Impact of Gross Domestic Product (GDP) On Economic Development

A pilot study on the research topic-impact of Gross Domestic Product (GDP) on Economic Development

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IMPACT OF GROSS

DOMESTIC PRODUCT

(GDP) ON ECONOMIC

DEVELOPMENT

Submitted To:

Research Supervisor : Mr. Nasir Shamsi

Submitted By:

Name of Student : Mohammad Asif Khan

Seat No. : 1332025

Enrolment No. : MAS/PAD/EP-24672/2013

Class : PGDPA

Section : “B”

Submission Date:

Dated : May 21, 2014


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Table of Contents

Abstract

Introduction

Background of the study

Problem Statement

Significance of Study

Research Methodology

Gross Domestic Product (GDP)

Measuring Gross Domestic Product (GDP) of Country

The Price Level and GDP

Unemployment and GDP

Economic Development and GDP

Development Indicators

Conclusion & Recommendations

Data Collection & References

Appendix


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About the Author

The author of this research study is the student of Post Graduate Diploma in

Public Administration (PGDAP-2013-14) and this research has been carry

out to fulfill the requirement of the PGDPA degree program.

The aim of the research is to provide complete understanding about the

Gross Domestic Product (GDP) as an economic indicator. First it has been

describe that how the GDP of a country has been calculated and what factors

are the part of the GDP and how the GDP explains the economic growth of a

country.

Furthermore, it has been try to find out the economic indicators other than

the GDP which provides more effective understanding of the economic well

being.


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Abstract

Gross Domestic Product (GDP) is the value of aggregate production in a

country during a given period (usually a year). The concept of GDP is based

on the distinction between stocks and flows and the circular flow of

expenditure and income.

Capital is the key macroeconomic stock, and investment is the flow that

increases the stock of capital. Wealth is also a stock, and saving-income

minus consumption expenditure-increases the stock wealth.

The circular flow of income and expenditure arises from the expenditures

of households, firms, governments, and the rest of the world and the payment

of factors incomes by firms. Aggregate expenditure on goods and services

equals to aggregate income. The value of aggregate production-GDP-is equal

to aggregate expenditure or aggregate income in an economy. Because

aggregate expenditure, aggregate income, and the value of aggregate

production are equal, national income accountants can measure the GDP by

using one of two approaches:

The Expenditure Approach

The Factor Incomes Approach

Inflation is measured by the rate of change of the GDP deflator. GDP

deflator gives an upward biased measure of inflation because some goods

disappear and new goods become available, and the quality of goods and

services change overtime.

Real GDP is not a perfect measure of either aggregate production or

economic welfare. It excludes quality improvements, household production,

and the underground economy, environmental damage, the contribution to

economic welfare of health and life expectancy leisure time, and political

freedom and social justice. But the growth rate of real GDP gives a good

indication of the phases of the business cycle. The change in real GDP also

reflects the changes in the unemployment rate in an economy.

This pilot study provides a concrete understanding of the topic and

base for the further research to intricate the topic.


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Introduction

Back Ground of the Study:

Economic development involves growth in the economic wealth of an

economy. Government policy in many countries generally aims for continuous

and sustained economic growth, so that their economies expand and become

more developed. Many less developed countries lack the capital required to

invest in modern infrastructure such as road and power networks, and they

also lack the consumer demand required to stimulate investments in an

industrial base and service sector. Instead, less developed countries tend to

depend heavily on agriculture for employment and incomes. It is the one of

the reason of slow economic growth in these countries.

Problem Statement:

Is the Gross Domestic Product (GDP) the only and the authentic

economic indicator to measure the economic development of a country? And

the difference between the less developed and developed economies are their

GDP growth or the government should consider other economic indicators for

the sustainable economic growth and development?

Significance of Study:

The study reveals that how the economic growth of the countries can

be measured. And, how the other economic indicator describes the social

well-being of the people of the country.

Research Methodology:

The Literature review method has been used to define the hypothesis.

Which includes the review of books, previous research work on the same

topic or related to the topic and references from the authentic web sites?

We try to explore the actual facts regarding economic development or the

real factors which contributes in the development of an economy. For the

same, we try to get the answers of the questions (See Appendix).


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Qualitative Method:

The data collected for this research is secondary in nature. It is

collected with the idea to add personal in-depth introspective opinions and

meaningful to the study.

Hypothesis:

Ho: Gross Domestic Product (GDP) is the authentic economic indicator

to measure the economic well being of the country in addition to people

of the country.

HĄ: Gross Domestic Product (GDP) is not the authentic economic

indicator to measure the economic well being of the country in addition

to people of the country.

What is Gross Domestic Product (GDP)?

Gross Domestic Product (GDP) is the value of aggregate or total

production of goods and services in a country during a given time period-

usually one year.

How it is calculated? Two fundamental concepts from the foundation on

which GDP measurements are based:

The distinction between stocks and flows,

The equality of income, expenditure, and the value of production.


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Stock and Flows:

To keep track of our personal economic transactions and the economic

transactions of a country, we distinguish between stocks and flows.

Stock:

A stock is a quantity that exists at a point in time. The water in a

bathtub is a stock. So are the numbers of the current deposits (CDs)

that are you own and the amount of money in your savings accounts.

Flow:

A flow is a quantity per unit of time. The water that is running from an

open faucet into a bathtub is a flow. So are the number of current

deposits (CDs) that you buy during a month and the amount of income

that you earn during a month.

GDP has another flow, it is the value of the goods and services

produced in a country during a given time period usually a year.

Capital and Investment:

Capital:

The key macroeconomic stock is Capital. Capital is the plant,

equipments, buildings, and inventories of raw materials and semi-

finished goods and services. The amount of capital in the economy is

crucial factors that influence GDP. Two macroeconomic flows changes

the stock of capital: Investments and depreciations.

Investment:

Investment is the purchase of new plant, equipment, and buildings and

the additions to inventories. Investment increases the stock of capital.

Depreciation:

Deprecation is the decrease in the stock of capital that results from

wear and tear and the passage of time. Another name for depreciation

is capital consumption.


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The total amount spent on adding to the stock of capital and on

replacing depreciated capital is called Gross Investment.

