Commonwealth Executive Masters in Business Administration / Public Administration

CEMBA 552: Economic Environment of Business
Block 2 Measures of Economic Activity

Block Objectives  

   

After working through Block Two of this course, you should be able to: Define Gross Domestic Product (GDP). Account for the different approaches to measuring GDP. Distinguish between nominal GDP and real GDP. State how the unemployment rate is defined, and describe how it is determined. Explain the definition and construction of the GDP deflator and the Consumer Price Index.

Introduction
This block is designed to increase the accuracy and power of your economic vocabulary by spelling out the strict meaning of economic measurement terms that you encounter often in business reading. reading.

Management and Measurement   

This block focuses on the main measures of economic activity. activity. There are many measures and indicators of overall (macroeconomic) activity such as the number of people with jobs, the total income of persons, the output of factories, the total quantity of goods and services produced in the economy, the unemployment rate, the consumer price index, retail sales, housing starts, etc. etc. Such measures are regularly reported in newspapers and television and radio news. news. A well-equipped business and public sector managers must wellunderstand these economic indicators in order to be able to make informed business decisions. decisions.

.2 Gross Domestic Product     GDP is the value of the final goods and services produced in the economy. standards.1. Differences in its growth rates produce large differences in living standards between countries. GDP is the most comprehensive measure of economic activity and a broad measure of people¶s income and well-being. during a given year. wellThe growth in real GDP is hence a measure of the growth of people's real incomes and therefore the pace of improvement in living standards. by foreign or domestic firms. countries.

it provides insight into the interaction of the various decision-making decisionsectors of the aggregate economy (households. and firms. particularly labour and capital. foreigners). business firms. demand. and to employ the best available technology.   . GDP can be viewed from either the demand side or the supply side. government entities. entities. The supply of goods and services requires firms to bring together the factors of production. side. in order to produce output that meets demand. foreigners). (households. On the demand side.

A rapidly growing economy is one in which people enjoy rapidly rising living standards and in which good jobs are easy to find. problem. In a slow-growing or shrinking economy. living slowstandards decline and unemployment becomes a serious problem.     As a manager. There are even occasions when the economy stops growing and actually shrinks for a period. slow. you need to be aware of these limits and any ongoing changes in them to manage your resources efficiently. find. period. . efficiently. Sometimes economic growth is rapid and at other times it is slow.

a person may take a long time to find a job.    .1.3 Unemployment Rate Unemployment rate is the ratio of the unemployed to working age (adult) population The unemployment rate is the key and the most watched indicator. At times when the unemployment rate is high.

Governments macroeconomic policy Governments have set the following as goals of macroeconomic policy: ‡ sustained income growth ‡ low unemployment ‡ mild fluctuations ‡ price stability ‡ exchange rate stability ‡ balance of trade surplus. .

ground.   .1 GDP versus GNP GDP is total income earned domestically: all domestically: economic activity that takes place within the country. It includes income earned domestically by foreigners.2 Measuring Economic Performance: Output and Income 2. but it excludes income earned by domestic residents on foreign ground. country.

income. GDP is not a perfect measure of total domestic income.  . statisticians also compute an alternative measure of aggregate economic activity. Thus. Since some income is received from individuals owning capital equipment in other countries. the gross national product (GNP). (GNP).

  . GNP is total income earned by nationals. abroad. But it does not include the income earned within a country by foreigners. foreigners. known as ³net investment income from non-residents. therefore.´ non-residents. It nationals. includes the income that nationals earn abroad. The difference between GDP and GNP is.

   Most countries pay more attention to GDP than to GNP for measuring aggregate economic activity. we are interested in a broad measure of job-creating jobactivity within the nation. . nation. For evaluating trends in the standard of living of many nations. appropriate. GNP is more appropriate. For the purpose of stabilizing employment. We use the GDP. activity. including the Organization for Economic Cooperation and Development (OECD) of nations. GDP.

manufacturing.  . on. on. profits. services and so on. The income method/approach: ie the income method/approach: that production generates in the form of wages.Methods (Ways) of measuring GDP   There are three different ways measuring GDP. mining. interest and so on. salaries. agriculture. GDP. rent. They are: are: The production method/approach: ie the method/approach: production of each industry.

