UNIT 2. Measuring the Performance of the economy

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1 UNIT 2 Measuring the Performance of the economy

2 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.

3 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.

4 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.

5 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.

6 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.

7 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

8 3 METHODS USED TO CALCULATE THE GDP The income method: It involves adding up all the income received by the four factors of 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.

9 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.

10 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.

11 TABLE 1: INCOME METHOD Income method N$ millions Compensation of employees Net operating surplus Consumption of fixed capital GDP at factor cost Other taxes on production Less: Other subsidies on production Taxes on products Less: Subsidies on products GDP at market prices

12 ACTIVITY 2 Use the following statistics to calculate the GDP at factor cost and at market prices. N$ millions Consumption of fixed capital Other taxes on production Net operating surplus Taxes on products Subsidies on products Compensation of employees Other subsidies on production 3 133

13 FEEDBACK TO ACTIVITY 2 N$ millions Compensation of employees Net operating surplus Consumption of fixed capital GDP at factor cost Other taxes on production Less: Other subsidies on production Taxes on products Less: subsidies on products GDP at market prices

14 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)

15 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

16 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.

17 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

18 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.

19 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.

20 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$ Less: GDP at Market P N$ Residual item N$ 4 297

21 TABLE 2: EXPENDITURE METHOD Expenditure method Consumption expenditure by households Consumption expenditure by the general government Gross capital formation Gross domestic expenditure Exports of goods and services Less: Imports of goods and services Residual item N$ millions Expenditure on GDP (GDP at market prices)

22 TABLE 3: ILLUSTRATION OF THE INCOME AND EXPENDITURE METHODS Income method N$ Millions Expenditure method N$ Million Compensation of employees Consumption expenditure by Households Net operating surplus Consumption expenditure by the general government Consumption of fixed Gross Capital formation capital GDP at factor cost Gross Domestic Expenditure Other taxes on production Exports of good and services Less: Other subsidies on production Less: Imports of goods and services ( ) Taxes on product Residual item Less: Subsidies on product GDP at Market prices GDP at Market prices

23 ACTIVITY 3 1. Use the data provided below to derive the GDP for Namibia by the expenditure approach. Items Amount in Trillions of N$ Durable goods 1.2 Non durable goods 2.4 Services 7.1 Fixed investment 1.9 Change in business inventories 0.04 Consumption expenditure by the National Government Consumption expenditure by the Local and Regional Government Export 2.1 Import 2.6

24 SOLUTION ACTIVITY 3 Expenditure method In N$ Amount (Trillion of N$) Consumption expenditure by the household (C) Durable goods 1.2 Non durable goods 2.4 Services Gross Capital Formation 1.94 Fixed investment 1.9 Change in Business inventories 0.04 Consumption expenditure by the Government National 1.2 Regional and Local 1.8 Net Export of goods and services -0.5 Exports 2.1 Imports 2.6 Gross Domestic Product

25 ACTIVITY 4 Use the following statistics to calculate the GDE and the GDP (expenditure on GDP) according to the expenditure method: N$ millions Exports of goods and services Change in inventories Final consumption exp by households Imports of goods and services Final consumption exp by government Gross fixed capital formation

26 SOLUTION ACTIVITY 4 N$ millions Final consumption exp by households Final consumption exp by government Gross capital formation: Gross fixed capital formation Change in inventories GDE Exports of goods and services Less: Imports of goods and services Expenditure on GDP (GDP at market prices)

27 C) VALUE ADDED METHOD This method calculate GDP by adding the value of each producer s contribution to the final product. Value added method calculations: A farmer produces 1000 bags of wheat which he sells to a miller at N$10 per bag, yielding a total of N$ The miller processes the wheat into flour, which he then sells to a baker for N$ After baking bread with flour, the baker sells it to a shop for N$ The shop subsequently sells the bread to final consumers for N$

28 TABLE 4: MARKET VALUE AND VALUE ADDED Firm Market value (N$) Value (N$) Farmer Miller Baker Retailer/shop keeper Total: added