The amount spent an adding to the stock of capital is called Net

Investment equals Gross Investment minus Depreciation.

Net investment = Gross Investment - Depreciation

Wealth and Saving:

Wealth:

Another macroeconomic stock is wealth, which is the value of all the

things that people own. What people own, a stock, is related to what

they earn a flow. People earn an income, which is the amount they

receive during a given time period from supplying the services of

factors of production. Income can be either consumed or saved.

Consumption Expenditure is the amount spent on consumption goods

and services.

Saving:

Saving is the amount of income remaining after meeting consumption

expenditures. Saving adds to wealth and dissaving (negative saving)

decreases wealth.

National wealth and national saving work just like personal savings.

The wealth of a nation at the start of a year equals its wealth at the start of

the previous year plus its saving during the year. Its saving equals its income

minus its consumption expenditure.

Nation’s saving = Income - Consumption Expenditure

The Equality of Income, Expenditure and Value of Production:

The circular flow of income and expenditure helps us to see the

economy as whole income equals to expenditure and also equals the value of

production.

To keep track of the different types of flows that make up the circular

flow of income and expenditure, they are color-coded.


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Government Debt

Repayment Or Borrowing

Governments

Foreign Borrowing and Lending

Rest of The World

1. The red flows are expenditures on goods and services,

2. The blue is income, and

3. The green flows are financial transfers.

In the circular flow of income and expenditure, households receive

incomes (Y) from firms (blue flows) and make consumption expenditures (C),

firms make investment (I), governments purchase goods and services (G), the

rest of the world purchase net exports (NX) – (red flows). Aggregate income

(blue flow) equals aggregate expenditure (red flows).

Households’ savings (S) and net taxes (NT) leak from the circular flow.

Firms borrow to finance their investment expenditures, and governments and

the rest of the world borrow to finance their deficits or lend their surpluses

(green flows).

The Circular Flow of Income and Expenditure in the Economy

Diagram: S Household’s Savings

NT

C G

Y

I NX= X-M

Y

I

C

Y

G

NX=X-M

Firm’s Borrowing

Factor Markets

Goods Market

Financial Markets

Firms

Households


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In the circular flow of income and expenditure consists of four sectors:

Households,

Firms,

Governments and

Rest of the world.

It has been three aggregate markets:

Factors Markets,

Goods and Services Markets, and

Financial Markets.

Household and Firms:

Households sell and firms buy the services of labor, capital, land and

entrepreneurship in factor markets. For these factors services, firms pay

income to households: wages for labor services, interest for the use of

capital, rent for the use of land, and profits for entrepreneurship. Firm’s

retained earnings –profits that are not distributed to households-are also part

of the household sector’s income.

The total income received by all households in payment for the

services of factors of production is aggregate income. In diagram aggregate

income denote by ‘Y”.

Firms sell and households buy consumer goods and services in the

markets. The aggregate payment that households make for these goods and

services is consumption expenditure. In circular flow ‘C’ represents the

consumption expenditure.

Firms buy and sell new capital equipment in the goods market. The

purchase of new plant, equipment, and buildings and the additions to

inventories are investment.

The circular flow diagram shows investment by the red dots labeled ‘I’.

Notice that in the figure, investment flows from firms through the goods

markets and back to firms.

Some firms produce capital goods, and other firms buy them (and firms

‘buy’ inventories form themselves).


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Firms finance their investment by borrowing from households in

financial markets. Household’s saving flows into financial markets and firm’s

borrowing flows out of financial markets. The circular flow diagram shows

these flows by the green dots labeled “Households’ saving” or ‘S’ and “firms

borrowing. These flows are neither income nor expenditure. Income is a

payment for the services of factor of production, and expenditure is a

payment for goods or services.

Governments:

Governments buy goods and services, called government purchases,

from firms. In the circular flow diagram, these government purchases are

shown as the red flow ‘G’. Governments use taxes to pay for their purchases.

In diagram, green dots labeled ‘NT’ shows taxes as net taxes. Net taxes are

equal to taxes paid to governments minus transfer payments received from

governments.

Net Taxes = Total Taxes Received by the Governments –

Transfer Payment paid by Governments

Transfer payments are cash transfers payments received from

governments. Transfer payments are cash transfer payments are cash

transfers from governments to households and firms such as social benefits,

society developments, unemployment and other subsidies.

When government purchases ‘G’ exceed net taxes ‘NT’, the

government sector has a budget deficit, which is finance by borrowing in

financial markets. This borrowing is shown by the green dots labeled

“Government Borrowing”.

Rest of World Sector:

Firms export goods and services to the rest of the world and import

goods and services from the rest of the world. The value of exports minus

the values of imports is called net exports. It is the red flow ‘NX’.

Net Export = Exports - Import

If value of exports exceeds the value of imports, net exports are

positive and flow from the rest of the world to firms. But if the value of

exports is less than the value of imports, net exports are negative and flow

from firms to the rest of the world.


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When net exports are positive, the rest of the world either borrows

from the domestic economy or sells domestic assets that it has bought

previously. These transactions take place in financial markets and they are

shown by the green place in financial markets and they are shown by the

green flow labeled “Foreign Borrowing”. When net exports are negative, the

domestic economy either borrows from the rest of the world or sells foreign

assets that it had previously acquired. Again, these transactions take place in

the figure; we would reserve the directions of the flows of net exports and

foreign borrowing.

Measuring Gross Domestic Product (GDP)

Gross Domestic product (GDP) is the value of aggregate production in a

country during a year. Production can be valued in two ways:

1. By what buyers pay for it,

2. By what it costs producers to make it.

From the view-point of buyers, goods are worth the prices paid for

them.

It will be a real nuisance if these two values are different because we

will then have two different measures of GDP. But if these two values are

always equal, we will have a unique concept of GDP regardless of which one

we use.

Fortunately, the two concepts of value do give the same answer. Let’s

see, why it’s happen?

Expenditure Equals Income:

The total amount that buyers pay for the goods and services produced

is aggregate expenditure. Let’s analyze the aggregate expenditure in circular

flow diagram. The expenditure on goods and services are shown by the red

flows. Firm’s revenues from the sale of goods and services equal

consumption expenditure (C) plus investment (I) plus government purchases

of goods and services (G) plus net exports (NX). The sum of these four flows

in the economy equal to aggregate expenditure on goods and services.

