Covering the Measurement and Calculation of Real GDP - Assignment Example

? Managerial economics Contents Introduction 3 Covering the measurement and calculation of Real GDP 5 Analysis of the advantages of using Real GDP 5 Analysis of the disadvantages of using Real GDP 7 Conclusion 9 References 12 Introduction The market value of all goods as well as services produced within the geographical boundaries of the country within a particular time period is regarded as Gross Domestic Product. The standard of living of a country is often measured by the per capita GDP. It will not be wise to think GDP per capita to be the measure of personal income. If the economic theories are taken into account, then per capita GDP will be same as per capita GDI (Gross Domestic Income). The goods as well as the services produced in a certain country and brought to the market have some price. Some experts regard GDP as the price of the total output. The GDP can be calculated in the following ways. Cumulative figure of all income within an economy or the total spending made by all the participating agents within the same economy is referred to as GDP. Both the spending and the income will roughly be the same. It should be kept in king that Gross Domestic product and Gross National product is not the same thing. The market value of the goods as well as services produced within a particular time period by the residents of a particular country is regarded as the GNP. It allocates the production based on the ownership. Three approaches can be used in order to determine the GDP. They are- the income approach, the expenditure approach and the product approach. The product also called as the output approach sums the total produced within the economy in order to attain the value of GDP. The expenditure approach assumes that the products produced must be bought by someone and so the total value of the product must be matched by the total expenditure of the people in purchasing things. The last approach takes into consideration that the value of the products must be equal to the incomes of the factors of production. It determines the value of GDP by calculating the sum of the income of the producers. The expenditure method: Where, C= Consumption, I=investment, G=government expenditure, X=exports, M=imports. The reciprocal circulation of income between the producers as well as the consumers is referred as the circular flow of income. From the circular flow of income the following equation is derived: Leakages=Injections (Tucker, 2010, p.429). i.e. S+T+M=I+G+X where, S= net savings, T=net taxes, M= import expenditure, I=Investment, G=government expenditure, X=export expenditure. It following equation can also be derived from the above: (S-I) + (T-G) = (X-M). If the value of the left hand side of the equation is negative, then it must have been financed from somewhere. The right hand side of the equation denotes the current account balance. Therefore, (S-I) + (T-G) = (X-M) + foreign savings The production method consists of three stages. In the first step the gross value of the output produced domestically is estimated. The second step involves determination of the value of intermediate consumption while in the third step the value of the intermediate consumption is subtracted from the gross value in order to arrive at the net value. The total of the gross added value in various activities related to the economy is referred to as GDP at factor cost. The sum of the indirect taxes and GDP at factor cost subtracted from subsidies will give GDP at producers’ price. There are two methods to determine the gross output of any sector. The gross output can be determined by multiplying the products of each sector with the respective prices prevailing in the market and add them up. It can also be determined by manipulating data on sales as well as inventories from companies records and again add them up. According to the income approach, GDP is calculated by summing up the incomes that firms are required to pay to the households for providing the production factors namely wages, interest, rents as well as profits. However, in order to calculate the GDP precisely, two adjustments are required to be made. In the calculation the indirect tax subtracted from subsidies are summed to arrive at market prices and depreciation is summed to arrive at the net value of the products produced domestically. The indicator is treated as a positive indicator of macro economics. The usefulness of the GDP in measuring the well being is under debate (Haggart, 2000, pp. 5-6). Covering the measurement and calculation of Real GDP Analysis of the advantages of using Real GDP The real GDP is calculated from total GDP subtracted from the effects of inflation. The real GDP shows its utility in order to compare between countries. Using real GDP one can compare the figures of GDP as well as the changes or the alterations from one country to another across time. In this way, real GDP helps to evaluate the worthiness of the economy of a nation in terms of product prices of certain period under consideration. Real GDP is widely used by the policy makers, internal agencies as well as the media as the scorecard that shows the health of the economy of a particular nation. The well being of the nation is reflected in real GDP. Experts are of the opinion that standard of the living prevailing in an economy is linked and well connected with Real GDP. Higher value of real GDP signifies that the economy under consideration is wealthy enough and has the capability to produce more. Higher productivity implies the individuals are better off and they enjoy a higher standard of living. Therefore, suing the real GDP it is possible to compare the productivity across countries as well as the economic health without bias. The