Unit 2: Measuring the Performance of the Economy Objectives Distinguish between GDP at factor cost and at market prices. Distinguish between GDE and expenditure on GDP. Calculate GDP using the three different methods. Differentiate between nominal and real GDP. Derive personal disposable income from GDP.

1. Definition and content of the Various Accounts Countries record all transactions that take place inside the country as well as with other countries. The methods used to measure the performance of the economy is known as the National Accounts (NA). NA helps us to measure and analyse: How much our nation is producing and consuming. All economic activities regarding production, income, expenditure and trade with rest of the world as illustrated in the circular of income are summarised in the National Accounts.

National Accounts Account 1: Gross Domestic Product and Expenditure Account 2: Gross National Income and the way it is appropriated. Account 3: Gross Capital Formation and the way it is financed. Account 4: The account with the rest of the world (Balance of payment). Account 1,2 and 3 deals with the domestic economy. Account 4, Deals with foreign sector and record all transactions with the rest of the world.

2. Account 1: Gross Domestic Product and Gross Domestic Expenditure GDP is the market value of all final goods and services produced inside the borders of a country for a period of one year. Final goods and services: Everything that is produced and sold to the end user for consumption. They are not used to produce other goods and services. E.g. If you buy bread at a shop and take it home to eat, the loaf of bread is a final good and is included in the GDP. Intermediate goods are not included in the GDP. E.g. If you buy bread and use it to make sandwiches to sell at school, the bread is an Intermediate good and the Sandwich is the final good. Market value: GDP is measured in terms of the prices paid for goods on the market. Taxes and subsidies influence the prices of goods and we need to take them into consideration.

“Within the borders of the country” or domestic: Production that takes place in a country by citizens of the country as well as foreigners who live and work in the country is included in the GDP. GDP vs GNP GDP: Measure production that takes place inside Namibia. Including production by foreigners who live and work in Namibia but excludes production by Namibians who live and work in other countries. GNP: Measure production by Namibians. It excludes the production of Foreigners who live and work in Namibia.

3 Methods used to calculate the GDP The income method: It involves adding up all the income received by the four factors of production. The expenditure method: This method involves counting expenditure on goods and services by the four sectors of the economy. The value added method: This method measures activities inside businesses that occur as products move through the different stages of production.

Income method The income method uses the income earned by various factors of production to calculate the GDP. Compensation of employees: This item includes all salaries and wages. Net operating surplus: Profit earned by entrepreneurs. Consumption of fixed capital: Capital goods such as machines and equipment are consumed when production takes places. A part of every year’s production must be used to replace the old capital goods. In the national accounts it is called consumption of fixed capital. Taxes on production and products: Refer to indirect taxes that are levied on economic transactions. They are added because they increase the market prices of goods and services. Subsidies on the production and products: subsidies are deducted, because they decrease the market prices of goods and services.

Factor cost and Market prices GDP at factor cost: Measures the cost to businesses to employ the four factors of production. GDP at market prices: Include the prices consumer will pay for the goods on the market. The difference between GDP at factor cost and Market prices is subsidies and taxes levied by the Government.

Table 1: Income method Income method N$ millions Compensation of employees 423 713 Net operating surplus 243 991 Consumption of fixed capital 112 633 GDP at factor cost 780 337 Other taxes on production 16 023 Less: Other subsidies on production 2 367 Taxes on products 84 453 Less: Subsidies on products 4 809 GDP at market prices 873 637

Expenditure method This method uses various types of expenditures on goods and services by four sectors to calculate the GDP at market prices. It is shown on the right hand side of Account 1 in Table 3 below. The expenditures are: Consumption expenditure by households (C) Gross Capital formation (Investment by firms I) Consumption expenditure by the general government (G) Exports of goods and services (X) Imports of goods and services (M) Residual (Discrepancy)

Expenditure method GDP= Expenditure on GDP Y = C+I+G+(X-M) Gross Domestic Expenditure (GDE): Refers to the expenditure inside the country and excludes the foreign sector. GDE= C+I+G I= Gross Capital Formation

Final consumption expenditure by Household (C): Expenditure by households on all final goods and services can be divided into the following categories: Durable goods: Goods that are not used up in the process of consumption and last longer than one year, e.g. cars and furniture. Semi-durable goods: Goods such as clothing and shoes that can be consumed for a period of time but they do not last as long as Durable goods. Non-durable goods: These goods can be consumed only once e.g. food, petrol and cigarettes. Services: Intangible consumption items that are consumed as they are produced, e.g. Medical services and transport services.

