Saturday, April 12, 2008

GDP calculation

Macroeconomics – National Economic Accounting: Past, Present and Future

Date: April 22, 2006

Question 1: Three approaches to measure GDP:
- Value-added approach: GDP is the sum of the value-added at each stage of production, where value added is revenues minus material costs.
- Income approach: GPD is total income which is the sum of rent, wages and profits.
- Expenditure approach: GDP is total spending on final goods and services of a nation. In other words, GDP = C + G + I + X – M where C is consumption, G is government expenditure, I is investment, X is export and M is import.
Among three methods, expenditure approach is the most widely used because it provides policy makers with the most usefulness in formulating economic policies.

Question 2: In general the final results of these three approaches should be the same because GDP measures the value of output of a nation in a specific period of time (1 year). However, the results are not the same in reality. The reason is that the information on which the data is collected may come from different sources and inevitably contains inaccuracies and round-up data.

Question 3: Depreciation is a decrease in the value of a property as a result of wear and tear, obsolescence, accidental damage and aging. In macroeconomics, depreciation covers reductions of the capital stock by disasters. If the capital depreciation is very large, the investment might not be sufficient to support rapid growth in the long run. Therefore, the term Net Domestic Product (NDP), which is GDP minus depreciation, is used instead of GDP.

Question 4: According to Kuznet, the value of net output is the sum of Income Paid Out and Business Saving, where Income Paid Out is the sum of wages, salaries, rent and distributed post-tax corporate profits, and Business Saving is positive business saving (investment, reserves, additions to capital stock) and negative business saving such as depreciation, depletion of natural resources and withdrawals from reserves.
According to Keynes, the value of the net output is the sum of consumption, investment and government spending. This approach incorporates the relationship between employment, the quantity of money, the interest rate and aggregate expenditures.

Question 5: The reason why Kuznet was unhappy with the inclusion of government expenditures in the value of output is the double-counting problem in calculating the output value. Kuznet argued that most government spending was on intermediate goods crucial to the production process rather than on the final products. Therefore, if the government spending is counted, there would be double-counted products in the value of net output and the true value of output would be over-calculated.

Question 6: Challenges in accounting for aggregate output:
Inputting Output:
- How to count for new goods and services that were unsold in the formal economy or that were unpriced in the market. The challenge to count the value of unsold goods such as home-made clothes, unpaid household work and unpriced services like free bank services remains the most difficult challenge that each country faces in calculating their GDP.
- How to count the value of the informal economy. If a country has a big informal economy like Colombia, GDP would be under-calculated if this country ignores the informal economic sector.
- How to count the value of barter if the country still has barter systems.
- How to measure the quality of goods produced. The quality of goods is not fully reflected on the price.
Natural Resources:
- How and what to count the value and depletion of natural resources. Even though UN has provided guidance on how to estimate the annual value of natural resources used, this calculation remains inaccurate since natural resources are what we might not be able to measure accurately.

Question 7: Factors that should be considered:
- The value of non-tradable, un-owned aspects of the environment such as clean air, clean water and climate
- The value of non-market economy of household and community
- The value of informal economy
- Unpriced social cost associated with production such as pollution and environmental degradation

Question 8: Reasons for the importance of the traditional GDP: The traditional GDP suggested by Keynes reflects the relationship between employment, quantity of money, interest rate and aggregate expenditures. Therefore it is:
- An essential tool for analyzing and assessing the state of a nation’s economy.
- A valuable metric for short-term macroeconomic planning because the government can use fiscal and monetary policies to push or cool down the economy.
- An essential tool for formulating macroeconomic stabilization policies.
- An important indicator of the economic growth and potential for investors.

Question 9: Arguments for the environmental accounting:
- Economic growth must be sustainable, growth together with environmental protection.
- Sustainable growth is needed to ensure that our younger generations could have living standards at least as high as those of current generations.
- GDP will provide a more complete overview of economic performance and living standards than GDP without concerning about environmental matters.
- The value of output in environmental accounting (NNG) would be a better indicator of sustainable social well-being than traditional GDP.
- NNG would help policy makers make better decisions in planning the economic growth strategies for a nation.

Question 10: Reasons for “A higher GDP is not necessary mean a higher measure of welfare”:
- GDP might be over or under calculated, depending on the methods of collecting and interpreting data.
- GDP ignores the value of non-market economy of household and community such as recreation, intellectual capital, education…
- GDP treats depletion of natural resources, pollution, environment degradation, disasters as income because it measures expenses on those areas as economic gains.
- GDP takes no account for income distribution.
- GDP ignores the drawbacks of borrowing money from other countries.

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