The total amount it costs producers to make goods and services is

equal to the incomes paid for factor services. This amount is shown is

circular flow by the blue.


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The sum of the red flows equals the blue flow. The reason is that

everything a firm receives from the sale of its output is paid out as incomes

to the owners of the factors of production that it employs. That is,

Y = C + I + G + NX

Or

Aggregate income (Y) equals to (=) Aggregate expenditure (C + I + G + NX)

The buyers of aggregate production pay an amount equal to aggregate

expenditure, and the sellers of aggregate production pay on amount equal to

aggregate income, these two methods of valuing aggregate production, GDP,

equals aggregate expenditure or aggregate income.

The circular flow income and expenditure is the foundation for

measuring GDP. At the same time, it is foundation for understanding how the

finance investment flows and translate into growing capital stock.

How investment is financed in The Economy:

Investment is financed by national saving and by borrowing from the

rest of the world. National Savings equal household saving plus government

savings. Borrowing from the rest of the world equals the value of imports

minus the value of experts (or the negative of net exports). Let’s analyze how

these sources of funds combine to finance investment.

National Savings:

The flows into and out of households in circular flow diagram shows,

aggregate income (Y) flows in, and consumption expenditure (C), saving (S),

and net taxes (NT) flow out. Everything received by households is either

spent on consumption goods and services, saved, or paid in net taxes, so:

Y = C + S + NT

And household saving is:

S = (Y – NT) – C

Aggregate income minus net taxes (Y – NT) is called disposable

income, so household saving equals disposable income minus consumption

expenditure.


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Government saving equals net taxes minus government purchases,

(NT – G), which is the government budget surplus. If net taxes exceed

government purchases that is (NT – G) is positive, the government has a

budget surplus and this surplus is added to household saving as an additional

source of finance for investment.

But if net taxes are less than government purchases, this is, if (NT – G)

is negative, the government has a budget deficit and has to finance the

government deficit.

National Savings equals household savings plus government savings:

National Savings = S + (NT – G)

But because household savings equal disposable income minus

consumption expenditure:

National Savings = (Y – NT) – C + (NT – G)

Now we can say that net taxes cancel in the above equation. Household

pay then and government’s receive them, so when we add household saving

and government saving together, they wash out and we are left with:

National Savings = Y – C – G

National Savings equals aggregate income (GDP) minus consumption

expenditure minus government purchases.

Borrowing From The Rest Of The World:

If rest of the world spends more on our goods and services than we

spend on theirs, they must borrow to pay the difference.

That is, if the value of exports (EX) exceeds the value of imports (IM),

then we can lend to the rest of the world an amount equal to (EX – IM). In this

situation, part of national saving flows to the rest of the world and is not

available to finance investment.

Conversely, if we spend more on foreign goods and services than the

rest of the world spends on our, we must borrow from the rest of the world to

pay the difference. That is, if the value of imports (IM) exceeds the value of

exports (EX), then we must borrow from the rest of the world an amount


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equal to (IM – EX). In this case, part of the rest of the world’s saving flows

into the economy and becomes available to finance investment.

Investment Financing:

The total funds available to finance investment equals national saving,

S + (NT – G), plus borrowing from the rest of the world, (IM – EX). This

amount equals investment. That is,

I = S + (NT – G) + (IM – EX)

That is, investment (I) equals household saving (S) plus government

saving (NT – G) plus borrowing from the rest of the world (IM – EX).

Injection And Leakages:

The circular flow of income and expenditure as a system of tubes with

liquid flowing through them. The flow of factor incomes equals the flow of

expenditures. But some liquid leaks from the circular flow. The leakages from

the circular flow are saving, net taxes, and imports. For the flows to not run

dry there must also be some injections into circular flow. The injections are

investment, government purchases of goods and services, and exports.

I = S + (NT – G) + (IM – EX)

Add government purchases (G) and export (EX) to both sides of this

equation and we get:

=

INJECTIONS LEAKAGES

The left side is injections into the circular flow of income and

expenditure, and the right side is leakages from the circular flow.

Now, we analyze that how Economic Staticians of country use the

circular flow of income and expenditure to measure GDP.

Measuring The GDP of Country

To measure the GDP of a country, economic staticians use two

approaches:

I + G + EX S + NT + IM


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Expenditure Approach

Factor Incomes Approach

The Expenditure Approach:

The expenditure approach measures GDP by collecting data on

consumption expenditure (C), investment (I), government purchases of goods

and services (G), and net exports (NX). It can be explain in tabular form:

GDP: The Expenditure Approach:

Item Symbol

Amount

(In

Billions)

Percentage

of GDP

Personal Consumption

Expenditure

Gross Private Domestic

Investment

Government Purchases of

Goods and Services

Net Exports of Goods and

Services

C

I

G

NX

Xxx

xxx

xxx

xxx

X %

x %

x %

x %

Gross Domestic Product

Y

XXX

X %

The amounts can be shown in billions. The name of the item used in the

National Income appears in first column, and symbol we have used in our GDP

equations appears in the next column.

To measure GDP using the expenditure approach, we add together

personal consumption expenditures (C), gross private domestic investment

(I), government purchases of goods and services (G), and net exports of

goods and services (NX).

Personal Consumption Expenditures:

Personal consumption expenditures are the expenditures by households

on goods and services produced in the rest of the world. They include

all goods and services but do not include the purchase of new

residential houses, which is counted as part of investment.


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Gross Private Domestic Investment:

Gross private domestic investment is expenditure on capital equipment

and buildings by firms and expenditure on new residential houses by

households. It also includes the change in firms’ inventories.

Government Purchase of Goods and Services:

Government purchases of goods and services are the purchases of

goods and services by all levels of governments. This item of

expenditure includes the cost of providing national defense, law and

order, street lighting, garbage collection, and so on. It does not include

transfer payments. Such payments do not represent purchases of goods

and services but rather transfers of funds from government to

households.

Net exports of goods and services are the value of exports minus the

value of imports.

