Question

granny was interested last month when you explained real gdp to her at dinner .she has been doing some googling on the internet and has been reading that lots of people think real gdp is a flawed major of economics.she ask you ,"can we use gdp to measure anything useful economically?" give her a brief evolution (pros and cons ) of the economic usefulness of gdp.

Answer 1

Gross Domestic Product (GDP) is the monetary value of all finished goods and services produced, by the country's citizens and foreigners, within the country's border over a specific period of time. The five main components of GDP are:

1. private consumption

2. fixed investment

3. change in inventories

4. government purchases or government consumption

5. net exports

GDP can be expressed in two ways i.e., Nominal GDP and Real GDP. Nominal GDP (unadjusted GDP) accounts for the market value of all final goods and services produced within a country. The market value depeds on the quantities of goods and services produced and their respective prices. Thus, if the prices change from one period to another period, nominal GDP would change even if the output remained constant. On the contrary, real GDP accounts for price changes that may have occured due to inflation i.e., the real GDP is nominal GDP adjusted for inflation. A real value is not influenced by changes in prices but only by changes in quantity. Thus, if prices change from one period to the next period, the real GDP would remain the same provided the actual output remains constant over the period of time. Real GDP determines the net purchasing power of price changes for a given year. It reflects the changes in real production. If there is no inflation or deflation, nominal GDP will be equal to the real GDP. GDP deflator(implicit price deflator for GDP) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy i.e., it measures the price inflation/deflation in an economy. It is calculated by dividing nominal GDP by real GDP and multiplying by 100.

Advantages of GDP

1. GDP represents the economic production and growth of a nation. For example, if the GDP of a country is high then its production is high implying that people have the money to purchase the goods and services, which further implies that the firms have the money to employ pople. Thus, GDP gives a indicator to determine how well a country's economy is flourishing. GDP growth rate reflects the increase or decrease in the percentage of economic output in monthly, quaterly or yearly periods.

2. GDP enables the policymakers and central banks to assess whether the economy is weakening or progressing, whether it needs a boost or restrictions and if threats of recession or inflation are iminent. From these assessments, government agencies can determine what kind of monetary/fiscal policies are needed to address economic issues.

3. GDP growth rates are important to investors as it helps them to decide how the economy is changing so that they can make adjustments to their asset allocation. For example, when there is an economic slump, businesses experience low profits, which means lower stock prices and consumers tend to cut spending. Investors are on the lookout for potential investments (domestic / international) basing their judgment on countries' growth rate comparisons.

Disadvantages of GDP

1. One of the major drawback of GDP is it doesn't refect the black market, which may be a large part of an economy in certain countries. the Black market or the underground economy includes illegal economic activities, such a sthe sale of drugs, prostitution and some unlawful transactions that don't comply with tax obligations. Thus, GDP is not an accurate measure to determine the country's health.

2. GDP also doesn't take into account the income generated in a nation by an overseas company that are remitted back to foreign investors. This overstates a country's actual economic output.

3. GDP emphasizes economic output without considering economic well-being e.i., it alone cannot measure the nation's development or the well being of its citizens. For example, a nation may be experiencing rapid GDP growth, but this may impose significant cost to society in terms of environmental impact and an increase in income disparity.

4. GDP doesn't count volunteer work i.e., work that people do for free. In fact, volunteer work can actually lower GDP when volunteers do work that might otherwise have gone to a paid employee or contractor.