Lecture%201-%20measuremnt%20of%20output1.pptx

Measuring domestic output and national income
Economic Growth

1. Measuring domestic output and national income Lecture 1

2. Economic Growth Botswana has been one of the fastest-growing economies over the past five decades Source: World Bank. World Development Indicators 2012.

3. SADC’s macroeconomic performance   2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 AVG Angola 3.0 3.1 14.5 3.3 11.2 20.6 20.7 22.6 13.8 2.4 3.4 3.4 10.2 Botswana 5.9 3.5 9.0 6.3 6.0 1.6 5.1 4.8 3.0 -4.9 7.2 4.6 4.3 DRC -6.9 -2.1 3.5 5.8 6.6 7.8 5.6 6.3 6.2 2.8 7.0 6.9 4.1 Lesotho 5.7 3.3 1.6 4.1 2.4 3.1 4.4 4.9 4.7 3.6 5.7 4.2 4.0 Madagascar 4.5 6.0 -12.4 9.8 5.3 4.6 5.0 6.2 7.1 -4.1 0.5 0.5 2.8 Malawi 0.8 -4.1 1.7 5.5 5.5 2.6 2.1 9.5 8.3 9.0 6.5 5.5 4.4 Mauritius 7.2 2.6 1.9 4.3 5.5 1.5 4.5 5.9 5.5 3.0 4.1 4.1 4.2 Mozambique 1.5 12.3 9.2 6.5 7.9 8.4 8.7 7.3 6.8 6.3 6.8 7.1 7.4 Namibia 4.1 1.2 4.8 4.3 12.3 2.5 7.1 5.4 3.4 -0.4 6.6 3.6 4.6 Seychelles 4.3 -2.3 1.2 -5.9 -2.9 6.7 6.4 9.9 -1.0 0.5 6.7 4.9 2.4 South Africa 4.2 2.7 3.7 2.9 4.6 5.3 5.6 5.5 3.6 -1.5 2.9 3.1 3.6 Swaziland 2.0 0.9 1.8 3.9 2.3 2.2 2.9 2.8 3.1 1.2 2.0 0.3 2.1 Tanzania 4.9 6.0 7.2 6.9 7.8 7.4 7.0 6.9 7.3 6.7 6.5 6.7 6.8 Zambia 3.6 4.9 3.3 5.1 5.4 5.3 6.2 6.2 5.7 6.4 7.6 6.6 5.5 Zimbabwe n/a 0.7 -9.3 -17.0 -5.7 -5.7 -3.5 -3.6 -17.6 5.8 8.1 9.3 -3.5

4. Learning objectives How gross domestic product (GDP) is defined and measured. The relationships among GDP, net domestic product (NDP), national income (NI), personal income (PI), and disposable income (DI). The difference between nominal GDP and real GDP. Some limitations of the GDP measure.

5. Assessing Economy’s Performance National Income Accounting (NIA) - measures the economy’s performance by measuring the flows of income and expenditures over a period of time. NIA helps Assess the health of the economy by comparing the levels of production at regular intervals Track the long-run course of the economy to see whether it has grown, stagnated or declined provide a basis for appropriate public policies to improve economic performance. Gross Domestic product (GDP) a monetary measure of the total market value of all final goods and services produced within a country in a given year – it is location based. Final goods are consumption goods, capital goods & services that are bought by their final users, rather than for resale or further processing or manufacturing GDP includes only final products (G) and services (S); it avoids double/multiple counting, by eliminating any intermediate goods used in production of these final G & S. Intermediate goods are goods & services that are bought for resale or for further processing or manufacturing. Multiple counting could also be avoided by cumulating only the value added at each stage Value added is the market value of a firm’s product minus the value of the inputs the firm has bought from others (used in the production approach to measurement of GDP)

6. Example (agrarian economy) Output (bags) Price per bag (P) Market value (GDP) Year Oranges Tomatoes Oranges Tomatoes 1 4 3 75 100 2 3 4 75 100 3 3 3 100 110

7. Example: industrialized economy Suppose the economy becomes more sophisticated and The 4 bags are sold to a processor (@P75), who in turn use them to produce 100 litres of orange juice, which he sells to at retailer @P10.00 per litre. The retailer re-sells the juice @P10.00 per litre The 3 bags of tomatoes are sold to a processor @p100 per bag, who in turn produces 90 bottles of tomato source and sells it for P8.00 per bottle to a retailer. The retailer re-sells the source at P10.00 per bottle. Calculate GDP for this country

8. GDP Oranges side Tomatoes side Stage Sales value Value added (P) Farmer 300 300 Processor 900 600 Retailer 1000 100 GDP1 Stage Sales value (P) Value added (P) Farmer 300 Processor 720 Retailer 900 GDP2 Total GDP GDP1 GDP2 Total GDP (P)

