MEIKTILA UNIVERSITY OF ECONOMICS

MPA - 112
Economic and Public Policy II
Macroeconomics
Assignment for MPA(NPT)-6
Candidate – Ei Shwesin Htun
 Economic and Public Policy II
Macroeconomics (MPA-112)
First Year, First Quarter

Assignment for MPA(NPT)-5

Candidate – Ei Shwesin Htun

Date -27.6.2022 (Monday)

Content
1 Explain the two ways of computing GDP with a diagram.

Assignment Question and answer

1. Explain the two ways of computing GDP with a diagram.

Answer:

Introduction
(a) Gross Domestic product (GDP) of a country is defined as a sum total of all final goods
and services produced in an economy within the territories of the countries. And also, GDP is
the value of the goods and services produced by the nation’s economy less the value of the
goods and services used up in production. GDP is also equal to the sum of personal
consumption expenditures, gross private domestic investment, net exports of goods and
services, and government consumption expenditures and gross investment.

GDP is the sum of consumption, investment, government purchases, and net exports. Each
dollar of GDP falls into one of these categories. This equation is an identity—an equation that
must hold because of the way the variables are defined. It is called the national income
accounts identity.

Consumption consists of household expenditures on goods and services. Goods are tangible
items, and they in turn are divided into durables and non- durables. Durable goods are goods
that last a long time, such as cars and TVs. Nondurable goods are goods that last only a short
time, such as food and clothing. Services include various intangible items that consumers buy,
such as haircuts and doctor visits.

Investment consists of items bought for future use. Investment is divided into three
subcategories: business fixed investment, residential fixed investment, and inventory
investment. Business fixed investment, also called nonresidential fixed investment, is the
purchase by firms of new structures, equipment, and intellectual property products.
(Intellectual property products include software, research and development, and entertainment,
literary, and artistic originals.) Residential investment is the purchase of new housing by
households and landlords. Inventory investment is the increase in firms’ inventories of goods
(if inventories are falling, inventory investment is negative).

Government purchases are the goods and services bought by federal, state, and local
governments. This category includes such items as military equipment, highways, and the
services provided by government workers. It does not include transfer payments to individuals,
such as Social Security and welfare. Because transfer payments reallocate existing income and
are not made in exchange for goods and services, they are not part of GDP.
The last category, net exports, accounts for trade with other countries. Net exports are the value
of goods and services sold to other countries (exports) minus the value of goods and services
that foreigners sell us (imports). Net exports are positive when the value of our exports is
greater than the value of our imports and negative when the value of our imports is greater than
the value of our exports. Net exports represent the net expenditure from abroad on our goods
and services, which provides income for domestic producers.

Why GDP Is Important

(b) Some economists illustrate the importance of GDP by comparing its ability to provide
a high-level picture of an economy to that of a satellite in space that can survey the weather
across an entire continent. GDP provides information to policymakers and central banks from
which to judge whether the economy is contracting or expanding, whether it needs a boost or
restraint, and if a threat such as a recession or inflation looms on the horizon. The national
income and product accounts (NIPA), which form the basis for measuring GDP, allow
policymakers, economists, and businesses to analyze the impact of variables such as fiscal and
monetary policy, and economic shocks (such as a spike in oil price), as well as tax plans and
spending plans on the overall economy and specific components of them. Along with better-
informed policies and institutions, the skillful use of national accounts by policymakers has
contributed to a significant reduction in the severity of business cycles since the end of World
War II.

Ways of computing GDP

(c) There are generally two ways to calculate GDP: the expenditures approach and the
income approach. Each of these approaches looks to best approximate the monetary value of
all final goods and services produced in an economy over a set period (normally one year).
The major distinction between each approach is its starting point. The expenditure approach
begins with the money spent on goods and services. Conversely, the income approach starts
with the income earned (wages, rents, interest, and profits) from the production of goods and
services. These two ways of computing GDP must be equal because, by the rules of
accounting, the expenditure of buyers on products is income to the sellers of those products.
Every transaction that affects expenditure must affect income, and every transaction that
affects income must affect expenditure. For example, suppose that a firm produces and sells
one more loaf of bread to a household. Clearly this transaction raises total expenditure on
bread, but it also has an equal effect on total income. If the firm produces the extra loaf without
hiring any more labor (such as by making the production process more efficient), then profit
increases. If the firm produces the extra loaf by hiring more labor, then wages increase. In both
cases, expenditure and income increase equally.

The income approach to measuring the gross domestic product (GDP) is based on the

accounting reality that all expenditures in an economy should equal the total income generated
by the production of all economic goods and services. It also assumes that there are four
majors factors of production in an economy and that all revenues must go to one of these
sources. Therefore, by adding together all of the sources of income, a quick estimate can be
made of the total production value of economic activity over a period. Adjustments then must
be made for taxes, depreciation, and foreign-factor payments.

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income

where: Total National Income = Sum of all wages, rent, interest, and profits

Sales Taxes = Consumer taxesimposed by the governmenton the sales of goods andservices

Depreciation = Cost allocated to a tangible asset over its useful life

Net Foreign Factor Income=Differencebetween the total income that acountry’s  
citizen and companies in foreign countries,versusal income foreign citizens and companies
generate in the domestic country.

(d) GDP does fluctuate because of business cycles. When the economy is booming and
GDP is rising, inflationary pressures build up rapidly as labor and productive capacity near
full utilization. This leads central bank authorities to commence a cycle of tighter monetary
policy to cool down the overheating economy and quell inflation. As interest rates rise,
companies cut back, the economy slows down, and companies cut costs. To break the cycle,
the central bank must loosen monetary policy to stimulate economic growth and employment
until the economy is strong again.

1. Gross domestic product (GDP) measures the income of everyone in the economy and,
equivalently, the total expenditure on the economy’s output of goods and services.
2. Nominal GDP values goods and services at current prices. Real GDP values goods and
services at constant prices. Real GDP rises only when the amount of goods and services
has increased, whereas nominal GDP can rise either because output has increased or
because prices have increased. The GDP deflator is the ratio of nominal to real GDP
and measures the overall level of prices.
3. GDP is the sum of four categories of expenditure: consumption, investment,
government purchases, and net exports. This relationship is called the national income
accounts identity.
4. The consumer price index (CPI) measures the price of a fixed basket of goods and
services purchased by a typical consumer relative to the same basket in a base year.
Like the GDP deflator and the personal consumption expenditure (PCE) deflator, the
 CPI measures the overall level of prices, but unlike the deflators, it does not allow the
basket of goods and services to change over time as consumers respond to changes in
relative prices.
5. The labor-force participation rate shows the fraction of adults who are working or want
to work. The unemployment rate shows the fraction of those in the labor force who do
not have a job.

So, Economists and policymakers care not only about the economy’s total output of goods
and services but also about the allocation of this output among alternative uses.