Measuring GDP and price leval

MEASURING GDP AND PRICE LEVEL

MEASURING EONOMIC ACTIVITY

² Macroeconomics focuses on the economic activity of a country. If a flow of money is involved in a transaction, economists will count that transaction as "economic" activity.
² Overall, economic activity is the pattern of transactions in which things of real useful value--resources, goods and services--are created,
transformed, and exchanged.
² Macroeconomics focus is on the aggregate (or total) concept. We always discuss the aggregate output, the aggregate income, the general price level of goods and services, the total jobs in the entire economy, etc.
² Economic activity is measured by calculating gross domestic product (GDP). There are three ways to measure economic activity or GDP:
1. Product (or Value Added) Approach: output produced by all firms to be sold
2. Expenditure Approach: amount spent by ultimate buyers
3. Income Approach: income received by producers from the sale of the total output
² The three approaches are equivalent. Any output produced (product approach) is purchased by someone (expenditure approach) which results in income to someone (income approach) ? total production = total
expenditure = total income
² GDP provides a measure of total production, total expenditures, and total income, and can be used to make comparisons over time and across countries. So, what’s GDP?

GDP defined (The Product Approach)

GDP is the market value of all final goods and services produced within the border of a country in a given time period. This definition contains four parts:
1. Market value
2. Final goods and services
3. Within the border of a country
4. In a given period of time

1. Market value:
To measure total production we must add together the production of all final goods and services produced in a country. Since we cannot add tons to units to meters to gallons, it is necessary to convert all output to the same unit of measurement. Conversion is to calculate the market value (market price) of each good and service and then add them together. Thus, market value means valuing production according to market price.
² Market value of a good = (Price of the good) (Quantity of the good) = P*Q
² Example:
Suppose a country produces only three final goods. Quantities and prices of these goods for two different years are given in the table below:

Using market value allows us to add goods and services produced together, and to compare the GDP of one year to that of another. We can see here that GDP increases in 2004. This means the economy has grown from 2003 to 2004.

2. Final Goods and Services:
To calculate GDP we measure the value of the aggregate production of goods and services. However, we count only the value the final goods and services produced. We do not count intermediate goods.    A final good (or service), is an item bought by its final user during a specified time period. It is the good that does not require any further processing in the market and is available for immediate consumption or use. The bread bought by a consumer is a final good but the flour bought by the baker is not. The flour bought by the baker is an intermediate good. Consumption goods, capital goods, government purchases, and inventory investment are treated as final goods An intermediate good (or service) is the good that is needed to produce a final good in the same period. In other words, it is the good that requires additional processing before it is sold to consumers. Examples of intermediate goods:   Flour used to produce bread   Tires used on the car Intel Pentium chip inside a computer Some goods can be intermediate goods in some situations and final goods in other situations. For example, eggs may be used as a final good or an intermediate good. Excluding intermediate goods and services when calculating GDP avoids double counting.

3.   Produced within the border of a country:
Only goods and services that are produced within the border of a country counted as par of that country’s GDP, irrespective of who produces them.
² Examples:
1. The income received by a Bahraini worker working in Dubai is part of
UAE’s GDP.
2. The market value of the product provided by a Malaysian company working in Bahrain is part of Bahrain’s GDP.
3. Profits generated by a U. S. bank in Bahrain is included in Bahrain’s GDP


4. In a given time period:

² GDP includes only goods and services that are newly produced within the scurrent year. GDP does not include purchases or sales of goods and
services that were produced in previous years. All used goods traded during that year are excluded. The year of production not the year of sale determines the allocation of GDP.
² Example:
Suppose a house newly built in 2003 but sold in 2004. The market price of the house counted in the GDP of 2003 not in the GDP of 2004.
² Example:
Goods that are produced this year, kept in inventories, and then sold to consumers next year count in this year’s GDP