You are on page 1of 5

INTRODUCTION TO MACROECONOMICS

GROSS DOMESTIC PRODUCT (GDP)


The Scoreboard for economic performance is the National Income accounting system. Simon
Kuznets developed the basic concepts and outlined the measurement procedures during the
1920s.
DEFINITION: It is the market value of all final goods and services produced within a country
during a specific period, usually one year.
It measures the productivity output of a countrys economy. Its an indication of the wealth or the
stage of development of the nation.
WHAT COUNTS TOWARD GDP ?
1. Counts only FINAL goods (goods and services purchased by their ultimate or final users). AS
OPPOSED TO INTERMEDIATE goods (goods purchased for resale or for use in producing
another good or service).
2. Counts only CURRENT PRODUCTION i.e., only the goods and services produced during
the specified period. Examples : Annual GDP (Jan 1st Dec 31st ) or quarterly GDP (Jan 1st
March 31st ).
- Purchase of a used car (made in 2005) would not be counted in 2007 GDP.
- However if a used car dealer purchase a used car (made in 2005 for $200,000 refurbishes it and
sell it for $ 300,000 in 2007, the VALUE ADDED = $ 100,000 is included in 2007 GDP.
EXCLUDED FROM GDP.
1. ALL FINANCIAL TRANSACTIONS :Since they do not involve current production. eg.
Purchases and sales of stocks and bonds DO NOT count because only ownership rights are
transferred.
- However, if a stockbroker made the purchase of stocks on your behalf and charges a
COMMISION FEE, this fee (the cost of a service rendered) is COUNTED IN CURRENT GDP.
2. ALL PRIVATE AND PUBLIC SECTYOR INCOME TRANSFERS Since gift of $ 50,000
towards payment of school fee.
a. Aunts gift of $ 50,000 towards payment of school fee.
b. Social Security or welfare payments.
c. Student grants / bursaries.
3. NON-MARKET PRODUCTION : These are DO-IT YHOURSELF activities that does not
involve a market production. Examples. a. mow the lawn, b. paint the house.
4. UNDERGROUND ECONOMY: Market transactions that take place outside RECORDED
MARKET CHANNELS.
a. Some are UNREPORTED LEGAL market transactions just to evade taxes.
(eg. What is called Robot/ illegal taxis in Jamaica.)
b. Some are ILLEGAL ACTIVITIES such as drug trafficking and prostitution.
GDP FAILS TO COUNT (LIMITATIONS)

1. GDP fails to count LEISURE and HUMAN COST associated with the production of goods
and services.
Example: One country attains a US $ 20,000 per capita GDP. (GDP divided by population) with
an average work week of 30 hour. Another country attains the same US $ 20,000 per capita GDP
with an average work week of 50 hours. Internationally Both countries are recorded as having
the same GDP. HOWEVER, the first country is BETTER OFF because it produces MORE,
LEISURE or SACRIFICES LESS HUMAN COST.
2. GDP CANNOT ACCOUNT FOR PRODUCTIVE LOSS
When a National Disaster such as a hurricane, earthquake, occurs, goods that are
destroyed are not subtracted from GDP and there is no way to account for the loss in productive
capacity to the economy.
The REBUILDING that occurs after a natural disaster, however, is counted in GDP> For this
REASON, disasters like floods and earthquakes can actually end up INCREASING GDP
ANOTHER EXAMPLE: Your text book get stolen (DOESNT AFFECT GDP). Replace text
book (count towards GDP).
DOUBLE COUNTING
An accounting problem that occurs when measuring output. The problem is that final output is
made up of many stages. Hence, you must take care either to (A) include the extra value added at
each stage of production or (B) only record the value of FINAL output. Sales at intermediate
stages of production are not counted by GDP because the value user good. (IMPORTANT TO
NOTE when using the OUTPUT METHOD to calculate the GDP).
GDP AND THE STAGES OF PRODUCTION
Stages of Production
Production

Sales receipt at each


stage of production

Amount added to the


value of output

1. Farmers Wheat
$ 0.30

$ 0.30 Value added by farmer

2. Millers Flour
$ 0.65

$ 0.35 Value added by Miller

$ 0.90

$ 0.25 Value added by the Baker

3. Bakers Bread Wholesale

4. Grocers Bread Retail

$ 1.00

$ 0.10 Value added by Grocer

DOLLAR The Common Denominator of GDP :


The vastly different goods and services produced in our modern world have only one thing in
common. Someone pay a price for them. Therefore when measuring output, units of each goods
are weighted according to their Purchase Price.
THREE WAYS OF MEASURING GDP
I. THE EXPENDITURE APPROACH:
There are four (4) components : Personal Consumption Expenditure [C], 2. Gross Private
Domestic Investment [I], 3. Government Consumption and Gross Investment [G], and 4. Net
Exports [X Im].
GDP = C + I + G + X - M