Net Exports = Net Exports - Net Imports

Expenditures Not In GDP:

Aggregate expenditure, which equals GDP, does not include all the

things that people and businesses buy. To distinguish total expenditure

on GDP from other items of spending, we call the expenditure included

in GDP final expenditure. Spending that is not part of final expenditure

and not part of GDP include the purchases of:

Intermediate Goods and Services

Use Goods,

Financial Assets

Intermediate Goods and Services:

These are the goods and services that firms buy from each other and

use as inputs in the goods and services that they eventually sell to final

users.

To count the expenditure in intermediate goods and services as well as

the expenditure on the final good involves counting the same thing

twice-called double counting.


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Some goods are sometimes intermediate goods and sometimes final

goods. Whether a good is intermediate or final depends on what it is

used for, not on what it is.

Expenditure on Used Goods is not a part of GDP because these goods

were counted as a part of GDP in the period in which they were

produced and in which they were produced and in which they were new

goods.

Firms often sell financial assets such as bonds and stocks to finance

purchases of newly produced capital goods. The expenditure on newly

produced capital goods is part of GDP, but the expenditure on financial

securities is not. GDP includes the amount spent on new capital, not the

amount spent on pieces of paper.

Now we try to understand the other way of measuring GDP of a country.

The Factor Incomes Approach:

The factor incomes approach measures GDP by adding together all the

incomes paid by firms to households for the services of the factors of

production they hire--wages for Labor, interest of capital, rent for land and

profits paid for entrepreneurship. Let’s elaborate how the factor incomes

approach works.

The National Income divides factor incomes into five categories:

1. Compensation of Employees

2. Net Interest

3. Rental Income

4. Corporate Profits

5. Proprietors’ Income

GDP: The Factor Incomes Approach:

Item Amount

(in Billions) Percentage of GDP

Compensation of

Employees

Rental Income

Corporate Profits

Net Interest

Proprietors’

xxx

xxx

xxx

xxx

xxx

x%

x%

x%

x%

x%


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Income

Indirect Taxes

(Less: Subsidies)

Capital

Consumption

(Less:

Depreciation)

xxx

xxx

x%

x%

Gross Domestic Product

XXX

X%

Compensation of Employees:

Consumption of employees is the total payments by firms for labor

services. This item includes the net wages and salaries (called “take-

home pay”) that workers receive each week or month plus taxes

withheld on earnings plus fringe benefits such as social benefits and

pension fund contributions.

Net Interest:

Net interest is the total interest payments received by households on

loans made by them minus the interest payments made by households

on their own borrowing. This item includes, on the plus side, payments

of interest by firms to households on bonds and, on the minus side,

households’ interest payments on the outstanding balances on their

credit cards.

Rental Income:

Rental income is the payment for the use of land and rental inputs. It

includes payments for rental housing and imputed rent for owner-

occupied housing. (Imputed rent is an estimate of what homeowners

would pay to rent the housing they own and use themselves. By

including income accounts, we measure the total value of housing

service, whether they are owned or rental.)

Corporate Profits:

Corporate profits are the profits made by corporations. Some of these

profits are paid to household in the form of dividends, and some are

retained by corporations as undistributed profits.


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Proprietors’ Income:

Proprietors’ income is a mixture of the elements that we have just

reviewed. The proprietor of an owner-operated business supplies

labor, capital and perhaps land and buildings to the business. It is

difficult to split the income earned by an owner-operator into

compensation for labor, payment for the use of capital, rent payments

for the use of land or buildings and profit, so the national income

accounts lump all these separate incomes into a single category.

The sum of these five components of factor incomes is called net

domestic income at factor cost. It is not GDP. Two further adjustments

are needed to get to GDP, one from factor cost to market price and

another from net to gross.

Factor Cost To Market Price:

When we add up all the final expenditures on goods and services, we

arrive at a total called domestic product at market price. These

expenditures are valued at the market prices that people pay for the

various goods and services.

Another way of valuing goods and services is at factor cost. Factor

cost is the value of a good or service measured by cost. Factor cost is

the value of a good or service measured by adding together the costs

of all the factors of production used to produce it. If the only economic

transaction is between households and firms – if there are no

government taxes or subsidies – the market price and factor cost

values would be same. But the presence of indirect taxes and subsidies

makes these two methods of valuation differ.

An indirect tax is a tax paid by consumers when they buy goods and

services. (In contrast, a direct tax is tax on income.) State sales tax

and taxes on products (gasoline, tobacco, etc.) are indirect taxes.

Because of indirect taxes, consumers pay more for some goods and

services then the factor cost.

A subsidiary is a payment by the government to producer. Payments

made to gain growers and dairy farmers are subsidies. Because of

subsidies, consumers pay less for same goods and services than

producers receive. The market price is less than the factor cost.


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To use the factor incomes approach to measure GDP, we must add

indirect taxes to total factor incomes and subtract subsidies. Making

this adjustment brings us are step closer to GDP, but it does not quite

get us there. To achieve the GDP, we have to make another

adjustment.

Net Domestic Product To Gross Domestic Product:

If we total all the factor incomes and then add indirect taxes and

subtract subsidies, we arrive at net domestic product at market price.

What do the words Gross and Net mean?

The word Gross means before subtracting depreciation - the decrease

in the value of the capital stock that results from wear and tear and the

passage of time. Similarly, the word Net means after subtracting

depreciation.

A component of aggregate expenditure is gross investment – the

purchase of new capital and the replacement of depreciated capital. So

when we total all the expenditures, we arrive at a number that includes

that amount of depreciation, a gross measure.

A component of aggregate factor income is the net profit of business

-profit after subtracting the deprecation of capital. So, when we total

all the factor incomes, we arrive at a number that excludes

depreciation, a net measure.

The above given table summarizes these calculations and explains how

the factor income leads to the same estimate of GDP as the expenditure

approach.

The Price Level And GDP

The price level is the average level of prices of products measured by

a price index. To construct a price index, we take a basket of goods and

services and calculate its value in the current period. The price index is the

value of the basket in the current period expressed as a percentage of the

value of the same basket in the base period. This change of prices is called

inflation.

