1.3 GROSS NATIONAL PRODUCT
This video is relevant for this section despite it saying that it is for AQA.
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Measuring GDP
The circular flow of income is a very useful method of understanding the workings of an economy. It shows us how national income can increase and decrease as a result in a change in one of the flows. National income measures the monetary value of goods and services produced in an economy over a given period of time. The way we measure the national income of an economy is to find the level of GDP (Gross Domestic Product).
There are three different ways to measure GDP and they will all give us the same value.
The circular flow of income is a very useful method of understanding the workings of an economy. It shows us how national income can increase and decrease as a result in a change in one of the flows. National income measures the monetary value of goods and services produced in an economy over a given period of time. The way we measure the national income of an economy is to find the level of GDP (Gross Domestic Product).
There are three different ways to measure GDP and they will all give us the same value.
- The output method – this method looks at the value of the goods and services that an economy produces. This can be obtained by recording the value of the final output. This overcomes the problem of double counting. We ignore the value added in the intermediate stages and instead look at the final retail price, which is the cost of production plus profit. For example, if we look at the production of a laptop. We may have the component costs of £200, assembly costs of £100, marketing cost of £50 and profit of £150. The final price will be the sum of these and is £500. To avoid double counting we will only take the value of the final product. Another way to come up with the output method is to look at the value added to a good or service as a result of a production process. The value added is the value of production – value of intermediate goods. In our example above, the firms who create the components add value to the components of £200. Then the firm that assembles the product buys the components for £200 and assembles the product for £100, which means that they have added £100 of value. Advertising adds a value of £50 to the product and the firm who organises all of these stages of production adds a value of £150 on. This way looks at each stage of production and sees what value has been added to the product.
- The expenditure method – this looks at everything that is spent in the economy. It is calculated by measuring aggregate demand. The equation for GDP will become: GDP = C + I + G + X – M.
- The income method – this looks at the incomes generated from the production of goods and services. We would sum up the total level of wages, profits, rents and interest in the economy. Only incomes which are generated by the production of goods and services are included in the income approach. We will exclude transfer payments as no good or service has been given in return for the money that has been transferred. Income that has not been declared to Inland Revenue and Customs will not be included in this method. It was estimated in 2013 that around £150 billion of income was not declared to HMRC in the UK economy. This works out to be around 13% of GDP and is known as the shadow economy. In developing countries the shadow economy is expected to be much larger.
National Output = National Expenditure = National Income
Why is it Important to Measure GDP?It is important to measure the level of national income as it can give us information on:
- The rate of economic growth
- Living standards
- Disruption of income
Real GDP Growth Rate = Nominal GDP Growth Rate – Inflation rate
However, a better way to look at the level of GDP is to look at it per capita. For example, if an economy grows in real terms at a rate of 5% and there is an increase in the population by 10% (through migration) then the GDP per capita will be lower than it was the previous year. GDP per capita is important because living standards are closely linked to the level of GDP (up to a certain value). If GDP per capita is at a lower level, the population could potentially be worse off. GDP per capita and real GDP growth rate are ways to assess the performance and health of an economy. Governments will want an economy to experience sustained increases in economic growth.