Gross Domestic Production of a Country - Essay Example

Gross domestic production: Introduction: Stutely (2003) defines GDP as the total value of all products which include all goods and services produced in a country in a year. The GDP level is an important measure that is used to determine economic performance of a country, the GDP level is compared with previous values to calculate economic growth and performance, it is also used to compare two countries economic performance. There are three approaches that are used in the calculation of GDP and this include the expenditure method, the income method and the value added or product method. GDP calculation: As pointed out above there are three approaches used in the calculation of GDP, according to Hardwick and et (2002) the three methods include: 1. The expenditure method: This method involves adding consumption, investment, government spending and net exports, therefore the GDP equation is defined as follows: GDP = Consumption + Investment + Government spending + Net Exports Where Net export = exports - imports Therefore the expenditure method involves adding up all the expenditure in an economy on finished goods. 2. Income method: This method involves the calculation of GDP by adding up all the factor income plus taxes minus subsidies on locally produced and imported goods, the following equation summarizes calculation of GDP using the income method: GDP = employees compensation + operating surplus + Mixed income + taxes - subsidies From the above equation employee compensation, operating surplus and mixed income added together are referred to as factor income. It is therefore evident that this method involves adding up income earned by factors of production. 3. Value added or product method: This is another method used in calculating GDP and the method involves adding up the unit rise in prices of products in the production stages. Therefore this method involves adding up contributions of the factors of production that add value to a product. Value is added either through services rendered and goods used to process final products. However calculation of GDP using the above three methods should be the same, the expenditure method is commonly used in many countries to calculate GDP due to the availability of data, the following is an analysis of changes in GDP due to increase in production and change in price. Scenario: The following information on the production of a good is provided, Lenovo produces 10,000 units of a product with a market value of 2,000 each in 2009 December; however no units are sold until spring of 2010. The following are the requirements: a) GDP increase in 2009: In this case the expenditure method will be used to determine the changes in GDP, from the above discussion it is evident that GDP = Consumption + Investment + Government spending + Net Exports Consumption: This is the sum of spending by individuals in the economy which include spending on final goods and services, durable and non durable goods. Investment: This is the sum of investment on inventory, machinery and structures, inventory includes unsold products. For this reason therefore the Lenovo products produced and not sold in this year will increase the level of investment in terms of an increase in inventory, the following is a summary of the calculations: Given that 10,000 units were produced and the market price of these products is 2,000 then it is possible to determine the GDP level increase as a result of this production, the value of these products is determined by multiplying the quantity produced and the prevailing market price, and the following formula is used: Value of products = quantity X price (Obstfeld (1997)) Substituting the values as follows: 10,000 X 2,000 = 20,000,000 dollars From the above calculation therefore it is evident that the GDP level in 2009 will increase by 20,000,000 dollars, this increase will be as a result of the increase in investment in the year 2009. b) GDP increase in 2010: The GDP level will be affected in 2010; there will be an increase in consumption in this year by 20,000,000 dollars, this is because in the calculation of GDP includes adding up consumption, and the increase in consumption in 2010 will lead to an increase in the level of GDP in this year by 20,000,000 dollars. Comparing the year 2009 and 2010 and the change in GDP in the two years it is evident that there will be no significant change in the GDP level as a result of production of this products and the sale of these product, this is because the products in the year 2009 are added up to GDP as investment and in the second year the product sale is recorded as investment, in the two years therefore GDP level will not have any significant change in GDP due to this change. This is one of the limitations of using GDP to determine economic growth, according to Common (1995) one of the limitations is that the GDP does not reflect whether the production in a country is as as a result of expansion of wealth in a country or consumption of capital, in the above case it is evident that in 2009 we have wealth creation whereby investment increase, however in 2010 we have consumption of produced goods which is a sign of consumption of capital. However despite this disadvantage the GDP level is still an appropriate way of determining economic growth in 2009 and 2010. c) Suppose IBM decides to actually raise their price at the beginning of 2010 and successfully sells all of them for $2,100 each in 2010. How does this affect 2009 GDP In the calculation of GDP prices are used for the current period or selected base year prices, GDP is classified as nominal GDP and Real GDP, Lipsey (2007) states that Nominal GDP is calculated using current period prices whereby the value of goods in an economy is calculated using the same year prices and that Real GDP on the other hand will determine the value of goods and services in the economy using a selected year price. The advantages of determining the real GDP level instead of nominal GDP is that the comparison of GDP will be comparing only differences in production and not differences in the value of goods. For this reason therefore real GDP compares changes in production while nominal compares changes in production and price changes, in this case we determine the effect of GDP level for the year 2009 given that IBM increases their price at the beginning of 2010 and successfully sells them in 2010. Changes in prices will affect the level of GDP determined using the product value method. This is because the value of goods is determined using prices in an economy, an increase in the price in 2010 will affect the GDP level of 2010, if we assume that IBM produces 100 units in 2009 and these units are sold in 2010 at a higher price then this will affect 2009 GDP, this is because the value of goods produced in 2009 will increase and therefore their value will increase, the GDP level in 2009 will therefore increase resulting from this increase in the value of goods produced in that country. From the above it is evident that an increase in price will affect the GDP level, from the above discussion the Value of products = quantity X price and therefore an increase in price will affect the value of these goods, for this reason therefore the GDP level for 2009 will increase as a result of an increase in prices in 2010. The real GDP because it only compares production changes over time, nominal GDP reflects both price changes and production changes over time and may not clearly reflect accurate results of economic growth. Conclusion: From the above discussion it is evident that an increase in production in country will increase the GDP, an increasing consumption will also increase the level of GDP, considering a case where production was undertaken in the previous year and consumption in the present year the level of GDP will increase at the same rate in both years. Another case considered in the paper a n increase in the price level of products produced in the previous year and this will affect the GDP level of the previous year because values of these products increase. References: Michael Common (1995). Sustainability and Policy: Limits to Economics, Cambridge: Cambridge University Press. Paul Krugman and Maurice Obstfeld (1997). International economics: theory and policy, New Jersey: Prentice Hall Press. Phillip Hardwick and et (2002). Introduction to Modern Economics, New Jersey: Prentice Hall Press. Richard Lipsey (2007). Economics, Oxford: Oxford University Press. Richard Stutely (2003). Guide to Economic Indicators: Making Sense of Economics, New York: McGraw Hill Press. Read More