The Economics Of Gross Domestic Product - Case Study Example

Running Head: THE ECONOMICS OF GROSS DOMESTIC PRODUCT The Economics of Gross Domestic Product In APA Style By University Explain the distinction between nominal and real GDP and retrieve a time series for each from http://www.statistics.gov.uk or elsewhere. The well being and economic performance of a country is often directly measured through the value of its Gross Domestic Product (GDP). The most common computation of GDP is called expenditure method which aggregates the country's consumption, investment, government spending, and net exports (Parkin 2003). GDP is often expressed as either nominal or real GDP. When UK GDP trend from 1948 to 2005 is expressed in these measures and are graphed together, it should be noted that this will result into two different lines indicating the disparity between their values. The following table shows the nominal and real GDP of UK from 1948-2005 expressed in terms of country's domestic currency. Typically, an economy's GDP is expressed in nominal terms. Nominal GDP is measured in current prices, that is, each final good or service produced by the country is valued at the current price that it was sold (Begg, Fischer and Dornbusch 2000). Because it is a measure of production terms of current prices, nominal GDP directly reacts to increases and declines in prices or quantities of goods. Because GDP is primarily the market value of all goods produced, nominal GDP is not an efficient measure of an economy's actual level of production (Begg, Fischer and Dornbusch 2000). Real GDP, on the other hand, recognizes that the price level of goods and services produced by an economy changes over time which causes the movement in the value of GDP. It should be noted that an improvement in nominal GDP can be bloated by the mere increase in price level due to inflation. Thus, real GDP eliminates this possibility and renders a more accurate measurement by expressing the value of total production in terms of constant prices. In the computation of real GDP, the price level in a chosen base year is kept constant and functions as a deflator of the nominal GDP (Sloman 2003). Because changes in real GDP are solely brought about by more efficient and higher level of output, they are often referred to as economic growth rates. To what extent can a measure of GDP really measure the well-being of a country Assess the problems and suggest alternative measures or indicators. Currently, GDP is the most popular measure of the economic performance and well being of a country. It should be noted that the rise in GDP is almost often directly equated with economic growth. In a practical sense, the use of real GDP in assessing the health of an economy is somehow "satisfactory" as it indicates how materially well-off the population is. Since GDP eliminates the possibility of double counting by computing production via the value added, it gained recognition as an accurate and comprehensive measure of an economy's output over time. Even Paul Samuelson, Nobel Laureate, describes GDP as "truly among the great inventions of the 20th century, a beacon that helps policymakers steer the economy toward key economic objectives (Is GDP a Satisfactory Measure of Growth 2005, pg. 1-3)." However, amidst all the popularity and recognition that it receives, the appropriateness and adequacy of the GDP as an indicator of economic welfare is challenged because it only "measures the total market value of production but tells little about how economic returns to factors of production are distributed among society" (Messinger 1997). Amidst its widespread use, GDP receives criticisms because of its simplistic view of the components of economic performance and welfare. GDP also fails to include all the production in the economy since its computation does not take into account production outside formal marketplace such as underground market, unpaid housework, childcare, and even volunteer work. Also, GDP does not consider changes in leisure which directly accounts the opportunity cost of work. In a sense, calamities and other man-made disasters and accidents all contribute to the value of GDP as they require more production. Yet, it should be noted that these do not add but diminish the overall well being of the society. Summarizing the discourse of Messinger (1997), GDP is flawed for the following reasons: "it does not include the value of non-market production and leisure; it contains intermediate and regrettable expenditures that do not contribute to economic welfare; government expenditure on health, education, social services and environmental protection does not necessarily reflect outcomes in these areas; it does not account for resources required for sustainable development; and it does not directly measure investment in social capital." Recognizing the flaws of GDP in measuring the actual well-being of a country, alternative measures are suggested and utilized by economists. By far, two of the most popular measures are Measures of Economic