UNIT 2

Measuring the Performance of the economy

OBJECTIVES

• Upon completion of this unit students shouldbe able to:• Distinguish between GDP at factor cost and at market

prices.

• Distinguish between GDE and expenditure on GDP.

• Calculate GDP using the three different methods.

• Differentiate between nominal and real GDP.

• Derive personal disposable income from GDP.

1. DEFINITION AND CONTENT OF THE VARIOUS ACCOUNTS

• Countries record all transactions that take place insidethe country as well as with other countries.

• The methods used to measure the performance of theeconomy is known as the National Accounts (NA).

• NA helps us to measure and analyse:

• How much our nation is producing and consuming.

• All economic activities regarding production, income,expenditure and trade with rest of the world asillustrated in the circular of income are summarised in theNational Accounts.

NATIONAL ACCOUNTS

Account 1: Gross Domestic Product and ExpenditureAccount 2: Gross National Income and the way it is

appropriated.Account 3: Gross Capital Formation and the way it is

financed.Account 4: The account with the rest of the world

(Balance of payment).• Account 1,2 and 3 deals with the domestic economy.

• Account 4, Deals with foreign sector and record alltransactions with the rest of the world.

2. ACCOUNT 1: GROSS DOMESTIC PRODUCT AND GROSS DOMESTIC EXPENDITURE

GDP: is the market value of all final goods and services produced insidethe borders of a country for a period of one year.

Final goods and services: Everything that is produced and sold to the enduser for consumption. They are not used to produce other goods andservices. E.g. If you buy bread at a shop and take it home to eat, the loaf ofbread is a final good and is included in the GDP.

Intermediate goods: are not included in the GDP. E.g. If you buy breadand use it to make sandwiches to sell at school, the bread is anIntermediate good and the Sandwich is the final good.

Market value: GDP is measured in terms of the prices paid for goods onthe market.

Taxes and subsidies influence the prices of goods and we need to takethem into consideration.

2. ACCOUNT 1: GROSS DOMESTIC PRODUCT AND GROSS DOMESTIC EXPENDITURE

• “Within the borders of the country” or domestic:Production that takes place in a country by citizens of thecountry as well as foreigners who live and work in thecountry is included in the GDP.

GDP vs GNP

• GDP: Measure production that takes place inside Namibia.Including production by foreigners who live and work inNamibia but excludes production by Namibians who liveand work in other countries.

• GNP: Measure production by Namibians. It excludes theproduction of Foreigners who live and work in Namibia.

CLASS ACTIVITY 1

1. Which of the following are final goods or services, and which are intermediate goods or services?

a) A haircut purchased from a hair salon

b) A new automobile

c) An oil filter purchased in a new automobile

d) Crude oil

3 METHODS USED TO CALCULATE THE GDP

• The income method: It involves adding up allthe income received by the four factors ofproduction.

• The expenditure method: This methodinvolves counting expenditure on goods andservices by the four sectors of the economy.

• The value added method: This methodmeasures activities inside businesses that occur asproducts move through the different stages ofproduction.

A) INCOME METHOD

The income method uses the income earned by various factors of productionto calculate the GDP.

Compensation of employees: This item includes all salaries and wages.

Net operating surplus: Profit earned by entrepreneurs.

Consumption of fixed capital: Capital goods such as machines andequipment are consumed when production takes places. A part of every year’sproduction must be used to replace the old capital goods. In the nationalaccounts it is called consumption of fixed capital.

Taxes on production and products: Refer to indirect taxes that are leviedon economic transactions. They are added because they increase the marketprices of goods and services.

Subsidies on the production and products: subsidies are deducted,because they decrease the market prices of goods and services.

FACTOR COST AND MARKET PRICES

• GDP at factor cost: Measures the cost to businesses toemploy the four factors of production.

• GDP at market prices: Include the prices consumer willpay for the goods on the market.

The difference between GDP at factor cost and Marketprices is subsidies and taxes levied by the Government.

