Two Measures of National Product: Goods-Flow and Earning-Flow

How do we actually go about measuring GNP? As we will see, and as is illustrated in Figure 6-2 on p. 106, GNP can be measured either as a flow of products or as a sum of earnings.

   In this introductory discussion, we will consider GNP measurement in an economy with no government or foreign sector and with no investment taking place. For the moment, consider an economy that produces only consumption goods, which are items that are purchased by households to satisfy their wants.

   FIow-of-Product Approach Each year the public consumes a wide variety of final goods and services: goods such as apples, oranges, and bread; services such as health care and haircuts. We include only final goods-goods ultimately bought and used by consumers-for reasons to be discussed shortly. We spend our family incomes for these consumer goods, as in the upper loop of Figure 6-2. Add together all the consumption dollars spent on these final goods, and you will arrive at this simplified economy’s total GNP.

   Thus, in our simple economy, you can easily calculate national income or product as the sum of the annual flow of final goods and services: (price of oranges X number of oranges) plus (price of apples X number of apples) plus. . . . The gross national product is defined as the total money value of the flow of final products produced by the nation.2

   Why use market prices as weights in evaluating and summing diverse physical commodities and services? Because, as we shall see in Part Four, market prices reflect the relative economic value of diverse good and services. That is, the relative prices of different goods reflect how much consumers value their last (or marginal) units of consumption of these goods. Thus the choice of market prices as weights for different goods is not arbitrary: in a smoothly functioning market economy these weights reflect the relative satisfactions that consumers receive from each good.

Earnings or Cost Approach There is a second and equivalent way to calculate GNP: the earnings or cost approach. Go to the lower loop in Figure 6-2. Through it flow all the costs of doing business, which are also the earnings that households receive from the firm. These costs include the wages paid to labor, the rents paid to land, the profits paid to capital, and so forth.

   The lower-loop costs represent the factor earnings of land, labor, and capital and are the costs of production of the upper-loop flow of products. Statisticians can measure the annual flow of these earnings or income.3 In this way they will again arrive at the GNP.

    Hence, a second way to calculate GNP is as the total of factor earnings (wages, interest, rents, and profits) that are the costs of producing society’s final products.

Equivalence of the Two Approaches Now we have calculated GNP by the upper-loop flow-of-product approach and by the lower-loop earnings-flow approach. Which of these two is greater? They are exactly the same.

   We can understand the identity of the two approaches if we examine a simple economy with one barber producing only haircuts. Say the barber has no expenses other than labor. If he sells lO.haircuts at $6 each, then GNP is $60. But the barber’s earnings (in wages and profits) are also exactly $60. Hence, the GNP here is identical whether measured as flow of products ($60 of haircuts) or as cost and income ($60 of wages and profits).

   More generally, the two approaches are identical because we have included ‘ ‘profit" in the lower loop along with wages, interest, and rents. What exactly is profit? Profit is what you have left over from the sale of product (your oranges, apples, bread, and haircuts) after you have paid the other factor costs-wages, interest, and rents.

   So profit is the residual that automatically adjusts to make the lower loop’s costs or earnings exactly match the upper loop’s value of goods.

  To sum up:
  GNP, or gross national product, can be measured in two different ways: (1) as the flow of final products, 91' (2) as the total costs or earnings of inputs producing output. Because profit is defined as a residual cost, both approaches will yield exactly the same total GNP.