Unit 3 – Economic Measures of Performance

1. Unit 3 – Economic Measures of Performance Lesson 1 – GDP _Gross Domestic Product

2. Gross Domestic Product • Gross Domestic Product (GDP) is the most commonly referred to economic indicator to measure a country’s economic progress year after year.   • GDP represents the total market value of all final goods and services produced in a country in a given year (national income).  

3. How to Calculate GDP • 2 approaches: - Expenditure approach - Net Income approach

4. Expenditure Approach • The expenditure approach calculates GDP as the market value of final output by adding up expenditures made on the final purchase of goods and services.  • Total expenditure is the sum of four broad categories.  • The overall formula used to calculate national income through expenditures is:  C+ G+I (X-M)

5. Expenditure Approach - Consumption • Consumption expenditure (symbol=C) • This includes expenditures on all goods and services produced and sold to final users of a product.  • Example:  Haircuts, automobiles, medical care, clothes, food, computers etc.

6. Expenditure Approach - Investment • Investment Expenditure (symbol=I) • This is the expenditures of goods not for immediate consumption.  It includes inventories, capital goods, warehouses and residential housing. • These are considered investment goods.  

7. Expenditure Approach – Government Expenditure • Government Expenditure on Goods and Services (symbol=G) • When governments provide services or goods to households, this is included in the GDP.  • Such service includes roads, garbage pickup, policing services, health care services, court of law etc. • It is important to note that only currently produced goods count in this category and not future goods.

8. Expenditure Approach – Net Exports • Net Exports (symbol=X-M) • The fourth category arises from foreign trade. This category is separated into two areas:  Imports and Exports.                    a)  Imports (symbol=M) • This includes any goods or part of goods or services that are produced in another country.   While we may claim part of the value of these goods or services, we cannot claim what was produced in another country. •                     b)  Exports(symbol= X) • These include any goods that are sold in economies other than our own.   • A few notes about these two:  Exports are subtracted from imports to give us net exports.   A positive net export is desirable and healthier for a country. In other words, we want our country to export more than it imports.   In recent years, certain developed economies have run trade deficits, for example the United States. 

9. Income Approach to Calculate GDP • Wages - This includes the wages and salaries for the services of labour.   This includes your pay, taxes, pension fund contributions etc. • Rent - Rent is the payment made for housing and commerce.  For the purpose of calculation, owner occupied houses are calculated in this line item. • Interest - Includes any interest that is earned on bank deposits, loans etc. • Profits - This includes any dividends paid out by companies to shareholders as well as retained earnings

10. Income Approach to Calculating GDP • The sum of these four factors is called Net domestic income at factor cost. • GDP = Aggregate Income = Wages + Rent + Interest + Profit

11. Limitations of using GDP as a measure of economic progress • GDP as a measure of economic welfare, like other economic indicators, has limitations. • By welfare we mean the quality of life experienced by the average Canadian citizen. • We examine the consumption of leisure and the quality of life.

12. Limitation – Consideration 1- Population • Population SizeComparing GDP from previous years can be tricky.  If there was a significant growth in population, we must ask ourselves: has output per person actually grown?  Example:  If Canada’s population grew by 4% and the GDP grew by 2% did we actually increase output?  • NO.

13. Limitation – Consideration 2- Non Market Production • GDP only counts output that has a monetary value attached.  • For example, your dad may stay home to take care of you, but since this is unpaid labour it does not count in the overall value of GDP.  • Despite this, most would agree that this kind of contribution to the overall good of the society is very important.

14. Limitation – Consideration 3- The Underground Economy • Any transaction that is unofficial and done without reporting transactions to the government is considered underground.  • For example:  Illicit drugs are a huge market in Canada, yet no official means of tracking this exists.   • Many argue for the legalization of drugs based on the tax revenue and income that is lost by not tracking such items.  Some statisticians believe that up to 20% of the GDP is unaccounted for because of underground activity.

15. Limitation – Consideration 4Nature of Products/Services • Some argue that the inclusion of all types of goods and services weakens the GDP as a measure of well being.  For example, the number one export for some countries is weapons.  Should these be allowed as measure OF WELL BEING?  

16. Limitation – Consideration 5Leisure • If workers work many more hours, the GDP would definitely grow.  • On the other hand, a society where everyone works all the time would probably not be a pleasant society in which to live. • Leisure time is considered valuable by many even if it often has no monetary value. Imagine lazing on the beach in Barbados 24/7 in a hut with more than enough coconuts and fish to get by versus working 24/7 in the freezing cold of the Artic with enough ice and seals to get by.

17. Limitation – Consideration 6Environmental degradation • The GDP does not take into consideration the social costs and /or degradation of the environment.  A country could have no environmental regulations yet have a very high GDP output. It begs the question, “is this country really well off?”