TABLE 1: INCOME METHOD

Income method N$ millions

Compensation of employees 423 713

Net operating surplus 243 991

Consumption of fixed capital 112 633

GDP at factor cost 780 337

Other taxes on production 16 023

Less: Other subsidies on production 2 367

Taxes on products 84 453

Less: Subsidies on products 4 809

GDP at market prices 873 637

ACTIVITY 2

• Use the following statistics to calculate the GDP at factor cost and at market prices.

N$ millions

Consumption of fixed capital 58 575Other taxes on production 8 638Net operating surplus 108 602Taxes on products 41 611Subsidies on products 6 320Compensation of employees 218 159Other subsidies on production 3 133

N$ millionsCompensation of employees 218 159Net operating surplus 108 602Consumption of fixed capital 58 575GDP at factor cost 385 336Other taxes on production 8 638Less: Other subsidies onproduction

3 133

Taxes on products 41 611Less: subsidies on products 6 320GDP at market prices 426 132

FEEDBACK TO ACTIVITY 2

B) EXPENDITURE METHOD

This method uses various types of expenditures on goodsand services by four sectors to calculate the GDP atmarket prices. It is shown on the right hand side ofAccount 1 in Table 3 below.The expenditures are:Consumption expenditure by households (C)

Gross Capital formation (Investment by firms I)

Consumption expenditure by the general government (G)

Exports of goods and services (X)

Imports of goods and services (M)

Residual (Discrepancy)

EXPENDITURE METHOD

GDP= Expenditure on GDPY = C+I+G+(X-M)

Gross Domestic Expenditure (GDE): Refers to theexpenditure inside the country and excludes theforeign sector.

GDE= C+I+GI= Gross Capital Formation

FINAL CONSUMPTION EXPENDITURE BY HOUSEHOLD (C):

Expenditure by households on all final goods and services canbe divided into the following categories:Durable goods: Goods that are not used up in the process of

consumption and last longer than one year, e.g. cars and furniture.

Semi-durable goods: Goods such as clothing and shoes that can beconsumed for a period of time but they do not last as long as Durablegoods.

Non-durable goods: These goods can be consumed only once e.g.food, petrol and cigarettes.

Services: Intangible consumption items that are consumed as they areproduced, e.g. Medical services and transport services.

FINAL CONSUMPTION EXPENDITURE BY THE GENERAL

GOVERNMENT

The general government includes the:Central Government

Regional Government

Local Government

Consumption expenditure by the governmentincludes all current expenditure on:Salaries and wages

Goods and services of non-capital nature

GROSS CAPITAL FORMATION

Also known as Investment expenditure. It consists of thefollowing two components:

Gross fixed capital formation: Include all expenditure byproducers on production goods such as new buildings, newmachines and breeding livestock. It includes new capital goodsof the private as well as the public sectors. New lecturebuildings at NUST will be included in this category.

Change in inventories: Inventories include raw materials,semi-completed and completed products owned bybusinesses. These inventories change as goods are boughtand sold. It reflects goods produced in the currentperiod but not sold and goods produced in an earlierperiod but sold only during the current period.Therefore, change in inventories can be positive ornegative.

EXPORTS (X), IMPORTS (M) AND RESIDUAL ITEM

Exports (X): Are goods produced in Namibia and sold in other

countries.

Imports (M): Goods produced in other countries and sold in

Namibia. They are not part of GDP and arededucted.

RESIDUAL ITEM

When calculating GDP by income and expenditure methods, wecalculate the same thing, but calculation errors can occur.

Data to calculate GDP are obtained from different sources andcalculations may not be completely accurate.

Errors can be overcame by including the residual item. From table 3GDP calculated according to expenditure method is more than GDPobtained by Income method. The residual item is differencebetween the two.

