UNIT 2 Measuring the Performance of the economy OBJECTIVES • Upon completion of this unit students should be able to: • Distinguish between GDP at factor cost and at market prices. • Distinguish between GDE and expenditure on GDP. • Calculate GDP using the three different methods. • Differentiate between nominal and real GDP. • Derive personal disposable income from GDP. 1. DEFINITION AND CONTENT OF THE VARIOUS ACCOUNTS • Countries record all transactions that take place inside the country as well as with other countries. • The methods used to measure the performance of the economy is known as the National Accounts (NA). • NA helps us to measure and analyse: • How much our nation is producing and consuming. • All economic activities regarding production, income, expenditure and trade with rest of the world as illustrated in the circular of income are summarised in the National Accounts. NATIONAL ACCOUNTS Account 1: Gross Domestic Product and Expenditure Account 2: Gross National Income and the way it is appropriated. Account 3: Gross Capital Formation and the way it is financed. Account 4: The account with the rest of the world (Balance of payment). • Account 1,2 and 3 deals with the domestic economy. • Account 4, Deals with foreign sector and record all transactions with the rest of the world. 2. ACCOUNT 1: GROSS DOMESTIC PRODUCT AND GROSS DOMESTIC EXPENDITURE GDP: is the market value of all final goods and services produced inside the borders of a country for a period of one year. Final goods and services: Everything that is produced and sold to the end user for consumption. They are not used to produce other goods and services. E.g. If you buy bread at a shop and take it home to eat, the loaf of bread is a final good and is included in the GDP. Intermediate goods: are not included in the GDP. E.g. If you buy bread and use it to make sandwiches to sell at school, the bread is an Intermediate good and the Sandwich is the final good. Market value: GDP is measured in terms of the prices paid for goods on the market. Taxes and subsidies influence the prices of goods and we need to take them into consideration. 2. ACCOUNT 1: GROSS DOMESTIC PRODUCT AND GROSS DOMESTIC EXPENDITURE • “Within the borders of the country” or domestic: Production that takes place in a country by citizens of the country as well as foreigners who live and work in the country is included in the GDP. GDP vs GNP • GDP: Measure production that takes place inside Namibia. Including production by foreigners who live and work in Namibia but excludes production by Namibians who live and work in other countries. • GNP: Measure production by Namibians. It excludes the production of Foreigners who live and work in Namibia. CLASS ACTIVITY 1 1. Which of the following are final goods or services, and which are intermediate goods or services? a) A haircut purchased from a hair salon b) A new automobile c) An oil filter purchased in a new automobile d) Crude oil 3 METHODS USED TO CALCULATE THE GDP • The income method: It involves adding up all theincomereceivedbythefourfactorsof production. • The expenditure method: This method involves counting expenditure on goods and services by the four sectors of the economy. • The value added method: This method measures activities inside businesses that occur as products move through the different stages of production. A) INCOME METHOD The income method uses the income earned by various factors of production to calculate the GDP. Compensation of employees: This item includes all salaries and wages. Net operating surplus: Profit earned by entrepreneurs. Consumption of fixed capital: Capital goods such as machines and equipment are consumed when production takes places. A part of every year’s production must be used to replace the old capital goods. In the national accounts it is called consumption of fixed capital. Taxes on production and products: Refer to indirect taxes that are levied on economic transactions. They are added because they increase the market prices of goods and services. Subsidies on the production and products: subsidies are deducted, because they decrease the market prices of goods and services. FACTOR COST AND MARKET PRICES • GDPatfactorcost:Measures the cost to businesses to employ the four factors of production. • GDPatmarketprices:Include the prices consumer will pay for the goods on the market. The difference between GDP at factor cost and Market prices is subsidies and taxes levied by the Government. TABLE 1: INCOME METHOD Income method N$ millions Compensation of employees 423 713 Net operating surplus 243 991 Consumption of fixed capital 112 633 GDP at factor cost 780 337 Other taxes on production 16 023 Less: Other subsidies on production 2 367 Taxes on products 84 453 Less: Subsidies on products 4 809 GDP at market prices 873 637 ACTIVITY 2 • Use the following statistics