Introduction to Macroeconomics - Gross Domestic Product - Essay Example

Running Head: Introduction to Macroeconomics Introduction to Macroeconomics This paper examines the relevance of GrossDomestic Product as a metric for measuring the economic well being of the present days economies. The paper explains the different types of GDP's and their differences. Later it discusses the shortcomings of GDP as a economic and social indicator and the alternatives available to it. Introduction Gross domestic product can be defined as a measure of the market value of all final goods and services produced by a country in a given time frame. It has always been considered an important indicator of economic activity. The GDP is estimated by three distinct theoretical approaches, these are GDP from the output or production then the GDP from the income and finally the GDP from the expenditure. A single estimate is then derived and published as the official estimate of GDP. There are two ways to measure the GDP, Real and the Nominal. Every country uses estimates of GDP in real terms as the international standard to measure growth in an economy. It is essential to follow a common standard so as to allow meaningful comparisons between different economies. United Kingdom follows the international conventions and European Union guidelines. This paper examines the GDP as a metric for measuring the health of an economy. It begins by analysing the distinction between the real and the nominal GDP and then goes on to elucidate the voids in using GDP as a sole quantifier of national economy. It then suggests other alternatives and gives the relative merits of using other systems to access the state of national economy of any country. Real and Nominal GDP The GDP of every economy tends to rise over a period of time. This rise in the size of the expenditure could be due to two reasons, either due to increase in output or due to increase in prices .If the GDP has risen because of more production of goods and services in the country then there is economic growth; but if the rise in GDP is due an increase in the prices of the goods and services; then the economy has experienced inflation and not growth in production. Economists have devised two ways to measure GDP these are the nominal GDP and the real GDP. The real GDP is the value of the GDP at constant prices using a given base year value. It excludes any inflation and reflects the changes purely in volume terms; thus giving the actual level of economic activity. It is estimated using chained volume measures. The nominal GDP gives the value of GDP at current prices, prices for which year the GDP is taken. Growth in nominal GDP reflects the effects of inflation, as well as real GDP growth .It reflects change in value terms. For example to calculate the value of 1999 nominal GDP, we will sum the value of all expenditures in 1999, using the prices that prevailed then. The real GDP would be calculated by taking the sum of the values of all the expenditures in 1999, but using the prices that prevailed in the base year (2003). When the economists need to quantify inflation they take the ratio of nominal to real GDP, and take its percentage. This then is called the GDP deflator. A Time Series data of nominal and real GDP. Year GDP at current market prices (millions of pounds) GDP at constant (2003) market prices (millions of pounds) GDP Deflator (index 2003=100) Population (in millions) 1990 558,160 814,956 68.49 57.237 1991 587,080 803,892 73.03 57.439 1992 611,974 805,699 75.96 57.585 1993 642,656 824,085 77.98 57.714 1994 680,978 859,566 79.22 57.862 1995 719,747 884,748 81.35 58.025 1996 765,152 909,102 84.17 58.164 1997 811,194 936,717 86.60 58.314 1998 860,796 968,040 88.92 58.475 1999 906,567 997,295 90.90 58.684 2000 953,227 1,035,295 92.07 58.886 2001 996,987 1,059,648 94.09 59.113 2002 1,048,767 1,081,469 96.98 59.322 2003 1,110,296 1,110,296 100.00 59.554 2004 1,176,527 1,146,523 102.62 59.834 2005 1,224,715 1,167,792 104.87 60.209 Source : http://eh.net/hmit/ukgdp/ Efficacy of GDP as a Measure The famous economist S. Kuznets who is regarded as the creator of the concept of GDP defines it as the gross total of all the final production of goods and services, with it making no distinctions between transactions that add to the social welfare, and those that don't. During the World War II, GDP was used for the first time to compute the war time production. Since then it has become the most significant measure of economic progress. The GDP through its growth rate provides a snapshot of the economic growth of the country. Being easily quantifiable the GDP also serves as a barometer of the business environment of the country. However Kuznets contends that the GDP's role is primarily meant as a gross tally of all the final goods and services and is in no way is it intended to serve as a measure to for the nation's social health and well being. GDP includes only all money transactions (with the exception of gifts as this money exchange does not lead to production in the bargain).It also makes the assumption that all monetary transactions add to the economic and social well being of the society. Thus even the negative expenditures like expenditure on crime prevention natural disasters, prisons etc make the same positive addition to GDP as would any other socially relevant and progressive expenditure like creating more facilities for education, sanitation