9. Assessing Economy’s Performance Gross National Product (GNP) - ) the monetary measure of the total market value of all final goods and services produced by a country’s owned resources within in a given year irrespective of where production takes place – it is ownership based GDP & GNP are flow variables, not stock variables Since GNP is harder to measure, economists tend to favor the use of GDP GDP can be measured at factor cost, basic prices and market prices GDP at factor cost is normally linked with the income approach of measuring GDP. The expenditure approach is associated with GDP at market prices GDP at basic prices is associated with the production approach

10. Relationships/differences between the 3 measures of GDP Gross value added at factor cost Plus Other taxes on production Less Other subsidies on production Equal Gross value added at basic prices Plus Taxes on production Less Subsidies on production Equal Gross domestic product (GDP) at market prices

11. Nonproduction Transactions excluded GDP is the value of what has been produced in the economy over the year, not what was actually sold. Excludes Nonproduction Transactions – 2 types Purely financial transactions Public transfer payments , like social security or cash welfare benefits Private transfer payments , like student allowances or child maintenance payments, remittances to parents Stock market transactions , sale of stocks and bonds represent a transfer of existing assets. (However, the brokers’ fees are included for services rendered.) Secondhand sales since they do not represent current output (However, any value added between purchase and resale is included, e.g. used car dealers ).

12. Two Approaches to GDP Income Approach – incomes created producing the goods and services Wages Rental Incomes Interest Incomes Profits Expenditure Approach - sum of all the money spent on buying output Final-Product or Value-Added The Sum of the Money Spent to Buy the Output Illustrate with circular flow diagram Important identity – what is spent on a product is the income to those who helped to produce and sell it

13. The black arrows represent flow of real objects and the red arrows represent flow of financial objects The Simple Circular Flow Model

14. Two Approaches to GDP Income Approach Consumption by Households + Investment by Businesses + Government Purchases + Expenditures By Foreigners Wages + Rents + Interest + Profits + Statistical Adjustments Expenditure Approach

15. Expenditure Approach We add up all the spending on final goods and services that has taken place through the year GDP is divided into the categories of buyers in the market; household consumers, businesses, government, and foreign buyers Personal Consumption Expenditures (C ) Durable Consumer Goods (cars, stoves, beds, etc) Nondurable Consumer Goods (bread, sugar, movies, etc) Consumer Expenditures for Services (doctors, lawyers, etc Gross Private Domestic Investment ( Ig ) Machinery, Equipment, and Tools by business enterprises All Construction (includes residential because they can be rented out to earn income) Changes in Inventories (if output exceeds current sales, inventories build up).

16. Expenditure Approach Government Purchases (G) Expenditures on Goods and Services (labor & other services) Expenditures for Social Capital (schools, roads Net Exports X n = Exports ( X ) – Imports ( M ) Putting It All Together: GDP = C + I + G + X n

17. Income Approach to GDP Demonstrates how the expenditures on final products are allocated to resource suppliers Compensation of employees includes wages, salaries, fringe benefits, etc Rents: payments for supplying property resources Interest: payments from private business to suppliers of money capital Corporate profits: earnings of owners of corporations, sole proprietorships, partnerships & cooperatives. It includes Corporate income taxes – taxes levied on corporations’ net earnings & it flows to the government Dividends – part of profits that are paid to corporate stockholders & thus flow to households Undistributed corporate profits – monies saved by corporations to be invested later in equipment

18. GDP Approaches Compared Receipts Expenditures Approach Allocations Income Approach Personal Consumption ( C ) $ 8746 Compensation $ 7125 Gross Private Domestic Investment ( I g ) 2105 Rents 73 Government Purchases ( G ) 2363 Interest 498 Net Exports ( X n ) -727 Proprietor’s Income 939 Corporate Profits 1352 Taxes on Production and Imports 917 National Income $10904 Net Foreign Factor Income -34 Statistical Discrepancy 43 Consumption of Fixed Capital 1574 Gross Domestic Product $ 12,487 Gross Domestic Product $12,487

19. Relationships between measures From National Income to GDP - some definitions Net Foreign Factor Income Income earned by nationals abroad less income earned by foreigners locally (can be positive or negative) Statistical Discrepancy Added to national income to equalize the two approaches Consumption of Fixed Capital Depreciation allowance (set aside to replace machinery & equipment used up). We need to know how much output was available for consumption and for additions to the stock of capital Net Investment = gross investment – consumption of fixed capital Net domestic product – measures the total annual output that the entire economy can consume without impairing its capacity to produce in the future National income – income earned by a nation’s owned resources Personal income – includes all income received, whether earned or unearned

