Measuring Domestic Output and National Income PDF

Measuring Domestic Output and National Income Lecturer: N. Malimba Learning outcomes By the end of studying this chapter, you should be able to: Explain how GDP is defined and measured using the expenditure, income and production approaches; Explain the re...

Measuring Domestic Output and National Income Lecturer: N. Malimba Learning outcomes By the end of studying this chapter, you should be able to: Explain how GDP is defined and measured using the expenditure, income and production approaches; Explain the relationship between GDP, net domestic product, national income, personal income and disposable income; Calculate GDP and net domestic product at factor cost, basic and market prices from data; Explain how inflation affects GDP (real and nominal measures) and the function of a GDP price index; Discuss some of the limitations of GDP as a measure of economic progress. 2 National Income Accounting Measures the overall performance of an economy so as to: – Compare levels of production at regular intervals – Track economic growth in the long run – Develop policies to keep the economy as close as possible to Y* (Potential GDP) ○ Use measures of domestic output and national income 3  Gross domestic product & Gross national income GDP (location based): – Market value – Final goods & services – Produced within the borders of a country – In a given time period GNI (ownership based) – Market value – Final goods and services – Produced by residents or businesses from the country – In a given time period 4 Types of GDP – difference due to taxes (increase market price) & subsidies (decrease market price) GDP at factor costs Associated with income approach GDP measured by adding up all income received by 4 factors of production (land, labour, capital, entrepreneurship) i.e. rent, wages, interest, profit. GDP at basic prices (+ taxes - subsidies on production) Associated with production approach GDP factor cost + production taxes – subsidies on production. GDP at market prices (+ taxes - subsidies on products) Associated with expenditure approach GDP = C + I + G + (X – M) GDP at market prices (price paid on the market which is increased by taxes and reduced by subsidies) 5 GDP at factor cost, basic prices and market prices (SARB, 2021) 6 GDP should… Account for inflation (real versus nominal GDP) Avoid double counting (don’t count goods used in stages of production before final good reaches the market) i.e. intermediate goods. Exclude financial payments – Public and private transfer payment – Second-hand sales 7  Gross Domestic Product · The rest of the world buys goods and services from us, X and sells us goods and services, M (through goods market) · - Net flow = X - M 8  Gross Domestic Product – Blue = income (through factor market) – Red flows = circular flow of expenditure through goods market. – Green flows = borrowing and lending (financial markets). – Note: One person’s spending becomes another’s income 9 Approaches to measuring GDP 10  GDP (exp) = C+I+G+(X-M) Consumption (C): exp. by HH on goods & services Gross investment (Ig): exp. on machinery, equipment, tools; construction; inventories (accum stock - positive or negative); includes depreciation – Net investment = gross investment – depreciation – Can gross investment be negative? Government purchases (G): Gov spending on goods & services; not incl. transfer payments Net exports (Xn): Exports minus imports 11 C, I, and G in South Africa 12 National Income Accounts:Q1 2020 at current prices (Rm) 13 GDP from the income side (market prices) GDP (income) = · Compensation of employees (wages) · Net operating surplus (rent, interest, owner’s income, corporate profits) · [+production/product taxes – production/product subsidies]: the adjustment to get from GDP @ factor cost to GDP @ mkt P’s · + depreciation: to adjust net operating surplus and therefore GDP from NET to GROSS 14 GDP from the income side · Subsidy/Tax adjustments are to ensure final value of goods and services produced at market prices. E.g. Maize subsidy R 10 000 – Market value = R 20 000 – Total income = R 30 000  Market value produced is total income earned from product – less subsidy.  +Depreciation: value that must be invested to maintain existing capital stock (to give GROSS DP). 