Final consumption expenditure by the general government The general government includes the: Central Government Regional Government Local Government Consumption expenditure by the government includes all current expenditure on: Salaries and wages Goods and services of non-capital nature

Gross Capital Formation Also known as Investment expenditure. It consists of the following two components: Gross fixed capital formation: Include all expenditure by producers on production goods such as new buildings, new machines and breeding livestock. It includes new capital goods of the private as well as the public sectors. New lecture buildings at Poly will be included in this category. Change in inventories: Include raw materials, semi-completed and completed products owned by business. These inventories change as goods are bought and sold.

Exports (X), Imports (M) and Residual item Are goods produced in Namibia and sold in other countries. Imports (M): Goods produced in other countries and sold in Namibia. They are not part of GDP and are deducted.

Residual item Calculating the residual item: When calculating GDP by income and expenditure methods, we calculate the same thing, but calculation errors can occur. Data to calculate GDP are obtained from different sources and calculations may not be completely accurate. Errors can be overcame by including the residual item. From table 3 GDP calculated according to expenditure method is more than GDP obtained by Income method. The residual item is difference between the two. Calculating the residual item: Total expenditure N$877 934 Less: GDP at Market P N$873 637 Residual item N$ 4 297

Table 2: Expenditure method N$ millions Consumption expenditure by households 555 818 Consumption expenditure by the general government 160 640 Gross capital formation 135 591 Gross domestic expenditure 852 049 Exports of goods and services 253 804 Less: Imports of goods and services 227 919 Residual item - 4 297   Expenditure on GDP (GDP at market prices) 873 637

Table 3: Illustration of the income and expenditure methods Income method N$ Millions Expenditure method N$ Million Compensation of employees 423 713 Consumption expenditure by Households 555 818 Net operating surplus 243 991 Consumption expenditure by the general government 160 640 Consumption of fixed capital 112 633 Gross Capital formation 135 591 GDP at factor cost 780 337 Gross Domestic Expenditure 852 049 Other taxes on production 16 023 Exports of good and services 253 804 Less: Other subsidies on production 2 367 Less: Imports of goods and services (227 919) Taxes on product 84 453 Residual item - 4 297 Less: Subsidies on product 4 809 GDP at Market prices 873 637

Value added method calculations: This method calculate GDP by adding the value of each producer’s contribution to the final product. Value added method calculations: A grape farmer sells ten load of grapes to a wine cellar @ N$10 000 a load. The wine cellar processes the grape and sells the wine to the wholesaler @ N$ 18 000. The wholesaler sells the wine to retailer @N$ 20 000. The retailer sell the wine to consumer @N$ 25 000.

Table 4: Market value and value added Firm (N$) Market Value (N$) Value added (N$) Farmer 10 000 Wine cellar 18 000 8000 Wholesaler 20 000 2000 Retailer 25 000 5000 Total: 73 000

Value added method The wine did not increase GDP by N$ 73 000 but only by N$ 25 000. Because the final product is worth N$25 000. N$73 000 is obtained by double counting. The original of grapes N$ 10 000, is incl. In each market value or selling price. We eliminate double counting by counting the total value of the first producer and the value added during the stages of production (value of the final product). From table 4: total value added is N$25 000 and the value of wine sold to consumer is N$ 25 000. Thus, wine increase GDP by N$25 000.

Value added method As product move through the production process, we refer to them as intermediate goods. In table 4: the intermediate goods are grapes, wine processed by the cellar and wine sold by the wholesaler. Intermediate goods are not included in the GDP because if included it will result in double counting. Final goods form part of GDP. Final goods are purchased for consumption by individuals, households and firms. Value added is the contribution that each stage of production makes to the final value of a good.

Using GDP figures To compare one country’s GDP with that of another country, wee need to distinguish between nominal GDP and real GDP. Nominal GDP: Is the GDP calculated at existing prices. Also known as GDP at current prices. E.g Goods produced in 2010 will measured in terms of 2010 prices. Real GDP: Is nominal GDP adjusted for inflation. It is calculated at constant prices. P are adjusted to eliminate inflation. We compare GDP figures from one year to those of another year to see if economic growth had taken place.

