The cartoon
above shows the measuring stick for GDP. GDP stands for “Gross Domestic Product.” This is the total market value of all final
goods
and services produced in an economy in a given time period; therefore, when the goods and
services in an economy increase, so does GDP. There are two different values in
which GDP is calculated. The Nominal Gross
Domestic Product which measures the value of all the goods and services produced in
current prices. On the other hand, Real Gross Domestic Product measures the
value of all the goods and services produced in the prices of some base year. In
regard to measuring, Gross
Domestic Profit is difficult to measure, for this reason we leave it to
economists; however, the calculation is fairly easy. Gross Domestic Product has
two approaches. The first approach is the expenditure approach and it is the
sum of consumption, investment and government spending, plus the value
of net exports, minus the value of imports.
The second approach is the income approach and it is calculated by adding wages,
interests, rent and profit. Logically, both methods approximately equal the
same total, but never equal the same.
GDP is
important in the economy because it is the primary indicator that economists
use to measure the overall standard of living in a country. Its goal is to
tell us what is going on with output; if there is a growth or contraction in
the economy. Therefore, it is important to distinguish the differences between GDP and GNP
(Gross National Product). GDP as
mentioned above includes goods and services produced within
an economy; whereas GNP doesn't include goods and services but instead
goods and services produced by U.S. businesses
operating in foreign countries. Some of the
changes in GDP are simply caused by the business cycle. The business cycle is a
series of cycles of economic expansion and contraction. This happens when the
economy experiences booms, downturns and recessions in the economy and vice
versa. However, the level of real GDP in an economy depends on Aggregate Demand
and Aggregate Supply and where the equilibrium intersects.
In the cartoon for example, inventory is causing the
increase in GDP. Although changes in inventory make up a small section of GDP,
it plays an important role. In fact, changes in inventory causes changes in the
aggregate demand and therefore also causes changes in future economic indicators. For example,
an increase in large amounts of inventory may reduce the aggregate demand thus
causing firms to cut back on production and output. This is due to the fact that the more a firm produces, the more inventory and the more excess there is going to be in the future. Overall, an increase in
inventory affects investments and therefore GDP. This happens because the
change in inventory eventually increases expenditures.
I liked the use of this economic cartoon. It is showing that over time, the gross domestic product will grow bigger with a little help from inventory. Inventory investment is an important part of GDP. Inventory investment is the result of the difference between production and sales. This can represent the economy as a whole or even to an individual firm. If the production is greater than the sales, then the inventory investment is positive; if the production is less than the sales, then the inventory investment is negative. If it is positive, the stock of inventories on hand will be bigger than it was at the beginning; if it is negative, the stock of inventories on hand will be smaller than it was at the beginning.
ReplyDeleteThere are intended and unintended inventory investments that can occur. A positive flow of intended inventory investment happens when a firm expects sales to be high enough that the current level of inventories on hand would not be sufficient. The firm would then purposely build up their inventories. (It is also known as a form of spending.) If a firm decides that their current level of inventories is too high, then it will become a negative flow of intended inventory investment by producing less than what they expect to sell.
Positive or negative unintended inventory investment happens when customers buy a different amount of the firm’s product than the firm expected. If customers buy more than expected, inventories will decrease and unintended inventory investment will be negative; if customers buy less than expected, inventories will increase and unintended inventory investment will be positive. Positive or negative intended or unintended inventory investment are separate events, because intended is based on actions to adjust the stock of inventories, while unintended is results from predictions that were not exact for customer demand.
In the business cycle, there are two ways that inventories can go: become too high or too low. Inventories can become high because there is a drop in demand and they failed to lower their production (resulting in a recession); inventories can become low because consumers, government, or purchasers of exports increased their spending (resulting in the economy booming).
Overall, this cartoon and blog entry is showing that GDP is the sum of all final products, but it is important to include gross investment, for it represents additions to the stock of durable capital that can increase production possibilities in the future.