The two main price indexes that are used to measure the price level are:

The Consumer Price index


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The GDP Deflator

The Consumer Price Index (CPI):

We will discuss the Consumer Price index in brief. The consumer price

index can be defined as follows:

A consumer price index (CPI) measures changes in the price level of

market basket of consumer goods and services purchased by households.

Or

A measure of changes in the purchasing-power of a currency and

the rate of inflation. The consumer price index expresses

the current prices of a basket of goods and services in terms of the prices

during the same period in a previous year, to show effect

of inflation on purchasing power. It is one of the best known lagging

indicators.

Or

The consumer price index (CPI) is a measure that examines the

weighted average of prices of a basket of consumer goods and services, such

as transportation, food and medical care.

The CPI is calculated by taking price changes for each item in the

predetermined basket of goods and averaging them; the goods are weighted

according to their importance. Changes in CPI are used to assess price

changes associated with the cost of living.

The CPI is a statistical estimate constructed using the prices of a

sample of representative items whose prices are collected periodically. Sub-

indexes and sub-sub-indexes are computed for different categories and sub-

categories of goods and services, being combined to produce the overall

index with weights reflecting their shares in the total of the consumer

expenditures covered by the index. It is one of several price

indices calculated by most national statistical agencies. The annual

percentage change in a CPI is used as a measure of inflation.

A CPI can be used to index (i.e., adjust for the effect of inflation) the

real value of wages, salaries, pensions, for regulating prices and for deflating

monetary magnitudes to show changes in real values. In most countries, the

CPI is, along with the population census and the National Income and Product

Accounts, one of the most closely watched national economic statistics.

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http://www.businessdictionary.com/definition/basket-of-goods.html

http://www.businessdictionary.com/definition/services.html

http://www.businessdictionary.com/definition/term.html

http://www.businessdictionary.com/definition/period.html

http://www.businessdictionary.com/definition/inflation.html

http://www.businessdictionary.com/definition/purchasing-power.html

http://www.businessdictionary.com/definition/lagging-indicators.html

http://www.businessdictionary.com/definition/lagging-indicators.html

http://www.investopedia.com/terms/w/weightedaverage.asp

http://www.investopedia.com/terms/c/consumer-goods.asp

http://www.investopedia.com/terms/p/price-change.asp

http://www.investopedia.com/terms/b/basket_of_goods.asp

http://www.investopedia.com/terms/c/cost-of-living.asp

https://en.wikipedia.org/wiki/Consumer_expenditures

https://en.wikipedia.org/wiki/Consumer_expenditures

https://en.wikipedia.org/wiki/Price_index

https://en.wikipedia.org/wiki/Price_index

https://en.wikipedia.org/wiki/Inflation

https://en.wikipedia.org/wiki/Pension

https://en.wikipedia.org/wiki/Census

https://en.wikipedia.org/wiki/National_Income_and_Product_Accounts

https://en.wikipedia.org/wiki/National_Income_and_Product_Accounts


Page 23 of 40

What is 'Weighted Average'?

Weighted average is an average in which each quantity to be averaged

is assigned a weight. These weightings determine the relative

importance of each quantity on the average. Weightings are the

equivalent of having that many like items with the same value involved

in the average.

What are 'Consumer Goods'?

Consumer goods are products that are purchased for consumption by

the average consumer. Alternatively called final goods, consumer

goods are the end result of production and manufacturing and are what

a consumer will see on the store shelf. Clothing, food, automobiles and

jewelry are all examples of consumer goods. Basic materials such as

copper are not considered consumer goods because they must be

transformed into usable products.

What is a 'Price Change'?

A price change is the difference in the cost of an asset or security from

one period to another. While it can be computed for any length of time,

the most commonly cited price change in the financial media is the

"daily price change", which is the change in the price of a stock or

security from the previous trading day's close to the current day's

close. Price change over a period of time such as year-to-date or past

12 months are also commonly used time periods, and is generally

computed as a percentage change.

What is a Basket Of Goods?

A relatively fixed set of consumer products and services valued and

used on an annual basis to track inflation in a specific market or

country. The goods in the basket are often adjusted periodically to

account for changes in consumer habits the basket of goods is used

primarily to calculate the Consumer Price Index (CPI).

What is Inflation?

Inflation is the rate at which the general level of prices for goods and

services is rising and, consequently, the purchasing power of currency

is falling. Central banks attempt to limit inflation, and avoid deflation, in

order to keep the economy running smoothly.

http://www.investopedia.com/terms/a/annual-basis.asp

http://www.investopedia.com/terms/i/inflation.asp

http://www.investopedia.com/terms/b/basket.asp

http://www.investopedia.com/terms/c/consumerpriceindex.asp

http://www.investopedia.com/terms/p/purchasingpower.asp

http://www.investopedia.com/terms/c/centralbank.asp

http://www.investopedia.com/terms/d/deflation.asp

http://www.investopedia.com/terms/e/economy.asp


Page 24 of 40

What is Annual basis Annual Basis?

The return earned by an investment over the course of a year.

Projections containing the phrase "on an annual basis" have usually

used less than a year's worth of data to project a full year's worth of

returns. For example, an investment might have returned 1.5% in one

month. By multiplying this return by 12, an 18% annual basis is the

result. The shorter the period of data used to determine an annual

return, the less accurate that projection is likely to be. Statements

about what an investment will return on an annual basis are always

estimates.

What is Cost of Living?

The amount of money needed to sustain a certain level of living,

including basic expenses such as housing, food, taxes, and healthcare.

Cost of living is often used when comparing how expensive it is to live

in one city versus another.

Calculating the CPI for a single item:

CPI = Updated Cost X 100

Base Period Cost

The GDP Deflator:

The GDP Deflator measures the average level of price of all the goods and

services that are included in GDP.

To calculate the GDP deflator, we use the formula:

GDP Deflator = Nominal GDP X 100

Real GDP

In this formula, nominal GDP is GDP valued in the current year’s price.

Real GDP in a base year scaled up by the growth rate of real GDP since the

base year.

With an estimate of real GDP, we can calculate GDP deflator by

dividing with nominal GDP. The answer will tell us that either the prices of

goods has been increased or decreased, with respect to the base year prices.


Page 25 of 40

Nominal GDP

Diagram:

In the base year, nominal GDP equals real GDP and the GDP deflator is

100. In current year the real GDP has been increased due to growing

production and rising prices.

