The rate of growth here will depend on the fraction of national income devoted to new investment; the higher the rate of investment, the higher the potential output will be.
A labour increase of the working population will vastly improved potential output. A larger proportion of the working population will be seeking employment which will probably increase the “participation rate.” For instance is more women and children want to join the labour market, the working population will rise.
Land can only add tiny amounts to the national output because it is a virtual fixed quantity so land can only be opened up marginally. If a raw material is found a country may “be lucky” and find vast resources of coal, oil and minerals. For instance North Sea gas, which provides huge one off benefits providing short term growth for countries such as Britain. Output will result in being at a higher level until the raw material begins to run out and the output will then fall.
The economic growth of a country can be altered by the government. They may focus on the demand side of the economy by attempting to increase the demand to ensure investment and potential output is turned to actual output. On the other hand they could concentrate on the supply side to increase potential output by encourage research and development, innovation and development.
There are 3 methods which are used to calculate Gross Domestic Product (GDP). These three methods can be shown in a circular flow of income diagram;
The first method in measuring GDP is to add up the value of goods and services produced in the country – the product method. A measurer will focus on firms and add up all their production.
The second method is the income method. The production of goods and services produces wages, salaries, profit, rent and interest. The method is realised when all of these are added.
Finally the expenditure method, this measures the sales value. It focuses on the expenditure necessary to purchase the nation’s production. In this simple circular flow of income, with no injections or withdrawals, whatever is produced is sold. The value of what is sold must therefore be the value of what is produced.
The three methods of calculating GDP are the same;
National Product = National Income = National Expenditure
The product method of calculating GDP – by adding up everything that has been produced in a years such as cars, timber, football matches and haircuts. One problem with this method is double counting. An example would be if a music store bought a CD from a manufacturer for £5 and sold it to a consumer for £10 the contribution to the GDP is not £15, this adds up both the shop buying from the manufacturer and the consumer buying from the shop this is double counting. The ways to get around this is to just count the £10 paid by the consumer.
The alternative is to include the extra value that each firm adds to an item this is called value added. To arrive at the final stage of all products we must add up the values added in each stage. A computer, for instance will go through 3 very basic stages;
Stage 1 – A firm produces the raw materials and then sells them for £350 to firm “B”.
Stage 2 – Firm “B” manufactures the computer into a finished product and then sells it to the retailer for £650.
Stage 3 – Finally Firm “C” sells them to households for £900.
Using the value added method it would add to £350 + £300 + £250 = £900.
It is also important to remember that stock appreciation must be deducted from value added. As it is the increase in monetary value of stocks due to increasing prices. Since this does not represent increased out put, it is not included in GDP.
Another potential problem is government services, if they government give you free advice, it must be valued in terms of what costs to provide.
The income method of measuring GDP – the incomes generated from the production of goods and services must be the same sum as the value added. This is because the value added is simply the difference between the firm’s revenue from sales and the costs of its purchases from other firms;
Value added = Wages, ret, interest and profit = factor incomes.
Transfer payments are an example of qualifications. GDP only includes incomes from production of goods. A gift to someone would not increase GDP, for instance if a friend gave you £5. By far the largest category of transfer payments are pensions, child benefit, social security and family credit. Since they are not payments of goods and services, they are not included in the GDP. It is also important to remember that wages, rent, interest and profits are taken into account before the deduction of taxes since it is the gross that have arrived from the goods.
As in the case of product approach, any gain in profits form stock appreciation must be deducted. The reason being, they don’t arise from a real increase in output.
Indirect taxes and subsidies on goods and services are not deducted from the GDP, because it will not be available for wages, profits, rent or interest. Subsidies are added because it forms part of a companies revenue and therefore contributes to their output. The term for this is called GDP at factor cost.
The Expenditure Method of measuring GDP – I calculating this, an economist would start at the total domestic expenditure at market prices. What is produced in a companie can be sold or just added to stocks. If additions to stocks are added to expenditure of goods and services a measure is obtained and will be equal to output and income. The method of expenditure needs to be added on exports and deducted on imports. The reason being sales of export represents UK income. Imports will provide an income for overseas countries.
As with income, directing indirect tactics is important and adding subsidies to get the real value that is the same as the outcome generated in the production of the output. You cannot spend indirect taxes but subsidies can be spent.
The problem of measuring national output is that some items go unrecorded and thus GNP figures cannot truly represent the nation’s output. A non marketed item is such an example, if you buy paint and pay someone to paint your house it will contribute to the GDP. If you decide to paint your house yourself, it will not. As “do it yourself” activities increase, the figures will underestimate the rate of growth of national output.
The underground economy also applies to this. It consists of illegal and undeclared transactions. They could be drugs or prostitution. Alternatively they could be transactions that are legal but are not put through taxes. For instance “moonlighting,” where people do extra work outside their normal job and do not declare the revenue to tax. An electrician may work one evening outside his job and wire a friends house, he will probably ask for cash and not declare it.
There are problems with using national income statistics to measure welfare, GNP is basically an indicator of a nation’s production. However the following reasons undermine this;
Sometimes production does not equal consumption. If GNP rises as a result of investment, it will not lead to an increase of the current living standards, although it will help to raise future consumption. Likewise the GNP should not rise because of increased imports, it will be foreign firms who benefit, not domestic consumers.
The human cost of production – production may increase in a car factory because of technological advance. If, however it increases as a result of workers working harder, its net benefit will be less. This is because leisure and working conditions are desirable but are not included in the GNP figures.
The rapid growth of in industry is recorded in the GNP statistics. However external costs are not taken into account such as polluted air and rivers, ozone depletion and global warming, so the net benefits of industrial production may be less.
Total GNP figures ignore the distribution of income, some people become very rich and others very poor, particularly in developing countries. Therefore the problem of finding the real GDP is to put a greater weight on the growth of incomes of the poor people than the rich.
