Question

1. Describe what gross domestic product is and how it is measured. There are several transactions that are excluded from measuring GDP such as financial transactions, second-hand goods, etc.
2. Explain what these excluded transactions are and why they are excluded.
3. Select one of these excluded transactions and give your thoughts on how GDP would currently change if that item were included.

Answer 1

Gross domestic product is the value of the sum of all final goods and services produced in a country in a year. It is calculated by 3 methods: Output method, Income method, and Expenditure method.

1. Output method: Here the value of all final goods and services produced in a country in a year is summed up. The final goods and services are from all the sectors of the economy like the Primary, Secondary, and Tertiary sectors.

2. Income method: Here income earned by people from all the sectors is added like wages, rent, interest, and profits. And the sum of these values is the GDP.

3. Expenditure method: Here all the expenditures in a country in a year like consumption expenditure, investment expenditure, government expenditure, and net exports are added and that is called GDP.

There are some transactions that are excluded from the calculation of GDP they are:

1. Transactions of illegal items: Transaction of items that are illegal are not allowed by law of the country and therefore not counted as a part of GDP calculation.

2. Transfer payments by the government: Transfer payments are the payments that the government gives without the production of goods and services like unemployment benefits and subsidies. Since their payments are given without any work is done, they are not calculated in GDP.

3. Selling of used goods: Transaction of second-hand goods is not included in the GDP calculation because those goods were already calculated as a part of GDP in the year they were freshly made and therefore we cannot count them again.

4. Counting of intermediate goods: Intermediate goods are the ones that are part of the production process like raw materials for producing some final product. They are not counted in the GDP as they were already counted when they were the finished product in their production chain and now they are acting as a raw material for another good. So to avoid double counting of them in the GDP we will not include them.

5. Black marketing of goods: Black marketing of goods in off records and not done in a legal way and thus they are not included in GDP calculation.

Suppose the intermediate goods are calculated in the GDP. It will lead to the overestimation of GDP because of the double counting that has been done by including them. For example, there is a firm that produces bread and the raw materials used for its production are, sugar, salt, and flour.

The flour which is used here as a raw material is already calculated in the GDP when it was a finished product at the flour mill. The sugar and salt are already calculated as a part of GDP when they were the finished product at the sugar and salt mill respectively. Thus, counting them again when they are used as an intermediate good for the production of bread will lead to double counting and it will overestimate the GDP of a country.

Therefore we exclude the addition of intermediate goods in the calculation of GDP.