1. Consumption [C] : There are three main categories; Durable goods, non-durable goods and
services.
2. Gross Private Domestic Investment [I] : refers to the purchase of new capital housing,
plants, equipment and inventory. It includes expenditures for: replacements of machinery,
equipment and building worn out during the year, and net additions to the stock of capital goods.
3. Government Consumption and Investment [G]: includes expenditure by state and local Govt.
for final goods (eg. schools) and services (eg. military salaries).
4. Net Exports [X-M]: is the difference between Exports and Imports. This figure can be
positive (developed countries) or negative (developing countries).

II. INCOME EXPENDITRE APPROACH:


Looks at GDP in terms of who receives it as Income not who purchases it. The four (4)
components are National Income, Depreciation, Indirect Taxes minus subsidies, and Net factor
payments to the rest of the world.
GDP : National Income
+
Depreciation
+
(Indirect Taxes Subsidies )
+
Net factor payments to the rest of the world
National Income include income from employment, self-employment, profits and rent.

III. OUTPUT METHOD:


The output contributed by the various sectors (industries) of the economy is added to give
National Output. When calculating GDP by this method it is necessary to avoid DOUBLE
COUNTING. The economy is broken up into various sectors. The money spent on making the
goods (inputs) is taken away from the money received from the sale of the goods (outputs) to
give each sectors Value added. TAKING FINAL OUTPUT OR ADDING UP EACH
SECTORS VALUE ADDED
gives National Income. Industries includes agriculture,
manufacturing etc.
IMPORTANCE OF MAKING THE DISTINCTION
BETWEEN NOMINAL AND REAL GDP
A. NOMINAL GDP : is GDP expressed at current prices. It is often called MONEY GDP.
It reflects a). changes in the real size of the economic variable.
b) Inflation a change in the general level of prices.
B. REAL GDP : is GDP adjusted for changes in the price level.
Real Values eliminate the impact of change in the price level. leaving only the
real changes in the size of an economic variable.
HOW DO ONE MAKE THE ADJUSTMENT FROM NOMINAL TO REAL GDP
We can use the GDP deflator together with nominal GDP to measure Real GDP.
THE GDP DEFLATOR : is a price INDEX that reveals the cost of purchasing the items included
in GDP during the period relative to the cost of purchasing these same items during the base
year.
Since the BASE YEAR is assigned a value of 100, as the GDP deflator takes on values greater
than 100 ( or the base year) it indicates that prices have risen.
1. Real GDP
(current year)

= Nominal GDP X GDP deflator


(current year)
(base year)
______________________________
GDP deflator (Current year)

2. Growth Rate
(Real GDP)

= Real GDP
- Real GDP
(current year)
(base year)
__________________________
Real GDP (base year)

Year
2002
2005

Nominal GDP (US $ Billion)


$ 6,244
$ 7,246

X 100

GDP Deflator Real GDP (US $ Billion)


100
$ 6,244
107.5
?

Shows that between 2002 and 2005 Nominal GDP increased by 16 %.

But when the 2005 GDP is deflated to account for price increases, we see that real
GDP increased by only 7.9 %.

GDP - A GOOD MEASURE DESPITE ITS LIMITATIONS


GDP was designed to measure THE VALUE of the goods and services PRODUCED in the
MARKET SECTOR. In spite of its shortcomings and limitations REAL GDP is a
REASONABLY PRECISE measure of the rate of output in the market and how that output rate
is changing.
Adjusted for changes in prices, ANNUAL and QUARTERLY (Real ) GDP data provide the
information required to track the performance level of the economy.
]
GNP A closely related measure to GDP is the total market value of all final goods and services
produced by the citizens of a country.
GNP = GDP + income received by citizens
for factors of production
supplied abroad

income paid to foreigners


for the contributions to
domestic output.

RELATED INCOME MEASURES:


There are five (5) ALTERNATIVE measures of domestic output of income.
1. NET DOMESTIC PRODUCT = GDP Depreciation
2. NET NATIONAL PRODUCT
= GNP Depreciation
3. NATIONAL INCOME
= The total income payments to owners of human
(labour) and physical capital during a period. It
includes both DOMESTIC and FOREIGN
income earned by the nationals.
4. PERSONAL INCOME (GROSS INCOME) = The total income received by
individuals that is available for consumption,
saving and payment of personal taxes.
5. DISPOSABLE INCOME
= Gross Income minus Taxes. It is income
available after personal taxes which can either
be spent on consumption or saved..
*******