or other public utilities. Another area that the GDP totally ignores is the value that is created by the informal or the non monetised sectors regardless of their significance to the well being. Therefore the economic growth contributed by the households production like cooking , the volunteer services like repairing your friend's cycle , use of public gardens goes unnoticed completely because they don't have a price tag attached to them. . To add to it, the GDP's evaluation rather fails to recognise welfare activities such as child and elder care or ecological restoration work. The IMF analysis completed in 2002 reported that value addition by the informal sector contributes nearly 44% of the GDP in most developing nations, 16% in OCED economies and around 9% in United Kingdom. (Talberth 2006) Therefore GDP's use as an indicator of well being leads us to form biased conclusions, as it fails to make any distinction between the expenditures contributing towards the welfare of the society from those that are done to control its degradation. It also does not accrue the benefits and costs which come from the non cash sectors, which form an important ingredient of the social and economic well being. However ironical it may sound but as per GDP's calculations war expenditure would provide double benefit to the countries as the GDP would grow when the country does the destruction of it's assets and then again when it rebuilds the lost assets. GDP is also ignores the inequalities of income and wealth which exist, leading to wide disparities. It only gives importance to the rise in overall expenditure. This may at times lead to conspicuous consumption. Another ironic factor that goes against GDP to be an ideal measure of well being of the society is the fact that the GDP would decline proportional to the self reliance of the nation. For example if a community reduces its expenditure on energy by increasing its reliance on unconventional energy resources like solar or wind energy the GDP would diminish. But on the other hand if the depletion of economic resources like forests and wetlands can lead to production of goods and services the income generated will add positively to the GDP. Genuine Progress Indicator The Genuine Progress Indicator (GPI) is the first holistic measure of the nation's welfare and the only major contender to GDP. It is a variant of the Index of Sustainable Economic Welfare proposed by Daly and Cobb. It is intended to assess the sustainable economic development as well as the welfare activities of the country. GPI addresses the deficiencies of the GDP. It is a part of the 'green' economics. It tries to gauge if the economy is on the path of sustainable growth. The GPI uses estimates of personal consumption expenditures and adds the non market benefits associated with households and volunteer time and public services. Deductions are made for the costs related to pollution, defence, accidents as well as costs of depletion of natural resources, costs of crime and income inequality or the loss of leisure time. This way the GPI is able to overcome the deficiencies of GDP, and allow the policy makers to make more subjective value judgments about the economic growth in comparison to GDP. The two major systems in vogue at present are the Index of Sustainable Economic Welfare (ISEW) and the GPI. (Nafziger 2006). Though their methods of calculations are a bit different but they both follow the same three steps. These three components used to assess the national well being are welfare equivalent income, sustainable income and net social profit. The welfare equivalent income does not measure the goods produced in a year but the services enjoyed by the citizens of all man made goods. The sustainable income refers to the Hicksian notion of income which define a mans income as the maximum value that he can consume in a week and still be as well off at the end of the week as he was at the beginning.Net social profit is an expanded form of cost benefit analysis that uses welfare equivalent or sustainable income as a datum rather than GDP. Conclusion GDP though has been used as a measure of economic activity of the countries for the last 4 to 5 decades the GPI has more relevance in the present scenario where a large portion of non monetised or the informal sector contributes largely to the economic development. GDP has been used in the past mainly due to governmental support it enjoyed. Apart from GDP and GPI there are other indexes that try and measure the well being of the society for example the Human Development Index or the measure of domestic progress (MDP). Each method has its strengths and drawbacks but more often than not economists use these indices to give them a broader picture of the society and help them to make an informed analysis. Works Cited Clapp Jennifer, Dauvergne Peter (2005) Paths to A Green World: The Political Economy of the Global Environment MIT Press Smith David (1999)UK Current Economic Policy Harcourt Heinemann Clark Jeff R., Wilson J. Holton (1996) Survey of Economics South-Western College Ascher William L., (2001) Guide to Sustainable Development and Environmental PolicyBy Duke University Press Nafziger E. Wayne (2006) Economic Development,Cambridge University Press Talberth, Dr. John, Cobb Clifford, Slattery Noah Genuine Progress Indicator 2006 A Tool for Sustainable Development http://www.rprogress.org/newpubs/2007/GPI%202006.pdf Read More