29 VALUE ADDED METHOD The bread did not increase GDP by N$ but only by N$ Because the final product is worth N$ N$ is obtained by double counting. The original of wheat N$ , is incl. In each market value or selling price. We eliminate double counting by counting the total value of the first producer and the value added during the stages of production (value of the final product). From table 4: total value added is N$ and the value of bread sold to consumer is N$ Thus, bread increase GDP by N$

30 VALUE ADDED METHOD While products are moving through the production process, we refer to them as intermediate goods. Intermediate goods are used as inputs to produce other goods and services. They are processed further before they are sold to consumers. The intermediate goods in Table 4 are the wheat, the flour processed by the miller and the bread sold to the retailer by the baker. They are not included in the GDP because if they are included, it will result in double counting. Final goods form part of GDP. Final goods are purchased for consumption by individuals, households and firms. Value added is the contribution that each stage of production makes to the final value of a good.

31 Question 1 HOMEWORK You are given the following information: (a)a forester chops down 100 trees and sells them for N$40 each to a sawmill. (b)the sawmill processes the trees into timber and sells the timber to a factory for N$ (c)the factory uses the timber to make 200 tables and sells the tables for N$150 each to a wholesaler. (d)the wholesaler sells the 200 tables to a retailer for N$300 each. (e)consumers buy the 200 tables at N$350 each from the retailer. Using the above information, calculate the value of GDP by the value-added approach.

32 HOMEWORK The information in the Table below is a fictitious industrial column for canned fish in Please fill in the gaps. What is the value of the fishing industry s contribution to Namibia s GDP? Activity Market value (N$ million) Value added (N$ million) Fish trawling industry 253 Processing 45 Canning 352 Retailing 78 TOTALS:

33 USING GDP FIGURES To compare one country s GDP with that of another country, wee need to distinguish between nominal GDP and real GDP. Nominal GDP/ GDP at existing prices/ GDP at current prices: Is the GDP calculated at existing prices. Also known as GDP at current prices. E.g Goods produced in 2017 will measured in terms of 2017 prices. Real GDP/ GDP at constant prices: Is nominal GDP adjusted for inflation. It is calculated at constant prices. P are adjusted to eliminate inflation. We compare GDP figures from one year to those of another year to see if economic growth had taken place.

34 USING GDP FIGURES Real GDP= Nominal GDP x 100 Price Index Price index: Is a measure of how the price level has risen from one year to the next. Example: GDP at market prices = N$ million and consumer P index= Real GDP= /124.4 x 100= N$30 997Mil

35 USING GDP FIGURES Potential GDP: Refer to the GDP the economy could have earned if all its productive resources were fully employed. We refer to this as the full employment income or production level. Example: Real GDP in 2010 was N$ but 30% of the countries resources are unemployed. Thus, only 70% of the resources is responsible for GDP mentioned above. Potential GDP= 100/70x = N$

36 3. ACCOUNT 2: NATIONAL DISPOSABLE INCOME AND HOW IT IS APPROPRIATED Reflect income earned by Namibians both inside and outside the borders of the country. National aggregate and exclude income earned by foreigners who live in Namibia. Gross National Disposable Income indicates how income is earned. Appropriation means how citizens use their income. Income used in the following ways: Household can consume their income G spend income on consumption item Income can be saved

37 Gross National Disposable Income N$ million Appropriation of national income N$ million Compensation of employees Consumption expenditure by household Less: Net compensation to non residents Consumption expenditure by general government Gross operating surplus Final consumption expenditure Less: Net property income to the rest of the world Gross saving Taxes on production and imports Less: Subsidies Less: Net current transfer from the rest of the world Residual item Gross National Disposable Income Appropriation of National Income

38 4. ACCOUNT 3 Saving: Is the difference between total available national income and total consumption expenditure. Gross domestic saving consist of: Saving by households: Difference between household final consumption expenditure and current disposable income. Not used for consumption but available to finance investment. Corporate saving: Is part of the company profits that is left over after company tax and dividends have been paid. Saving by the General Government: Difference between Government current income and current expenditure. Consumption of fixed capital: Amount provided to replace old and worn out capital stock.

