Unit 3: GDP

Question 1

Gross Domestic Product (GDP):

Answer 1

The total value of all final goods and services produced by an economy in a given year.
It is one method of determining the economic wellbeing of a country

Question 2

GDP was first developed

Answer 2

During the Great Depression (1930s) by Simon Kuznets
- When he shared it with the US Congress, he warned against GDP being able to answer the most important questions for an economy:

Question 3

“The welfare of a nation can scarcely be inferred from a measurement of national income as defined by GDP.” (Report to the US Congress in 1934)

Answer 3

“The welfare of a nation can scarcely be inferred from a measurement of national income as defined by GDP.” (Report to the US Congress in 1934)

Question 4

There are three different approaches to calculating GDP:

Answer 4

1) The Expenditure Approach
2) The Income Approach
3) The Value Added Approach (least efficient method)

Question 5

1) The Expenditure Approach

Answer 5

The expenditure approach calculates GDP by utilizing the expenditure information of a country
Consumption (household consumption) (C)
Government Purchases (G)
Investment (purchases of new capital goods) (I)
Net Exports (exports - imports) (X - M)
Formula: GDP = C + G + I + (X-M)

Question 6

2. The Income Approach

Answer 6

This approach adds up all the income generated by the production of national product or factors income from factors of production
- This is a three step process

Question 7

Income Approach; Step 1

Answer 7

Step One: Calculate the net domestic income at factor cost
Rent (land) (r)
Wages (labour) (w/s)
Interest (capital) (i) [includes dividends paid to shareholders]
Business Profits (capital) (PR)
NI =W + R + i + PR

Question 8

Income Approach; Step 2

Answer 8

Step Two: Change the measure from factor cost to market price
This is done by adding indirect business taxes less subsidies

Question 9

Income Approach; Step 3

Answer 9

Step Three: Add the depreciation of capital that results from its use and obsolescence

Formula: GDP = NI + Indirect Business Taxes + Depreciation
GDP = W + R + i + PR + Indirect Business Taxes + Depreciation

Question 10

Common criticisms of GDP as a measure of economic welfare and well-being:

Answer 10

1) Omission of Economic Activity
2) Product Quality
3) Income Distribution
4) Leisure
5) Environment

Question 11

Limitation #1: Omission of Economic Activity

Answer 11

A lot of economic activity is not included in the calculation of GDP
1) Financial exchanges - goods and services exchanged between family members
It merely shifts purchasing power (examples: allowances, birthdays gifts)
2) Second hand purchases (used goods) - these have previously been included in GDP calculations for the years the were produced
3) Non-market activities - housework, unpaid childcare, work of “do it yourselfers”
4) Underground economy - productive transactions that are unreported, and thus left out of GDP

Question 11

Limitation #3: Income Distribution

Answer 11

One measure economist refer to is per capita GDP, which is GDP divided by the population of a country
This is deceiving because it states GDP as if every individual received the same portion of income
In actuality, individuals have far different living standards
Per capita GDP says nothing about how income is distributed in a nation

Question 12

Limitation #2: Product Quality

Answer 12

GDP only measures the dollar value of goods, not taking into account how the good contributes to society
Consider the three economic activities indicated below:
1) A stay at home dad takes care of his two children, cooks, cleans his family’s house and maintains the property.
2) A weapons factory engineer earns a salary of $125000 to design drones equipped with bombs, missiles and other munitions
3) A registered nurse makes $35/hour to work the ICU floor at a hospital
Rank these contributors to society according to GDP, then rank them according to how you value their contributions to society

Question 13

Limitation #4: Leisure

Answer 13

GDP is growth obsessed
The more productive a society is, the higher that country’s GDP will be
GDP does not measure or reflect well being which comes from decreased work and more leisure time to pursue interested or enjoyment

Question 13

Limitation 3 Cont’d

Answer 13

Calculate the per capita GDP (average income) of each nation in the table above.
Calculate the median income of each nation in the table above.
Which country does better according to GDP?
Which country do you think has a better quality of life?

Question 14

Limitation #5: Environment

Answer 14

GDP does not differentiate between economic activities which are harmful to the environment
1) Industries that emit CO₂ (Military, Airlines, Automobile, Oil)
2) Industries that destroy rainforests (Amazon farming, logging)
3) Industries that pollute water sources (mining, tar sands extraction)

Example: Exxon Valdez destroyed wildlife and the Arctic with a huge oil spill, but produced huge economic activity in cleaning it up

Question 15

The SIZE of the underground economy is the difference btwn

Answer 15

Difference btwn the income approach value and expenditure value