Calculating the residual item:

Total expenditure N$877 934Less: GDP at Market P N$873 637Residual item N$ 4 297

TABLE 2: EXPENDITURE METHOD

Expenditure method N$ millions

Consumption expenditure by households 555 818

Consumption expenditure by the general government

160 640

Gross capital formation 135 591

Gross domestic expenditure 852 049

Exports of goods and services 253 804

Less: Imports of goods and services 227 919

Residual item - 4 297

Expenditure on GDP

(GDP at market prices)

873 637

TABLE 3: ILLUSTRATION OF THE INCOME AND EXPENDITURE METHODS

Income method N$ Millions Expenditure method N$ Million

Compensation of employees

423 713 Consumption expenditure byHouseholds

555 818

Net operating surplus 243 991 Consumption expenditure by the general government

160 640

Consumption of fixed capital

112 633 Gross Capital formation 135 591

GDP at factor cost 780 337 Gross Domestic Expenditure 852 049

Other taxes on production

16 023 Exports of good and services 253 804

Less: Other subsidies on production

2 367 Less: Imports of goods and services (227 919)

Taxes on product 84 453 Residual item - 4 297

Less: Subsidies on product

4 809

GDP at Market prices 873 637 GDP at Market prices 873 637

ACTIVITY 3

1. Use the data provided below to derive the GDP forNamibia by the expenditure approach.

Items Amount in Trillions of N$

Durable goods 1.2

Non durable goods 2.4

Services 7.1

Fixed investment 1.9

Change in business inventories 0.04

Consumption expenditure by the National Government

1.2

Consumption expenditure by the Local and Regional Government

1.8

Export 2.1

Import 2.6

SOLUTION ACTIVITY 3

Expenditure method In N$ Amount (Trillion of N$)

Consumption expenditure by the household (C)

10.7

Durable goods 1.2

Non durable goods 2.4

Services 7.1

Gross Capital Formation 1.94

Fixed investment 1.9

Change in Business inventories 0.04

Consumption expenditure by the Government

3.0

National 1.2

Regional and Local 1.8

Net Export of goods and services -0.5

Exports 2.1

Imports 2.6

Gross Domestic Product 15.14

ACTIVITY 4

• Use the following statistics to calculate the GDE and the GDP(expenditure on GDP) according to the expenditure method:

N$ millions

Exports of goods and services 91 578

Change in inventories 3 603

Final consumption exp by households 265 392

Imports of goods and services 75 917

Final consumption exp by government 85 551

Gross fixed capital formation 62 601

SOLUTION ACTIVITY 4

N$ millionsFinal consumption exp by households 265 392Final consumption exp by government 85 551Gross capital formation: 65 204

Gross fixed capital formation 62 601Change in inventories 3 603

GDE 417 147Exports of goods and services 91 578Less: Imports of goods and services 75 917Expenditure on GDP

(GDP at market prices)

432 808

C) VALUE ADDED METHOD

• This method calculate GDP by adding the value of each producer’s contribution tothe final product.

• Value added method calculations:

• A farmer produces 1000 bags of wheat which he sells to a miller at N$10 per bag, yielding a total of N$10 000.

• The miller processes the wheat into flour, which he then sells to a baker for N$12 500.

• After baking bread with flour, the baker sells it to a shop for N$18 000.

• The shop subsequently sells the bread to final consumers for N$21 000.

•

TABLE 4: MARKET VALUE AND VALUE ADDED

Firm Market value(N$)

Value added(N$)

Farmer 10 000 10 000Miller 12 500 2 500Baker 18 000 5 500Retailer/shopkeeper

21 000 3 000

Total: 61 500 21 000

VALUE ADDED METHOD

The bread did not increase GDP by N$ 61 500 but only by N$ 21 000.Because the final product is worth N$21 000.

N$61 500 is obtained by double counting.

The original of wheat N$ 10 000, is incl. In each market value or sellingprice.

We eliminate double counting by counting the total value of the firstproducer and the value added during the stages of production (valueof the final product).

From table 4: total value added is N$21 000 and the value of breadsold to consumer is N$ 21 000.

Thus, bread increase GDP by N$21 000.

VALUE ADDED METHOD

• While products are moving through the production process, we referto them as intermediate goods.

