Chapter 9

GROSS DOMESTIC PRODUCT

Measuring the performance of the economy is one of the main concerns of macroeconomics.
Which statistic would you seek to tell how well the economy is doing?
The answer requires some understanding of the national income accounting.

National Income Accounting is the system used to measure the aggregate income and expenditures
for a nation. Despite certain limitations, the national income accounting system provides a valuable
indicator of an economys performance.

In this chapter, you will learn what Gross Domestic Product (GDP) is all about. In particular, you will
learn the different methods how GDP is measured. You will also know some of the limitations of GDP
as a measure of economic performance.

Gross Domestic Product and Gross National Product

Gross Domestic Product (GDP)
The most widely used measure of economic performance throughout the world.
is the total market or money value of all final goods and services produced in an economy over
a period of one year.
Gross National Product (GNP)
- is the total market or money value of all final goods and services produced by a nations
residents (e.g. Filipinos) no matter where they are located.

There are three important points that we need to understand when we talk about GDP:
1. that it is measured in market or money value.
2. it only counts new domestic production.
3. That it only includes final goods and services.

Approaches in Measuring GDP

There are three ways to measure GDP: (1) the expenditure approach , (2) the income approach, and
(3) the industrial origin approach.

The Expenditure Approach

the expenditure approach measures GDP by adding all the spending for final goods during a period of
one year. Thus, we can say that GDP is equals to:

GDP = C + I + G + (X-M)

Where: C is personal consumption expenditure, I is gross private domestic investment, G is

government consumption expenditures and gross investment, and (X-M) is net exports.

Personal Consumption Expenditures (C)

Personal consumption expenditures comprise the total spending made by households for durable
goods, nondurable goods, and services.
Durable goods are consumer goods such as automobiles, appliances, and furniture, which are
used up over relatively long periods of time rather than immediately.
Nondurable goods are used up in a single time period rather than over a relatively long time
period.
Services are intangible economic activities that contribute directly or indirectly to the satisfaction
of human wants.
Ex. Recreation, catering, banking, etc.
Gross Private Domestic Investment (I)
Gross private domestic product investment is the sum of two components:
1. Fixed capital, which includes construction, durable equipment, and breeding stock and orchard
development.
2. Changes in stock, which is the net change in spending for unsold finished goods.

Government Consumption Expenditure and Gross Investment (G)

This category includes the value of goods and services government at all levels purchase measured by
their costs.

Net Exports (X-M)

-the last component of GDP under the expenditure account. It is expressed as X-M. Exports (X) are
expenditures by foreigners for Philippine goods produced domestically. Imports (M)are the dollar
amount of Philippines purchase of Japanese and American Products like automobiles, oil products
from Saudi Arabia, and other goods produced abroad.

The Income Approach

-the second but somewhat more complex approach to measuring GDP is the income approach.
measures GDP by adding all the incomes earned by households in exchange for the factors of
production during a period of time.

GDP = compensation of employees + rents + profits + net interest +

indirect taxes + depreciation

Compensation of Employees
-the largest of the national income accounts.
- it comprises mainly of income earned from wages, salaries and certain supplements paid by
firms and government to suppliers of labor.

Rental Income of Persons

Another source of income is from rent and royalties received by property owners who permit
others to use their assets during a period of time.

Profits
Include those earned by self-employed proprietorships and partnerships who simultaneously run
their businesses and at the same time pay themselves for labor services rendered to their firms.

Net Interest
Household both receive and pay interest. Persons who make loans to businesses earn interest
income.

Indirect Business Taxes

Indirect Business Taxes are levied as a percentage of the prices of goods and services sold and
therefore become part of the revenue received by the firms.
These taxes include the value added tax (VAT), excise taxes on certain goods, and custom
duties.

Depreciation
 is an allowance for the portion of capital worm out in producing GDP.

The Industrial Origin or Gross Value Added Approach

the third approach to GDP calculation.
Is the domestic product of goods and services produced by industries within the country.
Under this approach, the economy is divided into three sectors composed of industries, as
follows:
1. Agriculture, fishery, and forestry sectors
2. Industry sector
3. Service sector

In this approach, the sum of all the value added by the three major sectors of the economy is
equal to GDP.

GDP Shortcomings
For whatever reasons, GDP omits certain measures of overall economic well-being. GDP is the basis of
government economic policies, there is a concern that GDP may be giving us the false impression of
the nations material well-being.
We should remember that GDP is a less-than-perfect measure of our nations economic pulse because
it excludes the following factors:

Nonmarket Transactions
GDP counts only market transactions, it excludes certain unpaid activities such as homemade
production, homemade services like repairs and maintenance.

