Fundamentals of Economics

1 January 2017

Gross domestic product, National accounts, Value added, Supply and demand, Aggregate supply, Final goods, Economics, Aggregate demand

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Q. : 1: The manuscript for this book was typed for free by a friend. Had I hired a secretary to do the same job, GDP would have been higher, even though the amount of output would have been identical. Why is this? Does this make sense? A. : 1: If a secretary were hired to type the manuscript, they would have had the opportunity to provide a service at a price. We know that each good and service produced and brought to market has a price. That price serves as a measure of value for calculating total output; in this case, the task of completing the typing for this book.

GDP is the total market value of all final goods and services produced within a nation’s borders in a given time period. If the job was undertaken by the secretary, the market price of the service provided would have been included in the calculation of the nation’s GDP for that year. Because the manuscript was typed by a friend, there was no exchange of money. GDP = C + I + G + (X – M) where; GDP = Gross Domestic ProductC = Consumption I = InvestmentG = Government Spending

X = Total value of goods exported out of the nation in the given time period M = Total value of goods imported into the nation in the given time period Because GDP reflects a summation of all individual consumption, investment and trade portions of the economy, the above scenario leads to a cascading impact on the overall GDP. Impact on Consumption: If the secretary received the money for services provided, it would have resulted in increased buying power for them. Increased purchasing power leads to increase in consumption; an important factor in the calculation of a nation’s GDP.

Increased purchasing power also creates a positive impact on the standard of living of individuals that can eventually push the demand curve outward. Impact on Government Spending: With the exchange of money for the exchange of services, an element of the entire transaction could have resulted in an increase in the taxes owed to the Government. ————————————————- Yes, it makes sense that the nation’s GDP would have been higher had a secretary been hired to accomplish the typing of the manuscript for this book. ———————————————— Q. : 3: If gross investment is not large enough to replace the capital that depreciates in a particular year, is net investment greater or less than zero? What happens to our Production Possibilities? A. : 3: Introduction: Changes in real GDP from one year to the next tell us how much the economy’s output is growing. Net Domestic Product (NDP) equals GDP depreciation on a country’s capital goods. NDP accounts for capital that has been consumed over the year in the form of housing, vehicle, or machinery deterioration.

Depreciation, also referred to as “capital consumption allowance”, represents the amount of capital that would be needed to replace those depreciated assets. Investment: Investment adds to the nation’s capital stock. An increase in capital shifts the aggregate production function outward, increases the demand for labor, and shifts the long-run aggregate supply curve to the right. Investment therefore affects the economy’s potential output and thus its standard of living in the long run. Investment is a component of aggregate demand.

Changes in investment shift the aggregate demand curve and thus change real GDP and the price level in the short run. An increase in investment shifts the aggregate demand curve to the right; a reduction shifts it to the left. Depreciation: We routinely use up plans and equipment (capital) in the production process. To maintain our production possibilities, we must at least replace what we’ve used. This value of capital used up in producing goods and services is called depreciation. Gross and Net Investment: As capital is used, some of it wears out or becomes obsolete; it depreciates.

Investment adds to the capital stock, and depreciation reduces it. Gross investment minus depreciation is net investment. If gross investment is greater than depreciation in any period, then net investment is positive and the capital stock increases. If gross investment is less than depreciation in any period, then net investment is negative and the capital stock declines. Conclusion: Thus, NDP is the sum total of money value of final goods and services produced in a country on an accounting year excluding depreciation cost. NDP estimates how much the country has to spend to maintain the current GDP.

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