GDP – Gross Domestic Product
-It is the monetary value of all final goods and services produced within a nation in a year.[break]
-The dollar value of a good or service is what we use to measure GDP because it standardizes everything and makes it easy to track changes.
-Suppose an economy produced the following outputs in Year 1 and Year 2. In which year was GDP greater?
Year 1’s Output: 5 Soccer balls and 1,000 basketballs
Year 2’s Output: 1,000 Soccer balls and 5 basketballs
-Without the dollar amounts, it would be difficult to tell how society values soccer balls and basketballs relative to each other.
-If it’s already this difficult with just two products, imagine how much harder it will be with thousands to millions of products and services a nation produces.
-If soccer balls cost $20 each and basketballs cost $25 each, then we can tell that in Year 1, this economy’s GDP was $25,100 and in Year 2 the GDP was $20,125, so GDP in Year 1 was greater.[break]
Final Goods and Services
-GDP only tracks the value of the final goods and services and ignores the values of intermediate goods.
-The way we distinguish the difference between a final good and an intermediate good is based on who’s buying it and how it’s going to be used.
–Final goods are goods and services that are bought by the final users, the people that are going to consume (use) this product or service themselves.
–Intermediate goods are goods and services that are bought to be included as part of the production process for another good or service.
-Do not confuse intermediate goods with capital goods. Intermediate goods are used up in the production of something else. Capital goods are goods that assist in the production of something else; they are not used up in the production process.
-The reason why we count final goods only and not intermediate goods is to avoid multiple counting. This is easier to understand with an example.[break]
-This table lists the manufacturing process for a bicycle.
-At each step of the process, value gets added to the intermediate good before it gets resold at a higher value to the next processor, before finally being sold to the end user for $700.
-According to our definition of GDP, only the final value of the bicycle ($700) should be counted.
-If we try to calculate how much the production of this bicycle adds to GDP by summing the values during the intermediate stages, we would get $1,840, which is overstating the value of this bicycle by $1,140.
-To avoid multiple counting, we can also sum up the value added at each stage of the production process, rather than looking at the final cost. (Although, theoretically these two numbers should be the same.)
-To use the value added approach, all you have to do is find the difference between what a producer sold his output for and how much he paid for his inputs. Sum up these numbers from the beginning to end of the production process and you’ll have the amount that should be added to GDP (Demonstrated in the Value Added column of the above table).[break]
-GDP only concerns itself with production.
-Transactions that don’t generate output either as a good or service (i.e. the transaction doesn’t product anything) won’t count towards GDP.
–Public transfer payments are direct payments from the government that aren’t related or contingent on production. Social security payments, unemployment benefits, welfare checks, etc. are all examples of public transfer payments that do not count towards GDP.
Private transfer payments are payments made between private individuals that aren’t related to production. For example, the money you get from your grandparents for your birthday or the money you collect from your friend on a bet does not count towards GDP.
–Stock market transactions are another form of financial transactions that are not included in the GDP measure. The act of buying and selling stocks in and of itself generates no output. Nothing is being created; ownerships is merely changing hands. However, the fee that you pay to your stock broker is included in GDP because he (or she) is providing you with a service.
–Secondhand sales, like the last three transactions, don’t contribute to current production, so they are omitted from GDP. This is regardless of now “new” the product being resold is. You can buy a brand new car and resell it a week later; the money generated from won’t be included in GDP (unless part of it went to a broker of some sort).[break]
Within a Nation
-Anything produced within a nation’s borders counts towards that nation’s GDP regardless of who owns the production company.
-The output produced by manufacturing plants in China counts towards China’s GDP regardless if those plants are owned by Chinese companies or American companies (or Japanese companies or European companies or Australian companies or whatever).[break]
In a Year
-Unless otherwise noted, GDP refers to the output for a calendar year, so it is a very specific time frame.
-Only production that takes place in that calendar year counts towards that year’s GDP and that year’s GDP only. So production on Dec 31, 2013 will count towards 2013’s GDP while production on Jan 1, 2014 will go towards 2014’s GDP.
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