GDP is the easiest to measure. The policy makers and the general public will be wisely benefited from the improvements to assess the well being of the individuals and the health of the economy. The per capita GDP is a prerequisite for improved techniques in decision making. The other indicators were inclined to attain the objective of sustainable development. There is an implicit link between economic growth and GDP. The GDP is often referred to be the proxy for human development as well as well being. But it is difficult to judge the relation between economic growths with well being. One of the other indicators that may be helpful in order to determine the well being of an economy is the average per capita GDP. It shows the share of each person within the total GDP if that could have been distributed into equal portions. An increasing value of the average per capita GDP tells there are more choices for the consumers ie. There are more goods as well as services available in the market and the consumers enjoy a better position to purchase them. The year to year value of GDP is often used by the economists to determine the success of economies. Inflation can limit the utility of using the GDP as the benchmark as GDP quantifies the total income of all people within the geographical boundary of a country. The usefulness accrued to the measure can be complicated by significant rates of inflation. The usefulness can face limitation when the value of the goods as well as services in the international market changes at a faster or at a slower pace relative to the labor involved in the production process. These limitations can be nullified by the use of real GDP. GDP are of two types- real and nominal. Real GDP has been discussed above and so some light needs to be thrown on nominal GDP as well. It is calculated at the levels of currency of the present market. Nominal GDP is often referred as adjusted GDP because it ignores inflation and deflation. The economic snapshot of a nation can be attained by nominal GDP. Experts use nominal GDP in order to assess the potential of an average consumer in order to afford something choosing a particular moment of time. The governments also include the nominal GDP in the process of budget making. The purchasing power of the country is also determined by the value of the nominal GDP. The value of real GDP is used by the authorities like World Bank and the International Monetary Fund to determine the potential of the economy to repay back the loans. Real GDP allows the policy makers to compare between the countries across multiple years. Real GDP is used by the multinational corporations to judge the location where they can send their investments in the form of dollars. If the value of the real GDP is higher in a particular country compared to another, the multinational corporation will be more inclined in investing in the country with higher value of real GDP as they belief that they have higher profit making opportunity in that part of the World. The targets of the currency exchange rates in also determined using the measure of real GDP. The national governments use the value of the real GDP in order to determine the effectiveness of economic policies. They do so by comparing the data on real GDP for a year with another. The Central banks as well take the help of real GDP to determine the fiscal policies and the appropriate rates of interests. The GDP acts as the barometer of the climate of business. A recession may result in negative value of GDP but it signals the policy makers and the government to adjust the existing policies (Morgenstern, 1975, p1). Analysis of the disadvantages of using Real GDP The real GDP suffers from some limitations as well. The first limitation is regarded as the limitation on the distribution of wealth. The GDP do not take into account the disparities in income levels between the rich and the poor. Since GDP shares a link with the economic growth this is a very important drawback. Several economists have regarded income inequality as one of the major concerns. Therefore one cannot ignore the importance of alleviation of income inequality to achieve long term economic growth. It can even be stated that increases in income inequality in the short term will lead to decrease in income inequality in the long term. The second limitations exist in the non-market transactions. The GDP often remain understated as it excludes the activities that are not operated through the market. The value of household work remains ignored in per capita real GDP sine such activities is not recognized in the market. There is some possibilities that a larger share of the gains in real GDP will move to comparatively smaller proportion of population. The gains are also likely to get skewed along ethnic lines, gender as well as race. The third limitation exists in what is called the underground economy. The underground economy is often ignored in the official calculation of real GDP. The GDP may remain underestimated as the transactions that contribute to production as well as illegal trade remain unreported. The changes in the quality of life remains ignored in the calculation of real GDP. Determinants like clean air, increased rate of life expectancy are not taken into account in calculation of real GDP. The cost of the undesirable changes like increase in traffic congestion or shortage of open space is ignored as well. The figure of GDP may result in low for economies where no money comes into the purview. It may be the case the one country has lower value of real GDP than another. Investments will get driven into the country with higher GDP figures but it may be the case that in that country there is lack of clean air or severe traffic congestion. Therefore only estimating the value of GDP fails to ensure