• Intermediate goods are used as inputs to produce other goods andservices. They are processed further before they are sold toconsumers.

• The intermediate goods in Table 4 are the wheat, the flour processedby the miller and the bread sold to the retailer by the baker.

• They are not included in the GDP because if they are included, it willresult in double counting.

Final goods form part of GDP. Final goods are purchased forconsumption by individuals, households and firms.

Value added is the contribution that each stage of production makesto the final value of a good.

HOMEWORK

Question 1You are given the following information:

(a)A forester chops down 100 trees and sells them for N$40 each to asawmill.

(b)The sawmill processes the trees into timber and sells the timber toa factory for N$10 000.

(c)The factory uses the timber to make 200 tables and sells the tablesfor N$150 each to a wholesaler.

(d)The wholesaler sells the 200 tables to a retailer for N$300 each.

(e)Consumers buy the 200 tables at N$350 each from the retailer.

Using the above information, calculate the value of GDP by thevalue-added approach.

HOMEWORK

The information in the Table below is a fictitious industrial column for canned fish in 2007. Please fill in the gaps. What is the value of the fishing industry’s contribution to Namibia’s GDP?

Activity Market value (N$ million) Value added (N$ million)

Fish trawling industry 253

Processing 45

Canning 352

Retailing 78

TOTALS:

USING GDP FIGURES

To compare one country’s GDP with that of another country, wee need to distinguishbetween nominal GDP and real GDP.

Nominal GDP/ GDP at existing prices/ GDP at current prices:

Is the GDP calculated at existing prices. Also known as GDP at current prices. E.gGoods produced in 2017 will measured in terms of 2017 prices.

Real GDP/ GDP at constant prices:

Is nominal GDP adjusted for inflation. It is calculated at constant prices. P are adjustedto eliminate inflation.

We compare GDP figures from one year to those of another year to see if economicgrowth had taken place.

USING GDP FIGURES

• Real GDP= Nominal GDP x 100

Price Index

• Price index: Is a measure of how the price level has risen fromone year to the next.

Example: GDP at market prices = N$38 560 million andconsumer P index= 124.4

Real GDP= 38 560/124.4 x 100= N$30 997Mil

USING GDP FIGURES

• Potential GDP: Refer to the GDP the economycould have earned if all its productive resources werefully employed. We refer to this as the fullemployment income or production level.

Example:

Real GDP in 2010 was N$ 150 000 but 30% of thecountries resources are unemployed. Thus, only 70%of the resources is responsible for GDP mentionedabove.

Potential GDP= 100/70x150 000 = N$ 214 285

3. ACCOUNT 2: NATIONAL DISPOSABLE INCOME AND HOW IT IS APPROPRIATED

• Reflect income earned by Namibians both inside and outsidethe borders of the country.

• National aggregate and exclude income earned by foreignerswho live in Namibia.

• Gross National Disposable Income indicates how income isearned.

• Appropriation means how citizens use their income.

• Income used in the following ways:

• Household can consume their income

• G spend income on consumption item

• Income can be saved

Gross National Disposable Income

N$ million Appropriation of national income

N$ million

Compensation of employees

423 713 Consumption expenditure by household

555 818

Less: Net compensation to non residents

1 695 Consumption expenditure by general government

160 640

Gross operating surplus 356 524 Final consumptionexpenditure

716 458

Less: Net property income to the rest of the world

20 820 Gross saving 132 541

Taxes on production and imports

100 476

Less: Subsidies 7 176

Less: Net current transfer from the rest of the world

6 422

Residual item 4 299

Gross National Disposable Income

848 999 Appropriation of National Income

848 999

4. ACCOUNT 3

• Saving: Is the difference between total available nationalincome and total consumption expenditure. Gross domesticsaving consist of:• Saving by households: Difference between household final

consumption expenditure and current disposable income. Not usedfor consumption but available to finance investment.

• Corporate saving: Is part of the company profits that is left overafter company tax and dividends have been paid.