Real GDP= Nominal GDP x 100 Price Index Price index: Is a measure of how the price level has risen from one year to the next. Example: GDP at market prices = N$38 560 million and consumer P index= 124.4 Real GDP= 38 560/124.4 x 100= N$30 997Mil

Potential GDP: Refer to the GDP the economy could have earned if all its productive resources were fully employed. We refer to this as the full employment income or production level. Example: Real GDP in 2010 was N$ 150 000 but 30% of the countries resources are unemployed. Thus, only 70% of the resources is responsible for GDP mentioned above. Potential GDP= 100/70x150 000 = N$ 214 285

3. Account 2: National Disposable Income and how it is appropriated Reflect income earned by Namibians both inside and outside the borders of the country. National aggregate and exclude income earned by foreigners who live in Namibia. Gross National Disposable Income indicates how income is earned. Appropriation means how citizens use their income. Income used in the following ways: Household can consume their income G spend income on consumption item Income can be saved

Gross National Disposable Income N$ million Appropriation of national income Compensation of employees 423 713 Consumption expenditure by household 555 818 Less: Net compensation to non residents 1 695 Consumption expenditure by general government 160 640 Gross operating surplus 356 524 Final consumption expenditure 716 458 Less: Net property income to the rest of the world 20 820 Gross saving 132 541 Taxes on production and imports 100 476 Less: Subsidies 7 176 Less: Net current transfer from the rest of the world 6 422 Residual item 4 299 848 999 Appropriation of National Income

Account 3 Saving: Is the difference between total available national income and total consumption expenditure. Gross domestic saving consist of: Saving by households: Difference between household final consumption expenditure and current disposable income. Not used for consumption but available to finance investment. Corporate saving: Is part of the company profits that is left over after company tax and dividends have been paid. Saving by the General Government: Difference between Government current income and current expenditure. Consumption of fixed capital: Amount provided to replace old and worn out capital stock.

Account 3… Net Capital inflow from the rest of the world Shows the net amount of funds flowing to or from the country. If more is coming in than goes out, this figure will be positive. If more flows out than comes in, the figure will be negative. Foreign investment: Is the balance on the current account in the BoP. If positive (Surplus) – Inflows > outflows, represents an increase in domestic capital formation.

4. Account 3: Gross Capital Formation and how it is financed N$ million Financing of Gross Capital Formation Gross Fixed Capital Formation 130 320 Saving by household 2386 Change in inventories 5271 Corporate Saving 33 390 Saving by Government -15 868 Consumption of fixed capital 112 633 Gross saving 132 541 Net capital inflow from the rest of the world 6242 Change in gold and other foreign reserves -3192 Foreign investment 3050 135 591 Financing of gross capital formation

5. Account with the rest of the world (Balance of Payment) All countries keep record of all transaction with the rest of the world. This accounting record is called the BoP Balance of payment consists of two major accounts: The current account The capital and financial account

Current Account On the left hand side. Records all exports, imports and transfer of money. Transfer include cash received by Government and private organization or individuals. Government receives grants from governments and their share of money from SACU. NGO receives money from foreign governments.

Capital and Financial account On the right hand side and records the net transfers from the rest of the world. Net capital transfer indicate the favorable difference between capital inflows and capital outflows. Capital includes direct investment, portfolio investment (A portfolio investment is a transaction in which securities are held purely as a financial investment). and any other investment including change in gold and foreign reserves. If balance on the current account shows a negative value, the financial account must provide funding through capital inflows shown on the right hand side as a positive value.

Table 7: Account 4: Account with the rest of the world Current account N$ millions Capital account Total exports of goods and services 268929 Net capital inflow from the rest of the world 6242 Less: Total imports of goods and services 265557 Change in gold and foreign reserves -3192 Transfers -6422 Balance on current account -3050 Financial flows and change in reserves 3050

6. Other Measures of Production, Income & Expenditure Gross National Product (GNP) Income and profits earned by Namibians in foreign countries and paid back to Namibia is called Factor receipts. Foreigners who live and work in Namibia pay income and profits back to their countries it is referred to as Factor payments. Factor payments – Factor receipts = Net Factor Payments GDP – Net Factor Payments = GNP

Net National Product (NNP) GNP – consumption of fixed capital = NNP National Income (NI) NNP is measured at market prices and NI is measured is measure at factor cost. NNP – Indirect business taxes + subsidies= NI Personal income (PI) PI=NI Less: Company tax Company saving Plus: Transfer payments Personal disposable income (PDI) PI – Personal taxes = PDI

END OF UNIT 2: Thank You!!! Questions???