15 An example Calculate: Net interest 237 1. Net Domestic Product G purchases 147 (NDP) at factor costs Wages 1189 2. Net Domestic Product at market prices Rental income 78 Production Tax 43 3. Gross domestic Subsidies 28 product using income approach at mark at Profits 194 market prices. Depreciation 112 Net interest 237 Gov purchases 147 Wages 1189 Rental income 78 Production (Indirect) Tax 43 Subsidies 28 Profits 194 Depreciation 112 NDP at factor cost? NDP at market price? GDP at market price? NDP at factor cost = 237 + 1189 + 78 + 194 = 1698 NDP at basic price = 1698 + 43 – 28 = 1713 GDP at market price = 1713 + 112 = 1825  The Value Added approach Stage Sales Value Add up the value added value of adde product d at each stage of production = GDP 1. Farmer - - 2. Wool 120 120 processor 3. Jacket 180 60 Value added = market manufacturer value of a firm’s output 4. Clothing 220 40 wholesaler MINUS the value of a 5. Clothing 270 50 firm’s inputs retailer 6. Total sales 350 80 value Value added R350 Other national accounts: Household Income HH income (HI): earned and unearned income received by households. Received, but not earned: Transfer payments (grants, pensions, etc) Earned, but not received: Taxes & undistributed profits Disposable income: HI - Tax Yd = C + S = HI - Tax 19  The importance of real GDP GDP at real prices : Food prices over time. Coca-Cola invented in 1886 and sold for 1886: $5c a glass 1950: $7c per bottle 1995: 99c per 2l bottle 2011: $1.89 per 2l bottle 2020: $2.27 per 2l bottle Macdonald’s Hamburgers 21 But taking into account purchasing power…. 22 Real GDP & the Price Level: The GDP deflator Deflating the GDP Balloon · – Nominal GDP increases because of increase in production and prices. Need to deflate GDP balloon (from nominal to real) which increases over time. How do we deflate? 23  How to deflate GDP How to measure real GDP 2 Methods Calculate: 1. Calculate price index from price changes, use price index to estimate real GDP from nominal 2. GDP from physical outputs and use base year prices. Can then calculate GDP price index Some points to note: CPI = prices of a representative basket of goods & services by avg urban consumer GDP price index – same as CPI but also measures price change for goods & services purchased by businesses, governments, and foreigners. GDP price index used to deflate GDP nominal to real. 24  Real GDP from price changes ○ Price index = Price of market basket in a specific year / price of market basket in base year ○ Year 1 10/10 = 1; x 100 = 100 ○ Year 2 20/10 = 2; x100 = 200 ○ Year 3 25/10 = 2.5; x 100 = 250 – Real GDP = Nominal GDP/Price Index – Use example one market economy – Pizzas Year Units of Price of Price Nominal Adjusted Output Pizza per Index GDP Real GDP unit (year1 = 100) 1 5 10 100 (1) 50 50 (50/1) 2 7 20 200 (2) 140 70 (140/2) 3 8 25 250 (2.5) 200 80 (200/2.5) 25 2. Calculate real GDP from output;Calculate price index from real and nominal GDP Use physical outputs and base year prices Determine market value in successive years if price remains the same Real GDP = Output*Base year prices. Price index (in hundredths)= Nominal GDP/ Real GDP ○ Year 1: 5*10 = 50 Year 2: 7*10 = 70 ○ Year 3: 8*10 = 80 Year Units of Price of Price Nominal Adjusted Output Pizza Index GDP Real per unit (year1 = GDP 100) 1 5 10 100 50 50 (5*10) 2 7 20 200 140 70 (7*10) 3 8 25 250 200 80 (8*10) 26 Price index from nominal & real GDP Real GDP = Nominal GDP/Price Index GDP (Q1 2019) @ current prices = R4 837 879m GDP (Q1 2019) @ constant (2010) prices · = R3 225 168m What is the current GDP deflator? Price index = nominal GDP/real GDP = 4837879/3225168 = 1.5 (or 150 as an index number) Nominal GDP I-GDP elinganiselweyo Nominale BBP The GDP measured in I-GDP elinganiswe terms of the price level ngokwenqanaba Die BBP gemeet in at the time of lexabiso ngexesha terme measurement lokulinganiswa van die prysvlak ten (unadjusted for (engalungiselelwanga tyde van die meting inflation) ukunyuka (nie vir inflasie kwamaxabiso). aangepas nie). 27 What is GDP used for? Comparing living standards & welfare over time Make international welfare comparisons Asses current situation & make predictions about the future so that stabilization policies can be used. 28 Problems with using GDP as an indicator of welfare GDP leaves out some vital welfare information: Quality improvements Household production/non-market activities Quality of Life (Health & life expectancy; Leisure time; political freedom etc.) Does not reflect the value of informal sector Environmental quality READ textbook for more information 29 GDP uses: International comparisons and forecasting To make international comparisons – Express GDP in one exchange rate – Purchasing power parity Forecasts for policy use: Can show cyclical changes towards achieving potential GDP BUT doesn’t take into account increases/decreases in HH production & leisure time, so may overstate fluctuations. GDP per capita (World Bank data) https://data.worldbank.org/indicator/ny.gdp.pcap.cd?most_recent value_desc=fals 30 Coming up next………………… · Wage determination and the classical model 31