The red balloon for base year shows real GDP in that year. The green

balloon shows nominal GDP in current year. The red balloon for the current

year shows real GDP for the current year. To see the real GDP in current

year, we deflate nominal GDP using the GDP deflator.

Unemployment And GDP

Unemployment occurs when employed people losing or leaving their

jobs (job losers and job leavers) and from people entering the labor force

(entrants and reentrants).

Labor Market Flows:

Real

GDP

Real

GDP


Page 26 of 40

Job Losers,

Job leavers,

And Retires

Entrants

Reentrants

The Anatomy Of Unemployment:

People become unemployed if they:

1. Lose their jobs

2. Leave their jobs

3. Enter or reenter the labor force

People end a spell of unemployment:

1. Are Hired or recalled

2. Withdraw from the labor force

Let’s explore how much unemployment arises from the three different

ways in which people can become unemployed. The labor market flow shows

unemployment by reason for becoming unemployed. Job losers are the

biggest source of unemployment. Entrants and reentrants also are a large

Employed

Unemployed

Not in Labor Force


Page 27 of 40

component of the unemployed and their numbers fluctuates mildly. Job

leavers are the smallest and most stable source of unemployment.

Types Of Unemployment:

Unemployment is classified into three types that are based on its causes.

These are:

Frictional

Structural

Cyclical

First two types of unemployment belong to normal labor turnover or due

to technological change or advancement. The third type of unemployment

directly belongs to country’s economic cycle. Let’s analyze the same.

Cyclical Unemployment: Cyclical unemployment is the fluctuating unemployment that coincides with

economic / business cycle. Cyclical unemployment is a repeating short-

term problem. The amount of cyclical unemployment increases during a

recession and decreases during and expansion.

Unemployment And Real GDP:

a) Real GDP:

9

Real GDP (Amount in Billions)

Real GDP

Potential GDP

0

10

Time Period (Number of years)


Page 28 of 40

b) Unemployment Rate:

10

Unemployment Rate

Unemployment

Rate (% of Labor Force)

Natural of Employment

0

10

Time Period (Number of Years)

The diagrams illustrate the cyclical unemployment in an economy.

Part (a) shows the fluctuations of Real GDP around “Potential GDP”.

Part (b) shows fluctuations in unemployment rate around a line labeled

“Natural Rate of Unemployment”.

The Natural rate of unemployment is the unemployment rate when there is

no cyclical unemployment or equivalently, when all the unemployment is

frictional and structural. The divergence of the unemployment rate from the

natural rate is cyclical unemployment.

In the figures the unemployment rate fluctuates around the natural rate of

unemployment, just as real GDP fluctuates around potential GDP. When the

unemployment rate equals the natural rate of unemployment, real GDP is

greater than potential GDP. And when the unemployment rate is greater than

natural rate of unemployment, real GDP is less than potential GDP.

It has been clearly seen that the unemployment rate fluctuates with the

real GDP. When real GDP decreases the unemployment rate automatically

increases, and when the real GDP increases the unemployment rate

decreases. As the real GDP shows the performance of an economy, so the

increase in real GDP creates more employment opportunities in the labor

market. On the other hand the decrease in real GDP increases the

unemployment in the economy.


Page 29 of 40

Economic Development And GDP

Economic Development involves growth in the economic wealth (can be

measure through GDP) of an economy. Government policy in many countries

generally aims for continuous and sustained economic growth, so that their

national economics expand and become more developed. A less developed

economy has a low level of economic development. Almost ninety percent

(90%) of the world population lives in less developed economies.

Development objectives therefore tend to include producing more necessities

(goods) as food, shelter and health-care, and making sure they reach more

people in need raising standards of living and expanding economic and social

choices.

However, different countries and even different regions with in the

same countries in the world today are at very different stages of economic

development. The countries with low GDP are considered less developed and

the countries with high GDP are supposed to be developed.

Developed Economies:

A developed economy is generally thought of as having large modern

farms, many firms of different sizes producing and selling a variety of goods

and services, a well-developed road and rail network, modern communication

systems, stable government and a relatively healthy, wealthy and educated

population. Developed economies are also sometimes called industrialized

nations, but this is despite the great majority of their output, income and

employment now being created by their service sectors rather than

manufacturing industries.

However, according to the United Nations there is no general rule for

designating regions or countries as developed or developing, but the standard

of living of the people of the countries.

Developing Economies:

A less developed economy has a low level of economic development.

Farming methods are poor, sometimes providing scarley enough food for a

rapidly growing population to eat. There are very few firms producing and

selling foods and services. Road, rail and communication networks are

underdeveloped and most people are poor. They live in poor housing

conditions, receive little or no education, do not expect to live to old age may

even lack access to clean water to live to old age may even lack access to

clean water. Many countries in Africa are considered less developed.


Page 30 of 40

Less developed countries (LDC’s) are also called developing

economies, suggesting that overtime they are becoming a little more

prosperous, that their industrial structure is developing and fewer people are

living in extreme poverty.

However, not all less developed countries are developing. Some are in

fact experiencing negative economic growth, meaning that incomes are falling

and levels of poverty, malnutrition and disease are rising. For example

between 1995 and 2004 the real GDP of Zimbabwe fell by forty percent

(40%). In contrast, some countries are developing rapidly, such as same

Eastern Europe countries such as Armenia, Georgia, but they have yet to

display the full range of characteristics of modern developed economies.

These are often grouped under the headings emerging economies or newly

industrialized countries.

Reasons For Low Economic Development (GDP):

There are number of reasons suggested for why some economies have

remained less developed than others.

An Over-Dependence On Agriculture To Provide Jobs And Incomes:

More people in less developed economies work in farming than in

industry and services compared to developed nations. Many produce

only enough food for themselves and their families, to live on and very

little surplus they can sell to earn money. In some areas there has been

over farming which means the land is no longer any good for growing

corps. Failures of rains to arrive in some areas due to global climate

change have also meant crops can no longer be grown for people to

survive.

It is the main reason for low economic growth or low GDP of different

countries.

