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College of Business – Rabigh. FINA 353 Principles of Macroeconomics Lecture 3 Topic : Related Measures & GDP uses and limitations. Lesson Objectives. To learn about After studying these topics you should be able to: Distinguish between nominal and real GDP Calculation Real GDP
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College of Business – Rabigh FINA 353 Principles of MacroeconomicsLecture 3Topic: Related Measures & GDP uses and limitations
Lesson Objectives • To learn about After studying these topics you should be able to: • Distinguish between nominal and real GDP • Calculation Real GDP • The Uses and Limitations of Real GDP • GNP
NOMINAL vs REAL GDP • Nominal GDP is GDP measured in current Saudi Riyal, or the current prices we pay for final goods and services. When a variable is measured in current prices, it is described in nominal terms. • Real GDP is the value of a nation's total final goods and services, adjusted for price changes. It valued at the prices of a reference base year. A base year is the year we choose against which to compare all other years. Real GDP is also called gross domestic product in constant prices(Riyals).Note that real GDP is also known as constant-price GDP and inflation-corrected GDP.
Calculating Real GDP To get real GDP we multiply the quantity of the final good or the service produced in the year by its price in the reference base year. Example:
Mathematical Note: Chained-Dollar Real GDP • Starting with real GDP in 2005 of $125 million and the growth rates in Table 3, real GDP in each year since 2005 is calculated as follows: • Real GDP in 2006 is 8 percent higher than the $125 million in 2005, which is $135 million. • The figure illustrates the linking back to the base year.
Calculating Real GDP Test: Let say Saudi Arabia produced only one good which is Dates. The nominal GDP in 2010 was SAR 100 million with SAR0.50 per kg. The nominal GDP in 2012 was SAR 120 million with SAR0.55 per kg. • How many % nominal GDP increased in 2012? • Calculate the quantity dates produced in 2012. • Calculate the real GDP in 2012. • Calculate actual/real growth. • Why not use two consecutive year’s nominal GDP to calculate economic growth?
Importance of Real GDP • Real GDP is important mainly for the following reasons: • To know that how much the economy is actually producing. It means to compute economic growth, known as the GDP growth rate. The computed growth rate is using to compare the standard of living over time. • To compare the size of economies throughout the world. That means to compare the standard of living among countries. • The GDP growth rate is critical for investors countries with strong growth attract more investors for their corporate stocks, bonds and even their own independent debt. • To track the course of the business cycle that means you can tell where the economy is in the business cycle.
The Business Cycle The business cycle is the periodic but irregular up-and-down movement in production. • Every cycle has two phases:1. Expansion2. Recession • and two turning points:1. Peak2. Trough
The Business Cycle Definitions of Four phases of Business Cycle : • An expansion is a period during which real GDP increases—A speedup in the pace of economic activity – movement from a trough to a peak. • A severe contraction, in which real GDP decreases for at least two quarters, is called a recession - A slowdown in the pace of economic activity - movement from a peak to trough. • Through point is the lower turning point of a business cycle, where a recession turns into an expansion. • Peakis the upper turning of a business cycle, where an expansion turns into a recession.
Time Real GDP
The GDP Deflator GDP price deflatormeasures the general price level i.e. the average price level of all final goods and services. It is an index of the prices of all goods and services included in GDP. It is calculated from the ratio of nominal GDP to real GDP. the GDP deflator is a measure of price inflation/deflation with respect to a specific base year.
The Inflation Rate Inflation Rate is The percentage increase in the price level from one year to the next. We can use the growth rate formula to calculate the Inflation Rate. Inflation Rate Between two years = [(GDP Deflatort – GDP Deflatort-1)/GDP Deflatort-1] x 100
The Inflation Rate Inflation Rate is also calculate by using Consumer Price Index (CPI). The percentage change in CPI from one year to the next. Calculation formula as follows. Inflation Rate Between two years = [(CPIt – CPIt-1)/CPIt-1] x 100
Consumer Price Index (CPI) A CPI is a measure of the average change over time in the prices paid by households consumers who are resident in the municipal city for a fixed basket of goods and services. It is an index of the prices of a fixed basket of final goods and services included in GDP.
Inflation Rate by Using CPI The CPI in Saudi Arabia was 172.1 (June 2010) and 178.3 (June 2012). Calculate Saudi’s annual inflation rate. • What does the result mean? • What are the difference between GDP deflator and CPI?
Gross National Product (GNP) Gross National Product is the market value of all final goods and services produced anywhere in the world by the factors of productions supplied by the residents of that country in a given period of time. • Examples : Nikes’ income from the capital that it supplies to its Saudi Arabia shoe factory is part of US GNP but not part of US GDP.
GNP= GDP+ net factor income received from abroad • Net factor income received from abroad = factor income received from abroad - factor income paid to other countries
Limitations of GDP as a measure of Standard of Living GDP excludes : • Household production of goods and services , because these are not bought or sold in the market. Examples: So GDP underestimates the value of production.
Limitations of GDP as a measure of Standard of Living • Underground Production: it is the production of goods and services hidden from the view of government because people want to avoid taxes and regulations or their actions are illegal. Underground Production is unreported so it is omitted from GDP
Limitations of GDP as a measure of Standard of Living • Leisure Time: It is an economic good . You must choose between work or leisure time. When leisure time increases that means our standard of living increases. The improvements of our standard of living are not measured in real GDP.
Limitations of GDP as a measure of Standard of Living • Environment quality: Pollution is an economic evil. The more we pollute our environment, the lower is our standard of living(other things being the same). This lowering of ourstandard of living is not measured in GDP.
Other influences on the Standard of Living • Health and life expectancy: Good health and long life do not show up directly in GDP. On the other side we do not take into account the negative effect of bad diseases. • Political freedom and social justice: A country might have a very large GDP per person but have limited political freedom and social justice. Such a country would be regarded as having lower standard of living
Limitations and inaccuracies of GDP measures Some questions on limitations and inaccuracies of GDP measures • Household production • Examples? Why is this activity not included in GDP? • Environmental quality • Examples? How can this problem be addressed? • Underground economic activity • Examples? Do you think this is a larger/smaller issue in Greece or Vietnam? • Political freedom and social justice • Examples of high growth economies with limited freedom?
