Understanding GNP, GDP, and Their Impact on the Economy
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GNP/GDP 4 elements:
- Consumption: the portion of GNP purchased by private households. It is what you, as a citizen, buy to fulfill your needs and wants.
- Investment: the portion of production consumed by private companies to produce their own output.
- Government purchases: all the consumption and investment of local and national authorities.
- Current account: difference between the exports and imports. It is part of the balance of payments. When a country is importing more than it is exporting, we say has a current account deficit. If it is exporting more than it is importing, it has a current account surplus. If a country is incurring in a CA deficit it has to fund it somehow. If we are importing more than what we are exporting, we need to borrow money and thus increase our foreign debt. That means that at some point in the future we will have to export more than what we import. Having a long and sustained current account deficit can lead to a large foreign debt and a negative net international investment position (IIP). CA deficit: Consuming more than producing. Will depreciation improve the situation of CA deficit? It depends. Exports will be cheaper, imports will be more expensive.
Elements affecting GDP:
- Consumption: Increase of consumption--> GDP increases. This means increase in living standards as more people can consume higher levels of goods & services. Increased GDP per Capita will improve government finances. This is because people will pay more income tax and more VAT; firms will pay more corporation tax. Also the government will spend less on income support and unemployment benefits. Therefore the budget deficit will decrease. Also the government could decide to spend more on investing into the economy. e.g. spending on better roads. This will enable higher rates of growth in the long term. An increase of consumption will immediately push up imports. An increase of domestic consumption might decrease export, since at the same level of production firms would prefer to sell inside the country.
- Investment: The GDP increases when businesses invest money in infrastructure, real estate and other physical operations. Financial investment can also have an impact on other GDP factors, such as consumer spending, by creating jobs and creating buying power for consumers.
- Unemployment: Employment ultimately affects C (disposable income) and G (taxes funding purchases), that ultimately affects I (why invest if you can’t sell) Okun’s law. Si hay desempleo varios meses hay un estancamiento dell PIB( bajan los ingresos de las empresas, sube el paro y ventas disminuyen).
- Productivity: falls because low levels of investment and falling real wages.
- Monetary policy: “Monetary policy is the process by which the monetary authority of an country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency”. Expansive, low interest rates, cheap money. If the money flows towards the economic agents with a low cost, governments can boost C and I. However, this does not always work, in the current crisis. Companies would not borrow because there was a shrinking demand - they didn’t want more facilities! - and Consumers would not buy because of the high unemployment and uncertainty.
- Fiscal policy: Increase on G, multiplying effect, somehow forces consumption. Governments can fund big projects to boost the economy. Keynesianism. Furthermore, governments ensure the supply of goods and services that markets fail to provide effectively (health, education…), and can ensure productivity and social stability. Equality as a growth factor.
High inflation: makes exports less competitive and reduces demand for currency. Hyperinflation: money loses its value so rapidly that nobody wants to use it as a medium of exchange.