Advantages and Disadvantages of Real Gdp

London School of Commerce Belgrade A Critical Analysis Of Real GDP Subject: Managerial EconomicsMentor:Student: Maja Paunovic Mirko Lazarevic Belgrade 2013 TABLE OF CONTENTS1. EXECUTIVE SUMMARY3 INTRODUCTION2. ADVANTAGES OF REAL GDP43. LIMITATIONS AND SHORTCOMINGS OF REAL GDP4 3. 1 RENEWABLE FINITE RESOURCE5 3. 2 OLD AND CHILD CARE5 3. 3 UNDERGROUND ECONOMY5 3. 4 UNEMPLOYMENT6 3. 5 THE INFLATION RATE6 3. 6 POLUTTION7 3. 7 LEISURE7 3. 8 POPULATION7 3. 9 INEQUALITY OF WEALTH7 4. CONCLUSION8 REFERENCES9 1. Executive summaryThe gross domestic indicator (GDP) is one of the main indicators used to measure the health of a country’s economy. GDP represents the sum of all goods produces over a specific period of time or in other words it is the size of the economy. Usually, GDP is compared to the previous quarter or year. As an example, if a yearly measurement was taken and the GDP went up 3%, this means that the economy has grown by 3% over the last year. Measuring GDP can be complicated, the calculation can be done in one of three ways: the product method, the income method and the expenditure method.The fi rst method of measuring GDP is to sum up the value of all goods and services produced in the country. Basically, we focus on firms and add up all their production. This method is known as the product method. The second approach is the income method which is focused on the incomes generated from the production of goods and services. When we look back, we will see that this is the same as the sum of all values added at each stage of production. The added value is basically the difference between a firm’s income from sales and the cost of its purchases from other firms.The difference is made up of wages and salaries, rent, interest and profit. Basically, it consists of the incomes produced by those involved in the production process. The final approach to calculating GDP is to add up all expenditure on final output. Which includes the following: consumer expenditure, government expenditure, investment expenditure, exports of goods and services and imports of goods and services. This final method is called the expenditure method. 1 Introduction Economic production and growth, what GDP represents, has a huge impact on nearly everyone within that economy.In order to analyze the health of an economy or examine economic growth, it’s necessary to have a way to measure the size of an economy. Economists usually measure the size of an economy by the amount of stuff it produces. When GDP is calculated in relation to the population of a country this is known as the average GDP per capita. This is often used as an indicator of a country’s standard of living. When calculating GDP international incomes are not included, even those earned by domestic workers in other countries. However, as a measure of the standard of living in a country, GDP has its limitations and shortcomings. . Advantages of real GDP You can use GDP to examine all economies of the world, from the USA to Somalia. No matter if a country is churning out fishing equipment or cars, all of i ts products have a certain monetary value, which added up gives a universally recognized measure. This measure is especially helpful if you consider how different economies around the world are in terms of the goods and services they produce, and the way they reinvest their income – pay back debts or invest in industry sectors. GDP is dynamic; it changes constantly based on new figures on productivity, consumption and investments.Therefore, economists and decision makers can use GDP to measure an economy’s growth or decline. However, they can only do that provided they have an established and accurate mechanism to measure GDP value regularly; without that, they don’t have any data to compare whether present activity is worth more or less than in the past. By removing inflation, real GDP allows economists to make more accurate comparisons between countries and across multiple years. Multinational corporations use real GDP when deciding where to send their investm ent dollars or headquarter their operations. National governments use real GDP to set currency exchange rate targets and evaluate the effectiveness of economic policy by comparing one year’s real GDP data against other years. Central banks put significant weight on real GDP data when determining interest rates and other fiscal policy. Real GDP is also used to compute economic growth, known as the GDP growth rate. This is calculated by comparing each quarter to the previous one. If real GDP were not used, then you wouldn’t know whether it was real growth, or just price and wage increases.The ideal GDP growth rate is between 2-3%. The GDP growth rate is critical for investors to adjust the asset location in their portfolios. Investors also compare countries’ GDP growth rates – countries with strong growth attract more investors for their corporate stocks, bonds and even their own sovereign debt.3. Limitations and shortcoming of real GDP GDP per capita is not a direct increase of living standards and qu ality of life in a country, so policies aimed at maximizing GDP may be seen as ill conceived. This is due to many reasons, including;3.1 Renewable finite resource: Most of country may grow rapidly by exploiting their non-renewable finite resources such as oil and forests. They may also over- exploit resources which renew slowly, such as fish and wildlife. While current living standards may be high, those of future generations may be jeopardized. Therefore, GDP is unable to act as an indicator of future welfare. For example; the fishing industry in Europe is currently facing many problems as a result of over fishing in the past. This has had a significant impact on the GDP of European countries.GDP measures the total value of output produced, but it cannot distinguish between the effects of different types of output on living standards. For example; two countries have the same GDP per capita, but country A has a well-funded education and health system, whereas country B has a well-eq uipped army. It is obvious that country A will have higher living standards than country B, but this is not apparent from their GDP figures.3. 2 Old and Child Care: If you care for your parents when they're old and enfeebled, it doesn't contribute to GDP, but if you pay someone else to care for them, it does contribute.The same goes for childcare and mental illness. The act of caring for the permanently sick, however compassionate that may be, is a use of resources for no tangible gain. Therefore, it does not contribute to GDP' For these reasons, some people prefer to use other indicator to measure a country's standard of living. These social indicators take non-economic factors into account, such as literacy rate, and life expectancy. Some examples are the physical quality of life index (PQLI), the Human Development Index (HDI), and the Basic Well-being Index (BWI).3. 