Domination Of International Trade By Developed Nations:

It is argued that rich nations have exploited many poorer nations by

buying up their natural resources and the food crops they produce at

very low prices, and then using these resources to produces goods and

services which they export back to the same less developed countries

at much higher prices.


Page 31 of 40

Further, many rich countries have protected their own mining and

agricultural industries by paying them subsidies. These subsidies have

increased the global supply of these products and forced down world

prices. Producers in less developed countries have not been able to

complete and as a result, they lost sales, incomes and jobs.

Lack of Capital:

While incomes remain low in many less developed countries, they have

little can invest in building factories and the purchase of machinery and

equipment to develop an industrial base. Without these capital goods

less developed countries will not be able to produce more of the goods

and services they need and which they could also export to earn money

from overseas trade.

Insufficient Investment in Education, Skills and Healthcare:

Many people in many less developed countries do not have access to

basic education, training and healthcare which can help them become

healthier, more productive and more innovative workers. Better

education about family planning may also help to reduce birth rates and

improve living standards.

Low Levels of Investment In Infrastructure:

Road, rail and communication networks are often poor in many less

developed countries. This poor infrastructure makes travel and access

and the sharing of information to the rural areas very difficult.

Lack Of Efficient Production And Distribution For Goods And Services:

Many less developed countries lack industries and services. If incomes

are low there is little incentive for businesses to setup different shops

and retail centers. If transport is difficult outside of cities then people

from rural areas cannot travel to cities to shops, and it is also difficult

to take goods and services to rural communities. If workers are

uneducated and lack skills then industry may be unable to employ them.

High Population Growth:

Many underdeveloped countries have rapidly expanding populations

because birth rates remain high. This means available goods and

services have to be shared among more and more people overtime.


Page 32 of 40

Other Factors:

Unstable and corrupt governments, and wars with neighboring

countries or between different tribes or religious groups, have often

blighted the development of some less developed countries. Money that

could have been used to invest in economic development has in some

cases been misused by corrupt officials or squandered on buying arms

and fighting wars.

Development Indicators And GDP

The most commonly used indicators of development and living

standards in different regions and countries in the world.

Gross Domestic Product (GDP) Per Capita:

Gross Domestic Product (GDP) per capita or average income per

person is the most commonly used comparative measure of development.

Developed countries tend to have relatively high GDP per capita. In 2005,

Bermuda had the highest GDP per capita of US $ 69,900.

However, GDP is a narrow measure of economic development or

welfare in a country. For example, it does not take account of what people

can buy with their incomes, access to health and education, or other non-

economic aspects such as the amount of political and cultural freedom people

have, the quality of their environment, or level of security against crime and

violence.

Calculating average GDP of persons also tells us nothing about how

incomes are distributed between populations. For example, consider China

has a rapid economic growth and it had increased the number of millionaires

in the country almost 250,000 by 2006, but still around 47% percent of the

Chinese population had to survive on less than $2/= per day, with almost 17

percent on less than $ 1 per day.

Similarly, Saudi Arabia has a reasonably high income per head, around

$13,100/= in 2005, but most the wealth in the country is held by less than 3

percent of the population.

But even within highly developed countries such as the US there are

still big disparities rich and poor people. For example, in 2005 around 9

percent of us households had an annual income of $ 10,000 or less compared

to 6 percent of households with $ 150,000 or more.


Page 33 of 40

Other countries such as Equatorial Guinea, Brunei or Triniland and

Tobago also have relatively high average incomes but are generally not

considered developed because their economies depend so much on the

production of oil. These countries also have very unequal distribution of

incomes. For example, in 2005 average income in Trinidad and Tobago was

$16,800/= but 39% (percent) of the population lived on less than $2/= per r

day.

Economic Indicators Other Than GDP:

Population On Less Than $1 Per Day:

A better measure of level of poverty in a country is the proportion of

people living on very low income, usually $1 or $2 per day. In 2002,

around 19 percent of the population of developing economies was

estimated to be living on less than $1 per day. However, even in

developed regions some 6 percent of the population in 2005 still lived

in slum condition.

Life Expectancy At Birth:

People in developed countries tend to live longer than people in less

developed countries because they tend to have better standards of

living access to good food and healthcare.

Life expectancy from birth is therefore a good measure of economic

development in a country or region. On average, a bay born in the

developed countries in 2005 could expect to live to seventy five (75)

years of age, while a baby born in less developed world expect could

expect to live around Sixty Six (66) years. However, in some of the


Page 34 of 40

poorest countries in Africa, average life expectancy from birth is less

than forty two (42) years.

Other health-related indicators of economic development include baby

and mother mortality rates, the proportion of children and adults

receiving inoculations against diseases, and death rates for various

diseases including tuberculosis and HIV / AIDS.

Adult Literacy Rate:

A good measure of education provision in an economy is the proportion

of the adult population that is able to read and write. For example, most

adults can read and write in developed countries such as the US,

Canada and those in Europe. In contrast, in 2004 only around 1 in 3

adult living in developing countries such as Chad, Equatorial, Guinea,

Niger and Sierra Leone could read and write.

Other education-related indicators include school and college

enrolment and completion rates among children and young people.

Access To Safe Water Supplies And Sanitation:

Clean water is a necessity and safe, clean sanitation can help stop the

spread of diseases. These are generally available services to most

people living and working in developed countries.

Yet, only around half of all people in developing regions had access to

good sanitation in 2004, and just 80% percent to a safe and sustainable

water source. Access to improved is particularly poor in rural areas in

developing countries with only thirty three percent (33%) of rural

population having access compared to seventy three percent (73%)

living in the cities and urban areas.

Ownership Consumer Goods:

low incomes and the lack of an efficient production and distribution

system of goods and services in many less developed economies means

ownership of consumers goods such as washing machines, cars,

telephones and personal computer is low as compared to many

developed countries.


Page 35 of 40

Proportion Of Workers In Agriculture Compared To Industry Or

Services:

As compare to the developed countries, most people are working in

agriculture sector.

Human Development Index:

To make international comparisons of economic development a little

easier the United Nations compiles the human development Index

(HDI). It combines a number of development indicators into one index

with a maximum possible value of 1. Changes in the index over time

can therefore show whether a country has improved or reduced the

economic well-being of its people in terms of their:

Standard of Living, as measured by gross domestic product (GDP)

per capita.

