MacroeconomicsEcon Brief 3
Whencountries desire to know how much they have produced in the economy,they usually use gross domestic product (GDP). The GDP of an economymay be calculated using the income and expenditure approaches. Whenmeasuring the GDP, illegal undertakings are not included because theyhave the impact of increasing the level of GDP, which may bringproblems in trying to differentiate what is legal and what isillegitimate. The purpose of this report is to define GDP, discusshow it can be calculated, as well as to provide the merits anddisadvantages of utilizing GDP per capita as a measurement ofwell-being in an economy.
Grossdomestic product denotes the total market value of the goods andservices that are produced within a country during a certain period.Although it is used for different purposes, its most important roleis to measure the entire performance of a given economy (U.S.Department of Commerce, 2015). GDP can be categorized as real ornominal. Real GDP is a measure of productivity not influenced byrising prices in this case, constant prices are used (Gonzalez,n.d). On the other hand, nominal GDP is a measure of productivitybased on the current prices.
Thereare three approaches used in the calculation of GDP the income,value-added and expenditure techniques. In the expenditure approach,GDP is usually measured in terms of purchases or expendituresincurred by the final users. This method shows the final goods andservices bought by individuals, governments, foreigners, andbusiness. The equation that is commonly used in this approach is asfollows: GDP = consumption + investment + government spending +exports – imports. The income method is utilized in examining thepurchasing power of house units, as well as the financial status ofbusiness income (Vancouver Community College, 2013). Alternatively,the value-added approach argues that GDP can be measured as totalsales of goods and services less the value of the intermediate inputsor as the total of the “value-added” at every phase of theproduction process. Depending on the choice of economies orcountries, any of the three approaches can be used in estimating thetotal GDP.
Duringthe process of calculating the GDP of an economy, the contribution ofillegal goods and services is not factored in. Failure of includingincome from illegal services and goods is important in helping todistinguish amid what is legitimate and illegal in a country. In casean economy legitimizes a good or service that was previously illegal,the economy’s GDP will increase. The following graphs show theimpact of legalizing a good/service that was previously illegal.
Considerfigure (a), where the level of GDP is at point A when the illegalgood/service is not included in the measurement of GDP. However, uponthe legalization of the good/services that had previously been termedas illegal, the GDP of the economy will shift from point A to B asshown in figure (b) below.
A B Income (Y)
Theuse of GDP per capita as a measure of well-being in an economy hasmerits and disadvantages. The advantage of using GDP per capita as ameasure of welfare is that it is possible to get a quick view of howindividuals are faring. Although it is just a component of welfare,it can be used to get a fast view of individuals in an economy sinceit tends to have a correlation with life expectancy and mortalityrate. On the other hand, it has a disadvantage in that it tends tocount both bad and good things as constituting GDP. Besides, GDP onlytends to counts goods that pass through organized markets, thus, itdoes not include black market activities and home production (Thoma,2016).
Inconclusion, Gross domestic product denotes the total market value ofthe goods and services that are produced within a country during acertain period. Although it is used for different purposes, its mostimportant role is to measure the entire performance of a giveneconomy. GDP can be measured through income approach, expendituremethod, as well as value-added approach.
Gonzalez,F. (n.d). Principlesof Macroeconomics: Nominal and Real GDP.Huntsville, TX: Department of Economics and Intl. Business, SamHouston State University.
Thepurpose of this source is to explain the concepts of real grossdomestic product versus nominal gross domestic product. The sourcealso provides an explanation of concepts related to GDP such as CPIand GDP deflator.
Thoma,M. (2016). WhyGDP Fails As A Measure of Well-Being. CBSMoneyWatch.Retrieved fromhttp://www.cbsnews.com/news/why-gdp-fails-as-a-measure-of-well-being/
Thissource provides different reasons as to why GDP fails to be regardedas a measure of well-being in an economy.
U.S.Department of Commerce (2015). Measuring the Economy: A Primer on GDPand the National Income and Product Accounts. Bureauof Economic Analysis.
Thissource describes how the economies are measured using the differentapproaches. The two methods of GDP measurement described in thissource are the output and income approaches.
VancouverCommunity College (2013). Macroeconomics:GDP, GDP Deflator, CPI, and Inflation.Vancouver: VancouverCommunity College Learning Centre.
Thisresource explains different concepts relating to gross domesticproduct and how the GDP of a given economy can be measured. Anexplanation of the methods that are using to measure GDP is given.