20. Relationships between measures From National Income to GDP to Other National Accounts Net Domestic Product (NDP) GDP – depreciation allowance (consumption of fixed capital) National Income (NI) : NDP +(-) net foreign factor income Income earned by nationals domestically & abroad. Personal Income (PI): NI + transfer payments – (payroll taxes, corporate profit taxes, undistributed corporate profits) Income received by households Disposable Income (DI) : PI – personal taxes DI = C + S (allocated to consumption and saving)

21. The Income Approach Gross Domestic Product ( GDP ) Consumption of Fixed Capital Net Domestic Profit ( NDP ) Statistical Discrepancy Net Foreign Factor Income National Income ( NI ) Taxes on Production and Imports Social Security Contributions Corporate Income Taxes Undistributed Corporate Profits Transfer Payments Personal Income ( PI ) Personal Taxes Disposable Income ( DI ) $ 12,487 -1,574 $ 10,913 -43 34 $ 10,904 -917 -871 -378 -460 +1,970 $ 10,248 -1,210 $ 9,038

22. Circular flow of income – open economy (links to be discussed in class) Domestic households Abroad Financial system Government Domestic producers

23. Detailed circular flow model

24. Botswana’s National Accounts 2011 current prices Receipts Expenditures Approach Allocations Income Approach Personal Consumption ( C ) P 54393.2m Compensation Gross Private Domestic Investment ( I g ) P37136.9m Rents Government Purchases ( G ) P23991.3m Interest Net Exports ( X n ) - P6149m Proprietor’s Income Net errors & omissions P9118.7m Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income Statistical Discrepancy CFC Gross Domestic Product P 118490.5m Gross Domestic Product

25. Nominal Versus Real GDP Nominal GDP – market value of all final goods and services produced in a year measured at the prices that prevailed when the output was produced ( PxQ ). Real GDP – is market value of all final goods and services measured at base year’s prices Allows comparison of physical output between years Nominal GDP is calculated using the current prices prevailing when output was produced but real GDP is a figure that has been adjusted for price level changes One method to adjust GDP is to first determine a price index and then adjust the nominal GDP by dividing by the price index (in hundredths, i.e., in decimal form) Price Index - a measure of the price of a market basket in a given year compared to the price of a similar basket in reference year (base year).

26. Nominal Versus Real GDP Price index in a given year = (Price of market basket in specific year/Price of same basket in base year)x100 This also known as consumer price index (CPI) E.g., from table next slide, in year 1 price of a basket containing pizza is P10.00 If yr 1 is base yr then Price Index is 100 In year 2 Price Index is (20/10)x100 = 200 The price of pizza rose from yr1 to yr 2 by 100% [(200-100)/100]*100 Real GDP = Nominal GDP/Price Index (in hundredths, i.e., price index/100) Real GDP (yr 2) = [140/(200/100)]=70 Real GDP (yr 4) = [300/(300/100)]=100

27. Calculating Real GDP (Base Year = Year 1) Year Units of output Price of pizza (P) Price Index (Year 1 = 100) Unadjusted or Nominal GDP (P) Adjusted or real GDP (P) Real GDP (column 1 x P10) 1 5 10 100 50 50 50 2 7 20 200 140 70 70 3 8 25 250 200 80 80 4 10 30 5 11 28 6 13 32

28. Real GDP alternative method Gather data on physical outputs & their prices Determine market value of output in successive yrs as if base yr price had prevailed (see column 7) previous slide To get Price index for a given year divide nominal GDP by the real GDP for that year Price Index (in hundredths)= Nominal GDP/ Real GDP . This is also called GDP deflator You can the multiply it by 100 to get the index similar to in the previous method.

29. Botswana’s National Accounts 2011- 93/94 prices Receipts Expenditures Approach Allocations Income Approach Personal Consumption ( C ) P 12111.7.2m Compensation Gross Private Domestic Investment ( I g ) P9743m Rents Government Purchases ( G ) P5736.3m Interest Net Exports ( X n ) - P937m Proprietor’s Income Net errors & omissions P829.7.7m Corporate Profits Taxes on Production and Imports National Income Net Foreign Factor Income Statistical Discrepancy CFC Gross Domestic Product P 27463.5m Gross Domestic Product

30. Shortcomings of GDP Nonmarket Activities – home makers’ services, Leisure – improves living conditions, but is not included Improved Product Quality The Underground Economy GDP and the Environment – harmful effects of pollution not subtracted from GDP Composition and Distribution of the Output – makes no difference between guns or tractors Noneconomic Sources of Well-Being – crime prevention not covered in GDP