commission is included since it involves a service.

Practice Question 2

A miller buys a pound of wheat from a farmer for 30 cents, grinds it into flour and sells it to a baker for 60 cents. The baker combines the flour with other ingredients and makes a loaf of bread. The baker sells the bread to the grocery store for 90 cents. The grocery store then adds 10 cents and sells it to a customer. How much should be included in the GDP in this example?

Correct Answer: $1

This reflects the value added at each stage of production and should be added to GDP.

Practice Question 3

Which one should be counted toward U.S. GDP?

A. An American purchases a Japanese stock in Tokyo.
B. Your uncle gives you $1,000 to pay for your college expenses.
C. A Vietnam veteran receives veteran's payments from the federal government.

Correct Answer: None of these amounts should be counted toward GDP.

A: Financial transactions are excluded from GDP since they don't involve production. They merely transfer ownership from one party to another. It does not matter where such transactions happen.

B: Income transfers are excluded from GDP since they don't involve production. Your uncle will have less wealth and you have more; the net effect is zero - the transaction adds nothing to current production.

C: Income transfers again. The veteran is not producing any goods in return for this money (although he served in the war).

Practice Question 4

If substantially more foreign money is invested in Ireland than Irish citizens have invested abroad, then one will likely expect ______

A. Irish net foreign factor income to be positive.
B. Irish GDP to exceed Irish GNP.
C. Irish GNP to exceed Irish GDP.

Correct Answer: B

Net foreign factor income is the difference between the foreign income of one's citizens and the income of residents who are not citizens. If more foreign money is invested in Ireland than Irish citizens have invested abroad, it is likely that the income of Irish residents who are not citizens will exceed the foreign income of Irish citizens. That is, net foreign factor income will be negative and GDP will exceed GNP in Ireland.