Welfare (MEW) and Genuine Progress Indicator (GPI). MEW is originally developed by two Yale economists, Nordhaus and Tobin in the 1970s which is defined as the "adjusted measure of national output, including only consumption and investment items that contribute directly to economic well-being" (Samuelson and Nordhaus 1998) This measure recognizes the limitations of the GDP as a measure of economic welfare and thus, includes items which GDP fails to take into account. Notably, the computation of MEW includes the value of leisure and the underground economy and deducts detrimental situations like environmental damage. The formula for the computation of MEW is as follows: Total Consumption = Personal Consumption Expenditure - Private Instrumental Expenditures - Expenditures on Consumer Durable Goods - Private Spending on Health - and Education + Services of Consumer Capital + Value of Leisure + Value of Non-market Activities + Disamenity Correction + Government Consumption + Services of Government Capital It should be noted the MEW is created in consideration of the flaws of GDP as a measure of a nation's economic well-being. However, as with any established measures, it is also has its own share of criticisms. MEW is regarded inefficient because it makes "no adjustments for inequality in personal consumption; no accounting changes in natural resource stocks; no adjustments for changes in the quality of environment, subjective inputed value of non-market activities, and investment in human capital (Messinger 1997)." The GPI is another measure of economic well-being which has been widely used by economists from the 1950s to the present. It is developed by a US research group named Redefining Progress and is split into two blocks: "a measure of current economic welfare and a measure of sustainable economic development" (Messinger 1997). Like the MEW, the creation of the GPI is an effort to overcome the shortcoming of GDP in measuring the welfare of an economy. Thus, it also contains the factors which are not covered by the GDP like the "contribution of family and community realms, and of the natural habitat, along with conventionally measured economic population" (What's Wrong with the GDP n.d.). However, the computation of GPI is much more complicated because it takes into account more than twenty aspects in the economy which the GDP fails to include. This measure comprises estimates of the economic contribution of numerous social and environmental factors as well as differentiates economic transactions which enhance the welfare as well as those which diminish it (What is Wrong with the GDP n.d.). While the GDP is only perceived as a measure of economic well-being, the GPI is more comprehensive as it shows how a country is performing over time. As mentioned above, the computation of GPI is complicated by the number of variables that it includes. Aside from the factors which are already taken into account in the GDP, GPI also embraces variables like "crime and family breakdown, household and volunteer work, income distribution, resource depletion, pollution, long-term environmental damage, changes in leisure time, defensive expenditures, lifespan of consumer durables and public infrastructure, and dependence on foreign assets (What is Wrong with the GDP n.d.)." Like the GDP and MEW, the computation of the GPI starts with the personal consumption expenditures as a base. The formula of GPI is as follows: GPI = Personal Consumption Expenditures + Value of Time Spent on Household Work, Parenting, and Volunteer Work + Value of Services on Consumer Durables + Services of Highways and Streets - Defensive Expenditures + Social Costs (Divorce, Crime, and Loss of Leisure Time) - Depreciation of Natural Resources and Natural Resources Notably, the inclusion of these various factors widen the very simplistic approach of GDP in measuring welfare through the use of variables which are outside the realm of the economy-environmental and social. It takes into stresses and highlights the fact that material wealth is not the sole basis of economic well-being and performance of a country. Its emphasis is on quantifying the qualitative factors which affects the utility of individuals in the economy. GPI shows the welfare is large a factor of the prevailing social conditions and looks forward by integrating the importance of sustainable development. References Begg, D., Fischer S. and Dornbusch R. 2000, Economics, 7th ed., McGraw Hill. Is GDP a Satisfactory Measure of Growth 2005, Retrieved 07 May 2007, from http://www.oecdobserver.org/news/fullstory.php/aid/1518/Is_GDP_a_satisfactory_measure_of_growth_.html Messinger, H. (1997). "Measuring Sustainable Economic Welfare." Statistics Canada. Retrieved 07 May 2007 from http://www.csls.ca/misc/cea9731.pdf Parkin, M. 2003, Economics, 6th ed., Addison-Wesley. Samuelson, P. and Nordhaus, W. 1998, Economics, McGraw Hill Sloman, J. 2003, Economics, 5th ed., Prentice Hall What's Wrong with the GDP n.d., Retrieved 07 May 2007, from http://dieoff.org/page11.htm Read More