Economics: Gross Domestic Product
(A) Illustrate the circular flow of income diagram and explain why different methods of measuring Gross Domestic Product should, in principle, always give the same result. (7%)
(B) Explain the difference between nominal and real GDP. (3%)
Gross domestic product (GDP) also known as national income is defined as the monetary value of all the finished goods and services produced within a country in a specific time period. GDP can be defined by the following four areas, Market Value, Final goods and services, Produced within a company and In a given time period. GDP is a market value where goods and services are valued at their market prices. We add the market value so that we have the total value of output in pounds. The market value of an asset is determined by fluctuations in supply and demand. It should be noted that market value represents what someone is willing to pay for an asset. [Parkin, et al. (2012)]. GDP is also the total values of the final goods and services produced. A final good is a good purchased by its final user. For example if we bought a new car tyre to replace an old flat tyre then this would be an example of a final good, however if a car manufacturer bought a new tyre, for example when Mercedes buy tyres to put on their new cars then this is an example of an intermediate good. We exclude intermediate goods from the definition of GDP to avoid double counting; we do this because the value of the intermediate good is previously included in the value of the final good. We can explain this by the concept of ‘Value Added’. Value added=Value of product-cost of intermediate products. The follow table explains the concept of Value added.
Figure 1
Stage of Production
Value
Raw Material Cost
Value-Added
Bread
1000
500
500
Flour
500
200
300
Wheat
200
0
200
Total:
1000
This above table shows the stages in making bread where bread is the final product. We can see the value added for
(B) Explain the difference between nominal and real GDP. (3%)
Gross domestic product (GDP) also known as national income is defined as the monetary value of all the finished goods and services produced within a country in a specific time period. GDP can be defined by the following four areas, Market Value, Final goods and services, Produced within a company and In a given time period. GDP is a market value where goods and services are valued at their market prices. We add the market value so that we have the total value of output in pounds. The market value of an asset is determined by fluctuations in supply and demand. It should be noted that market value represents what someone is willing to pay for an asset. [Parkin, et al. (2012)]. GDP is also the total values of the final goods and services produced. A final good is a good purchased by its final user. For example if we bought a new car tyre to replace an old flat tyre then this would be an example of a final good, however if a car manufacturer bought a new tyre, for example when Mercedes buy tyres to put on their new cars then this is an example of an intermediate good. We exclude intermediate goods from the definition of GDP to avoid double counting; we do this because the value of the intermediate good is previously included in the value of the final good. We can explain this by the concept of ‘Value Added’. Value added=Value of product-cost of intermediate products. The follow table explains the concept of Value added.
Figure 1
Stage of Production
Value
Raw Material Cost
Value-Added
Bread
1000
500
500
Flour
500
200
300
Wheat
200
0
200
Total:
1000
This above table shows the stages in making bread where bread is the final product. We can see the value added for
References: Parkin, Powell, Matthews, (2012) Economics: European Edition, 8th ed., Harlow, Pearson. Sloman, J., Hinde, K., Garratt, D., (2010) Economics for Business, 5th ed., Harlow. Sloman, J., Jones, E., (2011) Economics and the Business Enviroment, 3rd ed., Harlow. Griffiths, A., Hall, S., (2011) Economics for Business and Management, 3rd ed., Harlow. Beardshaw, J., (2001) Economics: a student’s guide, 5th ed., Harlow, Pearson.