On the Meaning of “Gross” vs. “Net,” “Domestic” vs. “National,” and “Product” in the “Gross Domestic Product” Statistic

A fundamental concept around which aggregate income accounting is based is GDP. It is defined as the aggregate economic output of the economy, and is meant to measure the total amount of goods and services available for government and consumers to consume. (For ease of exposition, I will leave out any discussion of the international sector.)

To understand what is meant by GDP, let’s consider each term separately. Let’s start with the term “domestic.” The adjective “domestic” replaced the previous adjective “national” in the 1970s. Before that time we talked about Gross National Product, not Gross Domestic Product. The difference between the two is usually small, but it makes a good question for grilling students. GDP is a measure of gross final domestic output, where “domestic” means output physically produced in the United States, and “national” means output produced by US national firms and citizens. The domestic production measure is used by most countries around the world and is easier to measure than the national production since, with globalization, it is hard to tell what is a US firm and what is a foreign firm. So “domestic” is simply a descriptor of some technical issues about measuring aggregate output.

Let’s next consider the term “gross.” In aggregate income accounting, the term “gross” has a specific meaning. It means that the measure includes production that is used for investment, and thus will not be available for consumption by government or consumers. After one subtracts that investment, one has net domestic product (NDP) and it is NDP that represents the output available for private and government consumption. Net production is gross production minus investment. The reason economists don’t focus on NDP, and instead focus on GDP is that we don’t have good measures of investment. To arrive at NDP we generally simply subtract a set percentage — what is called a capital consumption allowance. Given that fact, we often use the GDP measure as a proxy for final output of the economy.

Finally, let’s consider the meaning of the third term “product.” “Product” in aggregate income accounting is just another term for output. One could have as well called it gross domestic output. Skousen [2014], in his Wall Street Journal valedictory op-ed article calls his concept of gross output a “better economic measure” than GDP because it is a supply-side statistic that measures the production side of the economy, whereas the current measure of output, GDP, measure the demand side of the economy. That characterization doesn’t fit with the aggregate accounting conventions; GDP is a measure of the productive side of the economy just as much as gross output is.

—David Colander, “Gross Output: A New Revolutionary Way to Confuse Students about Measuring the Economy,” Eastern Economic Journal 40, no. 4 (September 2014): 452-453.

Aggregate Production Functions Are a Pervasive, But Unpersuasive, Fairytale

 Briefly, an examination of the conditions required for aggregation yields results such as:

• Except under constant returns, aggregate production functions are unlikely to exist at all.
• Even under constant returns, the conditions for aggregation are so very stringent as to make the existence of aggregate production functions in real economies a non-event. This is true not only for the existence of an aggregate capital stock but also for the existence of such constructs as aggregate labor or even aggregate output.
• One cannot escape the force of these results by arguing that aggregate production functions are only approximations. While, over some restricted range of the data, approximations may appear to fit, good approximations to the true underlying technical relations require close approximation to the stringent aggregation conditions, and this is not a sensible thing to suppose. . . .

All these facts should be well known. They are not, or, if they are, their implications are simply ignored by macroeconomists who go on treating the aggregate production function as the most fundamental construct of neoclassical macroeconomics. Yet the implications of the points I have listed are not merely theoretical. As this symposium’s papers show, they include:

• The specification and estimation of the aggregate demand curve for labor;
• The measurement of productivity and, especially, the interpretation (or, perhaps more properly, the misinterpretation) of the Solow residual; and
• The use of aggregate production functions to validate the neoclassical theory of distribution.

—Franklin M. Fisher, “Aggregate Production Functions: A Pervasive, But Unpersuasive, Fairytale,” Eastern Economic Journal 31, no. 3 (Winter 2005): 489-490.