39 4. ACCOUNT 3 Net Capital inflow from the rest of the world Shows the net amount of funds flowing to or from the country. If more is coming in than goes out, this figure will be positive. If more flows out than comes in, the figure will be negative. Foreign investment: Is the balance on the current account in the BoP. If positive (Surplus) Inflows > outflows, represents an increase in domestic capital formation.

40 ACCOUNT 3: GROSS CAPITAL FORMATION AND HOW IT IS FINANCED Gross Capital Formation N$ million Financing of Gross Capital Formation N$ million Gross Fixed Capital Saving by household 2386 Formation Change in inventories 5271 Corporate Saving Saving by Government Consumption of fixed capital Gross saving Gross Capital Formation Net capital inflow from the rest 6242 of the world Change in gold and other foreign reserves Foreign investment Financing of gross capital formation

41 5. ACCOUNT WITH THE REST OF THE WORLD (BALANCE OF PAYMENT) All countries keep record of all transaction with the rest of the world. This accounting record is called the BoP Balance of payment consists of two major accounts: The current account The capital and financial account

42 CURRENT ACCOUNT On the left hand side. Records all exports, imports and transfer of money. Transfer include cash received by Government and private organization or individuals. Government receives grants from governments and their share of money from SACU. NGO receives money from foreign governments.

43 CAPITAL AND FINANCIAL ACCOUNT On the right hand side and records the net transfers from the rest of the world. Net capital transfer indicate the favorable difference between capital inflows and capital outflows. Capital includes direct investment, portfolio investment (A portfolio investment is a transaction in which securities are held purely as a financial investment). and any other investment including change in gold and foreign reserves. If balance on the current account shows a negative value, the financial account must provide funding through capital inflows shown on the right hand side as a positive value.

44 TABLE 7: ACCOUNT 4: ACCOUNT WITH THE REST OF THE WORLD Current account N$ millions Capital account N$ millions Total exports of goods and services Less: Total imports of goods and services Net capital inflow from the rest of the world Change in gold and foreign reserves Transfers Balance on current account Financial flows and change in reserves 3050

45 6. OTHER MEASURES OF PRODUCTION, INCOME & EXPENDITURE Gross National Product (GNP) Income and profits earned by Namibians in foreign countries and paid back to Namibia is called Factor receipts. Foreigners who live and work in Namibia pay income and profits back to their countries it is referred to as Factor payments. Factor payments Factor receipts = Net Factor Payments GDP Net Factor Payments = GNP

46 6. OTHER MEASURES OF PRODUCTION, INCOME & EXPENDITURE Net National Product (NNP) GNP consumption of fixed capital = NNP National Income (NI) NNP is measured at market prices and NI is measured is measure at factor cost. NNP Indirect business taxes + subsidies= NI Personal income (PI) PI=NI Less: Company tax Company saving Plus: Transfer payments Personal disposable income (PDI) PI Personal taxes = PDI

47 ACTIVITY Consider the set of national accounts figures (all valued at market prices) given in the table below. Calculate (a) GDE, (b) GDP, (c) GNP and (d) NNP. Show your workings. N$ millions Consumption of fixed capital Net factor payments to the rest of the world Gross capital formation Exports of goods and services Private consumption expenditure by households Consumption expenditure by general government Imports of goods and services

48 END OF UNIT 2: THANK YOU!!! QUESTIONS???

ECO 209Y MACROECONOMIC THEORY AND POLICY LECTURE 2: NATIONAL INCOME ACCOUNTING

ECO 209Y MACROECONOMIC THEORY AND POLICY LECTURE 2: NATIONAL INCOME ACCOUNTING Gustavo Indart Slide1 GROSS DOMESTIC PRODUCT Gross Domestic Product (GDP) is the value of all final goods and services produced