 The expenditure method/approach: ie the method/approach: expenditure on the goods and services produced spending by households. in the form of consumption (C). Investment (I) and Government expenditure (G) . firms. governments.

Expenditure. economy. . and the Circular Flow  Figure 2-1 illustrates all the economic transactions that occur between households and firms in this economy.2.3 Income.

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Suppose a farmer produces $5 worth of them. explore two of them. which he sells to a baker. to report their output for the day. µI produced $5 worth of wheat. of effort to turn the wheat into bread.2. 25. The baker exerts $20 worth baker. wheat." bread.4 Value Added and Intermediate Goods Several difficulties arise when output is measured. But if we ask the farmer and the baker bread.¶ and the baker says. Let us measured. µI produced $25 worth of bread. At the end of the day. what has been produced? The answer is just $25 worth of bread. the farmer says.   . which she sells for $25.

  A statistician who naively adds these numbers might think that there has been $30 of output in the economy. . There are two ways to avoid this measurement pitfall: pitfall: 1. The baker consumers. total. The statistician is led astray by counting the wheat. bread. because his wheat is not a final good. good. which is not a final good but rather an intermediate good that disappears after it is used to produce the bread. 2. Ask the farmer and the baker to report the value of their sales of final goods to consumers. Ask the farmer and the baker to report the contribution of each made to the total. reports $25 and the farmer reports $0. economy.

costs. $5.     The farmer reports $5 worth of wheat. GDP. output. and the baker reports $20 worth of effort. When businesses report their output to the government. for a total value of $25 worth of output. $25. they subtract their costs. the farmer had no costs. The government then sums the value added by all businesses to arrive at GDP. value added is $5: in our example. The baker's value added is thus $20. so they are reporting value added. which the baker calculates by added. 25. . from her revenue. The farmer's 20. subtracting her costs. added. We call the baker's contribution to output her value added.

3 Several Measures of Income   To obtain GNP from GDP. . we subtract the net income of foreigners who own factors of production employed in Ghana: GNP = GDP .Net Income of Foreigners.

depreciation is called the capital consumption allowances .e. and residential structures that wear out during the year: year: NNP = GNP .. we subtract the depreciation of capital.Depreciation. In the national accounts. Depreciation. the amount of the economy's stock of plants. equipment. i.    To obtain net national product (NNP).

 Once we subtract indirect business taxes from NNP. income.  These taxes place a wedge between the price that consumers pay for a good and the price that firms receive. such as sales taxes and subsidies.  . it is not part of their income. we obtain a measure called national income at factor cost: cost:  National Income at factor cost = NNP .Indirect Business Taxes.The next adjustment in the national accounts is for indirect business taxes. Taxes. subsidies. receive. Because firms never receive this tax wedge.

Although it is true that actual GDP usually falls short of its potential.     . produce if labour and machines were fully used up. sometimes it could exceed it.1 Potential GDP Potential GDP. up. rates. Strong upward fluctuations are called booms and downwards ones are called recessions . it.3. indicates what the economy could GDP. This happens when the rate of utilization of the labour force and that of other factors of production exceeds their normal rates.

began in 1929. There is no technical definition of a boom. economy did not fully recover from it until four years later. have occurred when GDP falls for at least two consecutive quarters. The last depression. but there is one of a recession. Severe downturns are referred to as depressions.  . quarters. called the Great Depression because of its length and depth. The 1929. later. depressions. a recession is said to recession.

Economists call the bottom of a recession a trough and the top of a boom a peak  . next. The economy's fluctuations are sometimes called business cycles but the term µcycle¶ suggests a kind of regularity that cannot be found between one downturn and the next.

. Yt).4 Real versus Nominal GDP    To keep the comparisons of different years straight. The term real GDP (Yt) is used for inflationinflationadjusted GDP figures. prices. Unadjusted GDP is known as nominal GDP ($Yt). economists adjust GDP for changes in the average level of prices. produces. which are true year-toyear-toyear measurements of what the economy actually produces.