Distrinbution, Kind, and Quality of products

GDP is blind as to whether a small fraction of the population consumes most of a countrys GDP
or consumption is evenly divided.
GDP also wears blindfold with respect to the quality and kinds of goods and services that make
up a nations GDP.

Neglect of Leisure Time

In general, the wealthier a nation becomes, the more leisure time its citizen can afford. Thus
rather than working longer hours, workers often choose to increase their time for recreation and travel.

The Underground Economy

Illegal gambling, prostitution, illegal drugs, illegal guns, loan-sharking and lending, and small-
time trading are goods and services that meet all the requirements of GDP.
It is estimated that the size of the underground economy in the Philippines is 40 to 45 percent of
GDP.

Economic Bads
More productions means a larger GDP, regardless of the level of pollution created in the
process.
Air, water, and noise pollutions are economic bads that impose costs on society and the
environment but these are not reflected in private market prices and quantities bought and sold.

Nominal or Current GDP versus Real GDP

Nominal GDP
 Nominal or current GDP is the value of all final goods and services based on the prices existing
during the time period of production.
Also reffered to as the current market price of goods and services produced in a given time
period.
Nominal GDP grows in three ways:

1. Output rises and prices remain unchanged.

2. Prices rice and output is constant.
3. Both output and prices rise.

Real GDP
Is the value of all final goods and services produced during a given time period based on the
prices existing in a selected base year.
The Philippines uses 1985 as the base year.
We can therefore convert nominal GDP to real GDP by using the following formula:
ECONOMIC FLUCTUATIONS,UNEMPLOYMENT, AND INFLATION

THE BUSINESS CYCLE

-it is the fluctuations in the level of economic activityalternating between periods of

depression and boom conditions.

-it consists of alternating periods of economic growth and contraction.

-a key indicator of cycles is the rise and fall of GDP, which mirrors changes in employment
and other key indicators of macro economy.

THE FOUR PHASES OF THE BUSINESS CYCLE

1,PEAK OR BOOM - the economy is at,or close to,full employment.

- the economy is operating at or near the production possibilities curve,thus real GDP is at
its highest level.

2, RECESSION- is a downturn in the business cycle during which real GDP declines, business
profits fall,and the percentage of the labor force without jobs rises, and production capacity
is underutilized resulting to high unemployment rate.

- during a recession the economy is operating further inside its production possibilities
frontier.

3. TROUGH- is where the level of GDP 'bottom out'.

- the trough is the duration of the recession.

-the trough is both the bad and the good news.

4. RECOVERY- an upturn in yje business cycle during which the real GDP rises.

-during this phase of the cycle the profits generally improves,invetments rises,real gdp
increases,and the employment moves toward full employment thus a reducion in
umemployment.
ECONOMIC GROWTH- is generally defined as an expansion of the national output measured
by the annualpercentage increase in a national real GDP.

BOOM -AND-BUST ECONOMY- means that there are periods of high growth which is followed
by an abrupt decline in total production.
UNEMPLOYMENT

=refers to the unemployed labor resource,which is measured by unemployment rate during a

particular period of time.

UNEMPLOYMEN RATE- the percentage of people in the labor force who are without jobsand
are actively seeking jobs.

UNEMPLOYMENT RATE = number of unemployed/labor force

TYPES OF UNEMPLOYMENT

FRICTIONAL UNEMPLOYMENT- occurs when a worker moves from one job to another .while
he is searching for a job he is experiencing frictional unemployment.

-frictional unemployed are people who are between jobs or just entering or reentering the
labor market.

STRUCTURAL UNEMPLOYMENT- is caused by a mismatch between jobs offered by the

employees and the potential workers.this may be due to geographical location,skill
variation,and many other factors.even though the number of job vacancies is equal to the
number of unemployed,the unemployed workers lack the necessary skills for the job or are
in the wrong part of the country or woworld to take the job offered.

CYCLICAL UNEMPLOYMENT- this type of unemployment occurs when there is not enough
aggregate demand in the economy.

SEASONAL UNEMPLOYMENT- ay any given time in a year ,a couple of hundred thousand

people may be out of work because this is their 'slow season'

INFLATION- broadly based rise in the rice level.

-is the rise in the general level of prices of goods and services in n economy over a period of
time. Inflation is usually measured by CONCUMER PRICE INDEX (CPI)
THEORIES OF INFLATION

DEMAND PULL INFLATION- a rise in the general price level resulting them from an excess of
aggregate demand(total spending).

-often expressed as "too much money chasing too few goods"

COST PUSH INFLATION- a rise in the general price level resulting from an increase in the cost
of production.