to calculate the GDP at factor cost and at market prices. N$ millions Consumption of fixed capital 58 575 Other taxes on production 8 638 Net operating surplus 108 602 Taxes on products 41 611 Subsidies on products 6 320 Compensation of employees 218 159 Other subsidies on production 3 133 FEEDBACK TO ACTIVITY 2 N$ millions Compensation of employees 218 159 Net operating surplus 108 602 Consumption of fixed capital 58 575 GDP at factor cost 385 336 Other taxes on production 8 638 Less: Other subsidies on 3 133 production Taxes on products 41 611 Less: subsidies on products 6 320 GDP at market prices 426 132 B) EXPENDITURE METHOD This method uses various types of expenditures on goods and services by four sectors to calculate the GDP at market prices. It is shown on the right hand side of Account 1 in Table 3 below.The expenditures are: Consumption expenditure by households (C) Gross Capital formation (Investment by firms I) Consumption expenditure by the general government (G) Exports of goods and services (X) Imports of goods and services (M) Residual (Discrepancy) EXPENDITURE METHOD GDP= Expenditure on GDP Y=C+I+G+(X-M) Gross Domestic Expenditure (GDE): Refers to the expenditure inside the country and excludes the foreign sector. GDE= C+I+G I= Gross Capital Formation FINAL CONSUMPTION EXPENDITURE BY HOUSEHOLD (C): Expenditure by households on all final goods and services can be divided into the following categories: Durable goods: Goods that are not used up in the process of consumption and last longer than one year, e.g. cars and furniture. Semi-durable goods: Goods such as clothing and shoes that can be consumed for a period of time but they do not last as long as Durable goods. Non-durable goods: These goods can be consumed only once e.g. food, petrol and cigarettes. Services: Intangible consumption items that are consumed as they are produced, e.g. Medical services and transport services. FINAL CONSUMPTION EXPENDITURE BY THE GENERAL GOVERNMENT The general government includes the: Central Government Regional Government Local Government Consumption expenditure by the government includes all current expenditure on: Salaries and wages Goods and services of non-capital nature GROSS CAPITAL FORMATION Also known as Investment expenditure. It consists of the following two components: Gross fixed capital formation: Include all expenditure by producers on production goods such as new buildings, new machines and breeding livestock. It includes new capital goods of the private as well as the public sectors. New lecture buildings at NUST will be included in this category. Change in inventories: Inventories include raw materials, semi-completed and completed products owned by businesses. These inventories change as goods are bought and sold. It reflects goods produced in the current period but not sold and goods produced in an earlier period but sold only during the current period. Therefore, change in inventories can be positive or negative. EXPORTS (X), IMPORTS (M) AND RESIDUAL ITEM Exports (X): Are goods produced in Namibia and sold in other countries. Imports (M): Goods produced in other countries and sold in Namibia. They are not part of GDP and are deducted. RESIDUAL ITEM When calculating GDP by income and expenditure methods, we calculate the same thing, but calculation errors can occur. Data to calculate GDP are obtained from different sources and calculations may not be completely accurate. Errors can be overcame by including the residual item. From table 3 GDP calculated according to expenditure method is more than GDP obtained by Income method. The residual item is difference between the two. Calculating the residual item: Total expenditure N$877 934 Less: GDP at Market P N$873 637 Residual item N$ 4 297 TABLE 2: EXPENDITURE METHOD Expenditure method N$ millions Consumption expenditure by households 555 818 Consumption expenditure by the general 160 640 government Gross capital formation 135 591 Gross domestic expenditure 852 049 Exports of goods and services 253 804 Less: Imports of goods and services 227 919 Residual item - 4 297 Expenditure on GDP 873 637 (GDP at market prices) TABLE 3: ILLUSTRATION OF THE INCOME AND EXPENDITURE METHODS N$ Millions Expenditure method N$ Million Income method Compensation of 423 713 Consumption expenditure by 555 818 employees Households Net operating surplus 243 991 Consumption expenditure by the 160 640 general government Consumption of fixed 112 633 Gross Capital formation 135 591 capital GDP at factor cost 780 337 Gross Domestic Expenditure 852 049 Other taxes on 16 023 Exports of good and services 253 804 production Less: Other subsidies on 2 367 Less: Imports of goods and services (227 919) production Taxes on product 84 453 Residual item - 4 297 Less: Subsidies on 4 809 product GDP at Market prices 873 637 GDP at Market prices 873 637 ACTIVITY 3 1.