3 Underground economy: Oliver (2006) in his book ‘Macroeconomics' states about the underground economy as fol lows: ‘Underground economy is the part of economic activity not measured in official statistics, either because the activity is illegal, or because firms and workers would rather not report it to avoid paying taxes – is an old issue in Spain'. (p 45) Black market: Michael & Charles (1993) describes that everybody wants to take advantage of a carpenter's, car mechanics, or painter's, offer to do some work without a receipt.Agents engage in the black, or underground, economy for straight-forward reasons. First, they want to avoid taxes (the value added tax, employment and social security charges, profit taxes). Another reason is that criminal activities, such as drug dealing, prostitution, or racketeering, are obviously better kept underground. (p24) Different countries may have different sizes of informal/ ‘black' economy (e. g. crime, subsistence farming, drug dealer, and bartering and cash payments) and this is not taken into account by those who calculate GDP.GD P will therefore underestimate the actual value of output. For example; Russia has a very large black economy, so its relatively small GDP is a poor indicator of actual income and living standards. (Source: John Sloman, 2006, 6th ed,)3. 4 Unemployment: Oliver (2006) states that unemployment is the number of people who do not have job but are looking for one. It directly effects on the welfare of the unemployed. Although unemployment benefits are greater today than they were during the great Depression, unemployment is still often associated with financial and psychological suffering. It is not the question how much suffering depends on the nature of the unemployment. Real GDP is failure to measure unemployment of a country.3. 5 The Inflation Rate: Oliver (2006) states that ‘Inflation is a sustained rise in the general level of prices in the economy-called the price level. The inflation rate is the rate at which the price level increases. (Conversely, deflation is a sustained d ecline in the price level. It corresponds to a negative inflation rate)'. If the price level increase nothing happened for the rich people but something happened for the poor people. As example, some Asian Country there GDP is high, price of goods is also high, and the rich people can easily buy the goods because there income is high. But poor people which income is low they can't buy the goods. The real GDP mean per people per capital so real GDP can't measure the inflation rate which mean Standard of living.3. 6 Pollution: Environment is very important part of Standard of living. But this important part is polluted in many ways. Industry is produce lot of product. On the other hand, at the same time industry is throwing wastage or rubbish, smoke and useless chemicals.It is polluting environment by motor and vehicles which making sound and air pollution. Climate change is a big factor for standard of living. Power station and chemical plant which cause global warm and for that reas on why some countries like Maldives and south part of Bangladesh going down under water. Also High GDP per capita might be accompanied by high levels of pollution and exploitation of the workforce, thus causing a decrease in living standards which is not reflected in GDP figures. Therefore, GDP may overestimate living standards in a country. Here real GDP can't measure Standard of living. (Source: John Sloman, 2006)3. 7 Leisure: Leisure is important for every age. By growing GDP people going to be like machineries. People are all time busy for their earning money to build up their life. They don't have time for entertainment like cinema, game; party also there is not enough leisure centers where people can go easily. When people not involved with recreation to have proper leisure, it is not even mentionable whether the current GDP is high or low in the country. So, real GDP fails to measure the Standard of living.3. 8 Population: Population is a big impact of standard of living. Mos t of third world county has been suffering of this problem (Bangladesh, India, and Pakistan). If the population increase GDP automatic decrease as a result standard of living of county go down. Real GDP cannot solve the countrymen problem.3. 9 Inequality wealth: GDP per capita is not an indicator of the distribution of wealth, because when GDP increases, this extra wealth may be received by only a small section of society with the rest of society even worse off. For example; the GDP of oil producing countries like Saudi Arabia is very high, but the wealth is only shared among a small minority of citizens, while the majority of citizens living relative poverty. (John Sloman, 2006) GDP can only measure the material standard of living, without taking into account the quality of life as perceived by each individual, which cannot be standardized across a population or countries. Let’s take USA and France for example.The USA had a GDP per capita of USD 46, 900 in 2008 (http://www. indexmundi. om/united_states/gdp_per_capita_(ppp). html) while France had 45, 982 (http://www. indexmundi. com/france/gdp_per_capita_(ppp). html). Not a big difference, France trails by a little. Now let’s consider how well are people in each country – In the happy planet index, France ranks 71 while the USA ranks 114, just below Madagascar. People in France are much happier than people in the USA. They have better and free healthcare, free education and so on. Besides these two countries Costa Rica has a GDP much lower than both (http://www. ndexmundi. com/costa_rica/gdp_per_capita_(ppp). html) but its people are considered to be the happiest in the world. Some countries, even though they have low GDP’s, its people are better off. Countries that one rarely hears of have very good life expectancies like in Andorra, Cayman Islands, and so on. (http://www. happyplanetindex. org/data/).4. Conclusion GDP discusses how economists measure the total growth of a nation. At this point it is important to know about how the GDP is doing in the change of standard life style.It is already assumed that real GDP shows the total amount of growth in value in specific year. Economist can predict what to achieve and what is the difference in achievement by the end of the year. As we have seen that real GDP is countable by the value, it is easy to know for any people to predict what further contribution needed in the country. But whatever the economist prediction is, the economic factors should be remain same. Without the economic factors stability, the total development of the country is not possible.References:1.John Sloman & Dean Garratt (2010), Essentials of Economics, 5th Edition, Prentice Hall. (Pages259-267)2. (John Sloman. 6th edn , 2006).3. Oliver Blanchard (2006), ‘Macroeconomics, 4th Edition, New Jersey: Prentice Hall.4. Michael Burda & Charles Nyplosz (1993), Introduction to Macroeconomics, 1st Edition. Oxford University Press.5. http://www. indexmundi. com/united_states/gdp_per_capita_(ppp). html6. http://www. indexmundi. com/france/gdp_per_capita_(ppp). html7. http://www. indexmundi. com/costa_rica/gdp_per_capita_(ppp). html 8. http://www. happyplanetindex. org/data/