 To calculate real GDP. economists take the nominal value of GDP the money value of all the goods and services produced in the economy and divide it by a measure of the price level. level. real GDP is defined by the equation: equation: Real GDP = Nominal GDP/ Price level  . Thus.

decreased.  . unchanged. then real GDP is unchanged. for instance. real GDP has actually decreased. nominal GDP has risen 5% in the past year but prices have also increased by 5%. If. If nominal GDP has risen 5% in the past year but prices have increased by 6%.

1997. in the case of our example. Real GDP is also called GDP in terms of goods. This µparticular year¶ is called the year. GDP adjusted for inflation and. 1997. . 1997prices. dollars. GDP in constant dollars or price. base year.    Real GDP in year t (Yt) is the sum of the quantities of goods and services produced in year t times the prices of the same goods and services in some particular year. Then real GDP in any year is the value of that year's final goods and services measured at 1997prices. GDP in 1997 dollars. year. To calculate Yt we must first choose a base year. say.

. output. if real GDP in 2001 (measured at 1997 prices) increased by 2% over the level of real GDP in 2001. know that total output increased. Economists focus on real GDP since it eliminates the effects of changing prices on the measure of output. we 2001.  For example. increased.

Two main price indexes that are used are the Consumer Price Index and the GDP Deflator . index.5 Price Indexes and Inflation   In macroeconomics. the price level is the average level of prices measured by a price index.

5.2 The Consumer Price Index (CPI)  The CPI is a measure of the price level that considers the price of a list of specific goods and services purchased by a typical household at current prices.  . The nation¶s statisticians starts with this µbasket¶ of purchases and calculates this year's CPI by expressing the cost of the basket in the current year as a percentage of the cost of that same basket in the base year.

More precisely: precisely: . The CPI is the weighted average of price movements of several thousands goods and services grouped into several hundred categories. categories.

e. 1997)  . Where the value of the basket represents total expenditure on (or the cost of) the basket in any period. month or year. The base year is an year. Suppose the CPI in 2001 equals 107. statisticians. 1997).6% higher than the average price of the same basket of goods and services in the base period (i..6. (i. suggests that the average price of goods and services in 2001 is 7. arbitrary year employed by the nation¶s statisticians. This 107.

3 Implicit GDP Deflator   Economists generally tend to prefer measures of the inflation rate that are broader than the CPI. It is equal to nominal GDP (expressed in dollars) as a percentage of real GDP (expressed in the dollars of the base year): year):  . The GDP deflator is an average of the prices of all goods in the economy. weighted by the quantities of those goods that are actually purchased. CPI. purchased.5.

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the inflation rate is -10 percent. that is. If the price level rises from rate. . percent. the inflation rate for the period is 10 percent. $20 per good to $22 per good over a period of time. there is a 10 percent deflation. deflation. percent.4 Inflation Rate  The percent change in the price level is called the inflation rate. If the price level falls from $20 per good to $18 per good.5.

that is. percent. the inflation rate for the period is 10 percent. If the price level rises from $20 per good to $22 per good over a period of time. there is a 10 percent deflation.5. percent.4 Inflation Rate    The percent change in the price level is called the inflation rate. deflation. If the price level falls from $20 per good to $18 per good. the inflation rate is -10 percent. . rate.

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6 Unemployment Statistics  Unemployment rate is the ratio of the number of unemployed (those seeking employment) to the total labour force .

thus will provide an underestimate of the number that would choose to work if a job were available. Discouraged workers are those who do not have jobs may have in fact abandoned hope of finding one.6.1 Problems with Unemployment Statistics    Economists believe that the statistics agencies¶ unemployment surveys provide too high an estimate of the true unemployment rate. available. Statistics will not count them as unemployed. . one.

 Employment rate is the ratio of employment to working age (adult) population: population: .

. employment.Labour force participation rate is the fraction of the working age population that is employed or seeking employment.

Thank You .

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