• Saving by the General Government: Difference betweenGovernment current income and current expenditure.

• Consumption of fixed capital: Amount provided to replace old andworn out capital stock.

4. ACCOUNT 3…

• Net Capital inflow from the rest of the world• Shows the net amount of funds flowing to or from the country.

• If more is coming in than goes out, this figure will be positive.

• If more flows out than comes in, the figure will be negative.

• Foreign investment: Is the balance on the current account in theBoP.

• If positive (Surplus) – Inflows > outflows, represents an increase in domesticcapital formation.

ACCOUNT 3: GROSS CAPITAL FORMATION AND HOW IT IS FINANCED

Gross Capital Formation

N$ million Financing of Gross Capital Formation

N$ million

Gross Fixed Capital Formation

130 320 Saving by household 2386

Change in inventories 5271 Corporate Saving 33 390

Saving by Government -15 868

Consumption of fixed capital 112 633

Gross saving 132 541

Net capital inflow from the rest of the world

6242

Change in gold and otherforeign reserves

-3192

Foreign investment 3050

Gross CapitalFormation

135 591 Financing of gross capitalformation

135 591

5. ACCOUNT WITH THE REST OF THE WORLD (BALANCE OF PAYMENT)

• All countries keep record of all transaction with the rest of the world. This accounting record is called the BoP

• Balance of payment consists of two major accounts:• The current account

• The capital and financial account

CURRENT ACCOUNT

On the left hand side.

Records all exports, imports and transfer of money.◦ Transfer include cash received by Government and private

organization or individuals.

◦ Government receives grants from governments and their share of money from SACU.

◦ NGO receives money from foreign governments.

CAPITAL AND FINANCIAL ACCOUNT

• On the right hand side and records the net transfers fromthe rest of the world.

• Net capital transfer indicate the favorable differencebetween capital inflows and capital outflows.

• Capital includes direct investment, portfolio investment (Aportfolio investment is a transaction in which securitiesare held purely as a financial investment). and any otherinvestment including change in gold and foreign reserves.

• If balance on the current account shows a negative value,the financial account must provide funding through capitalinflows shown on the right hand side as a positive value.

TABLE 7: ACCOUNT 4: ACCOUNT WITH THE REST OF THE WORLD

Current account N$ millions Capital account N$ millions

Total exports of goods and services

268929 Net capital inflow from the rest of the world

6242

Less: Total imports of goods and services

265557 Change in gold and foreign reserves

-3192

Transfers -6422

Balance on current account

-3050 Financial flows and change in reserves

3050

6. OTHER MEASURES OF PRODUCTION, INCOME & EXPENDITURE

• Gross National Product (GNP)• Income and profits earned by Namibians in foreign

countries and paid back to Namibia is called Factor receipts.

• Foreigners who live and work in Namibia pay income and profits back to their countries it is referred to as Factor payments.

• Factor payments – Factor receipts = Net Factor Payments

• GDP – Net Factor Payments = GNP

6. OTHER MEASURES OF PRODUCTION, INCOME & EXPENDITURE

Net National Product (NNP)

GNP – consumption of fixed capital = NNP

National Income (NI)

NNP is measured at market prices and NI is measured is measure at factor cost.

NNP – Indirect business taxes + subsidies= NI

Personal income (PI)

PI=NI Less:

Company tax

Company saving

Plus: Transfer payments

Personal disposable income (PDI)

PI – Personal taxes = PDI

ACTIVITY

Consider the set of national accounts figures (all valued at market prices) given in the table below. Calculate (a) GDE, (b) GDP, (c) GNP and (d) NNP. Show your workings.

N$ millions

Consumption of fixed capital 42 937

Net factor payments to the rest of the world 11 229

Gross capital formation 47 260

Exports of goods and services 70 814

Private consumption expenditure byhouseholds

169 530

Consumption expenditure by generalgovernment

53 702

Imports of goods and services 54 146

END OF UNIT 2:THANK YOU!!! QUESTIONS???