Access to education and knowledge, measured by the adult literacy

rate and school and college enrolment rates.

Health, Diet and Life Style, measured by life expectancy at birth.

The World Human Development Index Values:

Countries can be ranked by their HDI.

High: 0.800 > 1.00

Medium: 0.500 > 0.799

Low: 0.300 > 0.499

In 2004, Norway had the highest HDI of 0.965 and Nigeria in

Africa the lowest at just 0.311. Countries with an HDI equal to or

greater than 0.800 are generally thought to have high human

development, while those with an index value less than 0.500 are

considered to have low human development. The regions and

countries of the world classified as developed, developing and

less developed according to their HDI value.

Human Poverty Index (HPI) by United Nations (UN):

The UN also used a Human Poverty Index (HPI) to rank developing

countries and developed countries. The indices for developing


Page 36 of 40

countries (HPI-1) and developed countries (HPI-2) each combine a

number of measures for economic hardship.

HPI-1 Developing Countries:

o Probability at birth dying before the age of forty (40),

o Percentage of people unable to read or write,

o Population below income poverty line,

o Population without sustainable access to an improved water

source,

o Proportion of underweight children.

HPI-2 Developed Countries:

o Probability at birth of dying before the age of sixty (60),

o Percentage of people unable to read or write very-well,

o Population with less than fifty (50) percent of average income,

o Proportion for people unemployed for 12 months or more.

In 2006, the Scandinavian countries of Sweden, Norway and Finland had

the lowest poverty values of the 17 developed countries, included in the

comparison. The United Kingdom (UK), Ireland and the United States of

America (USA) had the highest values, and therefore scored the worst in

terms of the poverty measure for developed economies.


Page 37 of 40

Research Findings

From this research we find the GDP is a narrow measure of economic

development or welfare in a country. For example, it does not take account of

what people can buy with their incomes, access to health and education, or

other non-economic aspects such as the amount of political and cultural

freedom people have, the quality of their environment, or level of security

against crime and violence.

Calculating average GDP of persons also tells us nothing about how

incomes are distributed between populations. For example, consider China

has a rapid economic growth and it had increased the number of millionaires

in the country almost 250,000 by 2006, but still around 47% percent of the

Chinese population had to survive on less than $2/= per day, with almost 17

percent on less than $ 1 per day.

Similarly, Saudi Arabia has a reasonably high income per head, around

$13,100/= in 2005, but most the wealth in the country is held by less than 3

percent of the population.

But even within highly developed countries such as the US there are

still big disparities rich and poor people. For example, in 2005 around 9

percent of us households had an annual income of $ 10,000 or less compared

to 6 percent of households with $ 150,000 or more.

Other countries such as Equatorial Guinea, Brunei or Triniland and

Tobago also have relatively high average incomes but are generally not

considered developed because their economies depend so much on the

production of oil. These countries also have very unequal distribution of

incomes. For example, in 2005 average income in Trinidad and Tobago was

$16,800/= but 39% (percent) of the population lived on less than $2/= per r

day.

The research reveals that the Gross Domestic Product (GDP) only

describes the wealth of an economy as whole but it does not reflect economic

wellbeing of the individuals of the country. Or, it is said that the GDP growth

of country does not provide accurate information that an increase in GDP will

guarantee to increase the standard of living of the people of the country.

It can be said that the GDP per capita is not sufficient to describe the

overall economic condition of the country. There are some other indicators

that must be considered while gauging the economic well-being of a country.


Page 38 of 40

Conclusion & Recommendations

From the whole discussion following conclusions has been extracted and

over and above some recommendations has been made:

The level of economic and human development in different economies

can be measured and compared using a range to indicators. Gross Domestic

Product (GDP) per capita, a measure of average income per person, is a most

commonly used economic indicator but it does not represent the economic

well-being and economic condition of whole population, due to unequal

distribution of wealth or income in many countries.

To analyze the economic well-being of the people of the country, we

can use other development indicators, therefore, such as the adult literacy

rate, life expectancy at birth and the number of people earning less than 1$ per

day.

Besides these, the UN defines HDI & HPI indices can be used to identify the

economic well-being of the countries.

The above mentioned social economic indicators provide better

understanding about the standard of living of the individuals and it can be

easily understand that, up to what extent, an increase in overall GDP of a

country put an impact on the standard of living of the people.

The less developed economies have not to work for the size of their

economy in shape of GDP, but also have to invest in their infrastructure,

education, skills development of human and healthcare facilities. They have

to control the growth of the population through controlling the birth rate in

their counties.

They should have to change their traditional agriculture system and have

to introduce modern technology in agriculture to increase their corps, which

not only fulfill their own needs but they can also export these and earn

income. They have to developed new base for the economy, which should be

based on industries. They can achieve this through more investment on

capital goods. The above all measures will help the less developed countries

to enhance their GDP per capita, but the true economic development will be

achieved through the human development and reduction of poverty in the

country.


Page 39 of 40

Data Collection & References

Books:

o Macro Economics, written by Michael Parkin

o Economics Analysis, written by Paul Simulsons

o Economics Theory and Practice, written K.K. Davit

Theses:

o GDP as trued economic indicator

o Difference between developed and developing countries

Web Sites:

o www.un.org

o www.worldbank.org

o www.globalissues.org/traderelated/poverty/hunger.asp

http://www.un.org/

http://www.worldbank.org/

http://www.globalissues.org/traderelated/poverty/hunger.asp


Page 40 of 40

Appendix

Questionnaire:

o What exactly is Gross Domestic Product?

o What does it mean?

o How it can be calculated?

o The Gross Domestic Product (GDP) growth will help to minimize

unemployment in the economy?

o Is the price of the products directly affected by change in the Gross

Domestic Product (GDP)?

o Is the investment key component for the Gross Domestic Product (GDP)

growth?

o Do investor’s consider the GDP growth before making an investment

decision in an economy?

o What appropriate measure should be taken by the government to

improve its GDP level?

o Is the Gross Domestic Product (GDP) is the real difference between less

developed and developed economies?

o Is it the real economic indicator of economic growth?

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Impact of Gross Domestic Product (GDP) On Economic Development

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