GDP Gauges the Status of a Countrys Economy - Essay Example

GDP The gross domestic product (GDP) is regarded as one of the primary indicators that can be used to gauge thestatus of a country’s economy. It is known to represent the total value of all goods and services that are produced over a given period of time. It can be regarded as the size of the economy. More often than not, GDP is usually expressed as a comparison of the earlier quarters or year. For example, if he year to year GDP is up to 4 % this is then perceived to mean that the economy grew by 4% over the last year. Measuring GDP is a bit complex, but the most basic form of the calculation can be done in two ways: this is through adding up what everyone earned in a year (income approach) or adding up what everybody spent in a year (expenditure method) (Baumol et al 69). Both methods can give you roughly a similar total. With the income approach, which is also known as (GDP) I is calculated by adding the total compensation to gross profits, employees for both incorporated and non-incorporated firms in addition to taxes without any subsidies. On the contrary, the expenditure method is a more usable or common approach and is calculated by adding investment, total consumption, government spending and net exports. Introduction GDP is termed as the market value of all the final goods and services that are produced domestically in one year. It is also regarded as the single most important measure of macroeconomic performance. It is closely related to the measure of the economy’s total output of products known as gross national product (GNP). This is regarded as the market value of all the final goods and services produced by a nation within a year. The difference between GDP and GDNP is a bit complex. In much more simpler terms, GDP involves only goods and services that are produced by a nations’ own people and their corporations. The goods and services that are produced from outside the nation’s boundaries by the nation’s own citizens and corporations are included in the GNP but excluded in the GDP (Taylor 32). On the contrary, the goods and services that are produced within a nation’s boundaries by foreign citizens and their corporations are excluded in the GNP but excluded in the GDP. In retrospect there is not a lot of difference in the reports value of GNP and GDP. A person can either use statistics to calculate the overall macroeconomic activity. Measuring GDP: The expenditure and income approaches There are two distinct ways of measuring GDP, the income and expenditure approach. In the expenditure approach, we add up the market value of all the domestic expenditure that was made on the final goods and services in a single year. The final goods and services are known as the goods and services that have been purchased for the final use or the goods and services that will not be used in production or resold again in that specific year. On the contrary, the intermediate goods and services are those that can be used in the production of the final goods and services. This type of foods and services are not included in the expenditure approach to obtain the GDP. This is due to the fact that expenditures on intermediate goods and services are included in the market value of expenditures that are made on the final goods and services (Mankiw 89). Therefore, including both intermediate and final goods and services using the expenditure approach will lead to double counting thus and exaggeration of the true market value of GDP. The total expenditure of the final goods and services can be broken down into four large types of expenditure categories with reference to the types of goods and services that are purchased. The average total of the four types of expenditure adds up to give us the GDP. These include: a) Investment expenditure: this can be divided into two groups: expenditures on fixed investment goods and that on inventory investment. The fixed investment goods are those that a regarded as useful over a long period of time. Examples of fixed investment goods include purchases of factories, warehouses, new machines and equipment and residential housing. Other expenses that can be included in fixed investment expenditure are the amount that will be used in replacing or repairing the already existing investment goods that have been worn or damaged. The market values of the investment good that will be replaced with a year are termed as depreciation for that year. On the other hand, inventory investment includes goods that are waiting to be sold that the corporation has had for the single year. The year- on year change in the market the corporation's inventory goods is termed as investment expenditure as these goods will eventually produce a flow of production or consumption service in the next year (Baumol et al72). b) Consumption expenditure – this includes personal consumption expenditure on goods and services. This usually compromises the largest share of the total expenditure. The consumption expenditure includes purchases of nondurable goods such as clothes and foods and, also durable goods such as household applications and automobiles. It includes purchases of all kinds of services that are offered by people like mechanics, barbers, lawyer and doctors. c) Net export – Exports are termed as goods and services that are produced by people or firms domestically but are sold to foreigners while imports are the goods and services that are produced by foreign countries and sold domestically. With reference to the expenditure approach, expenditures