that the economy is on the path of growth. The efficiency level is not taken into account. It may be the case that the new furnace is much more efficient that the old one but that improvement will not get reflected in the calculation of real GDP figures. The sustainability of growth cannot be measured by real GDP. A country can enjoy a temporary rise in the GDP figure by exploiting the natural resources or driving out the investments according to their wish. In calculating the growth of GDP, experts can come across problems like purchasing power of money. While calculating the growth of GDP across time the purchasing capability of money varies in dissimilar proportion respective to different goods. Therefore, when the figure of GDP is deflated with respect to time the growth can differ to a great extent depending on the goods chosen. One cannot regard the figure attained in real GDP as the measure of happiness. The real GDP may also suffer from the spillover effects. The GDP of a certain country can take the upward rising curve due to the production of the merit goods. Again the consumption of the same goods contributes to reduce the standard of living. Therefore a negative spillover effect is accrued in the calculation of real GDP. The income distribution of the population is not considered in the calculation of real GDP. The real GDP do not consider the products that are produced for self consumption. The interpretation and the use of GDP as the measure of social well being had to face significant criticisms from the economists since its inception. They opined that the GDP focuses only on the ongoing activities related to the economy and ignores the development in the natural or the social capital assets which are very important from the long term perspectives. It can also been found through Taylor’s rule that the real GDP rate is equally influential in affecting the stock market values (Federal Reserve Bank of Boston, n.d. p. 1-2). Conclusion The GDP is not the measure of the standard of living of the country. It can be used as an indicator that the population of a country would get benefitted from the increase in economic production. Per capita GDP cannot be used as the measure of personal income as well. It may be the case that the value of GDP increases while the real incomes decline. One can think of the advantage in measuring GDP per capita is that it is measured frequently as well as widely. It can also be taken to be consistent enough. The countries publish the GDP figures on quarterly basis. It allows to forecast the trends effectively. GDP allows for inter country comparisons. The definition of GDP is consistent across countries. It is estimated that the standards of living tends to move in line with the per capita GDP. Therefore one can detect the changes in the standards of living through changes in the GDP figure. The value of assets of an economy is not taken into account in GDP. The state of the economy is judged solely on the basis of the income statement. Since GDP fails to catch up with the requirements that is necessary for an indicator to deal with the economic well being, it is necessary to address the issues. One can think of an alternative measure that will take into account the issues relating to sustainable development as well as that of environmental degradation. Policy makers have put forward some measures but flaws are still in the purview. There is no such measure that deals with all the issues effectively and has the potential to overshadow the GDP. Monetary policies, implying changes in the Federal Funds Rates are likely to throw impacts over a large number of factors which guide the way in which an economy operates. For instance, changes in these rates could throw serious implications on the way that the investors decide their ventures, which in turn can significantly affect the GDP of the concerned economy. Although these implications are those applicable over the long run, the point is that a prior speculation of the monetary policy trends could guide the investors about the future economic traits and facilitate their decisions. Moreover, the policy makers, who are aware of the possible impacts of changes in the Federal Funds Rate, might also adopt additional actions to subside the multiplicative impact any policy implementations. Other than using the GDP as the economic indicator of social well being, one can use indicators like Genuine Progress Indicator, The Humana Development Index as well as the Index of Social Health. The various procedures in the preparation of public policy require the use of various different indicators. Although GDP certainly plays its part here but it can be complemented (Wesselink, Bakkes, Best, Hinterberger, Brink, 2007, pp. 12-14). References Tucker, I. 2010. Economics for Today. Available at: http://books.google.co.in/books?id=_GeHxvDMI6AC&pg=PA428&dq=circular+flow+model&hl=en&sa=X&ei=VJrIT5zNNMTTrQee5_nGDg&ved=0CEUQ6AEwAQ#v=onepage&q=circular%20flow%20model&f=false. [Accessed:17th August, 2012]. Wesselink, B.,Bakkes, J.,Best, A., Hinterberger, F., and Brink, P. 2007. “Measurement Beyond GDP”. [Pdf]. Available at: http://www.beyond-gdp.eu/download/bgdp-bp-mbgdp.pdf. [Accessed:17th August, 2012]. Federal Reserve Bank of Boston, n.d. “How Do We Measure Standard of Living”. [Pdf]. Available at: http://www.bos.frb.org/education/ledger/ledger03/winter/measure.pdf. [Accessed:17th August, 2012]. Haggart, B. 2000. “THE GROSS DOMESTIC PRODUCT AND ALTERNATIVE ECONOMIC AND SOCIAL INDICATORS”. [Pdf]. Available at: http://www.wikiprogress.org/images//THE_GROSS_DOMESTIC_PRODUCT_AND.pdf. [Accessed:17th August, 2012]. Morgenstern, O. 1975. “Does GNP Measure Growth And Welfare”. [Pdf]. Available at: http://mises.org/etexts/morgenstern_gdp.pdf. [Accessed:17th August, 2012]. Read More