that are incurred on exports are included in the total expenditure. On the contrary, the expenditures that are incurred on imports are subtracted from the total expenditure. Another method that can be used is by calculating the net export which is termed as the expenditure on exports minus hat on the imports and the value obtained added to the total domestic expenditure. d) Government expenditure – the government expenditure includes the consumption and investment of goods and services which are added separately when using expenditure approach to GDP. Examples of government expenditure include the expenses in military personnel, civil servants, the construction of public buildings and public roads (Mankiw 89). The recipients of transfer payment do not offer any current goods therefore they are not involved in the purchase of any goods or services. In the income approach, GDP is measured by adding up all the income that is earned household and corporation in a single year. The concept behind the income approach uses the principle that the total expenditure on final goods and services can be obtained by households and corporations in the form of rent, interest rates, wage and profit. Thus, when you add up all this together, you should be able to get the same value like when using the expenditure approach. Nonetheless, there are two types of expenditure that are included in the expenditure approach when measuring GDP however; they do not provide households and corporations with any time of income. These include indirect business taxes and depreciation. Mathematical method of determining GDP GDP = domestic consumption + gross investment + government Spending + (export –imports) Importance of GDP GDP is a very useful for determining the economic status of a country. GDP represents the economic production and growth which has a huge impact on every individual within that country. For instance, when the economy of a country is healthy, there will be indicators such as low unemployment and an increase in wage as there will be an increased demand for business labor that will drive the growing economy (Baumol et al 66). A change in the GDP either up or down will have a profound effect on the stock market. So, a positive GDP growth shows that a country had a good economy while a negative GDP growth shows that the country has a bad economy. GDP is a good indicator that economist use to determine if the economy is going into recession. The Great recession of 2007 -2008 The Great recession also known as the long recession is marked a global economic decline that start in December 2007 up to September 2008. The better part of the crisis was manifested by a liquidity crisis. Most of the banks terminated withdrawals, the housing bubble that had peaked in 2006 fell and this caused the real estate prices to plummet. All the financial institutions were closed. The global recession affected the entire world economy. Recessions pose significant challenges with regard to the accuracy of economic indicators such ad GDP (Taylor 46). In America the real GDP began contracting in the third quarter of 2008. The countries that were affected had to obtain an economic stimulus from G-20 group members that played a major role in the economic and crisis management. The Federal reserve, security and Exchange Commission also help to intervene the crisis and return he economy to normalcy. The area that is shaded in the above diagram shows the beginning and the end of the economic recession. In conclusion, GDP is defined as the market value of all the final goods and services that are produced domestically in one year. It is used to represent the total value of all goods and services that are produced over a given period of time. It can be regarded as the size of the economy. More often than not, GDP is usually expressed as a comparison of the earlier quarters or year. There are two distinct ways of measuring GDP, the income and expenditure approach. GDP is a very useful for determining the economic status of a country. It is used to determine the status of the economic production and growth of a country which has a huge impact on every individual within that country. Bibliography Baumol, William J, and Alan S. Blinder. Macroeconomics: Principles and Policy. Mason, OH: South-Western Cengage Learning, 2008. Print. This book gives great insight on Gross Domestic Product and how calculated. The Keynesian model is used in teaching how this this economic indicator works. The author gives a detailed explanation of how GDP is a fundamental tool for learning macroeconomics. The author uses well developed examples of how countries dealt with the recession. Mankiw, Nicholas G. Principles of Economics. Mason, Ohio: Thomson South-Western, 2011. Print. Mankiw’s book provides the reader with a detailed research with learning and reinforcing principle on how to calculate GDP and why it an important indicator. The book has various tutorials that help the readers to understand the significance of GDP and why foreign investors should to invest in countries that have a positive GDP growth. Taylor, John B. Economics. Boston, Mass: Houghton Mifflin, 2008. Print. This book offer great insight on the two methods which can be used to calculate the GDP. It gives a step by step approach that can be used to get the market value of the final goods and services that are produced domestically. Being a superb writer and economist, the author describes the importance of GDP and its significance when determining the economic status of a country. Read More