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World Economics - Measuring Global Economic Activity and GDP

About GDP Data

Gross Domestic Product (GDP) is used to calculate the total economic activity value of an economy, country, regions or trade bloc, such as the European Union. It is the aggregate monetary value of all goods and services produced domestically in a given period of time, usually, per quarter or per annum.

Limitations of GDP
One of the most notable limitations of GDP is that it excludes the shadow economy (the informal sector, any illegal trade, and undeclared cash or barter transactions). This is a particular problem in Africa, where officials try to incorporate estimates of the informal sector into the GDP. This happened in 1994 when Zambia attempted to account for the Shadow Economy and GDP rose by 42%. For more information on the shadow economy and the problem with African GDP data, see Measuring African GDP. [2]

GDP does not take into account negative externalities that are caused by the production of goods, such as pollution. They have negative impacts on the economy that aren’t accounted for by GDP, however the solutions to fix the externalities count towards GDP. [3]

GDP benefits from disasters; crime (causes more money to be spent on security and policing) and illnesses (lead to more spending on medical bills). This mainly due to GDP measuring all monetary transactions as positive, the costs of social problems and disasters are counted as economic progress, despite living standards falling.

GDP excludes the quality of goods and services. This results in innovation that produces higher quality goods which replace older items will have little effect on GDP, as the production is simply replaced and not increased.

GDP also ignores non-market production, most notably subsistence farming. It does not include the value of the goods produced, despite there being an opportunity cost. If you chose to spend your time on other tasks, rather than tending to your tomatoes so that you had to buy some from a supermarket, these tomatoes would be included in GDP. Even though they are direct substitutes, minus the ripening hormone and all the other chemicals, one is included in GDP and the other is not.

Measurement Types of GDP
There are four ways of reporting GDP data:
  • Current GDP
    GDP is reported in the current market value currency value of goods and services that actual year being reported. 

  • Real GDP
    As all countries have variations in inflation, an adjustment is made to cater for the price changes caused by the inflationary effect by adjusting the Current GDP value for a year by a conversion factor relative to a base year. The conversion factor is commonly referred to as the GDP Deflator. 

  • GDP – PPP (Purchasing Power Parity)
    GDP-PPP is used in making international GDP comparisons, takes into account the varying nature of prices between countries and strips out the misleading effects of exchange rate changes. As labour is cheaper and land more plentiful in developing countries such as those that make up the vast majority of Africa, a dollar goes much further in purchasing goods and services that are difficult to trade across borders. While the law of one price – that prices of identical goods and services within a market will converge due to arbitrage – may ultimately hold for many commodities such as oil or minerals, it does not for services such as haircuts. Thus, by taking into account different price levels, PPP gives a better reflection of economic activity and allows all countries to be measured in GDP PPP terms to be accurately compared.

  • GDP Per Capita
    Each of the primary measurements of GDP can be presented in “per capita” terms which has the effect of removing the influence of the size of a country’s population to make a more valid comparison between nations and over time. Current GDP, Real GDP or GDP measured in PPP terms can be divided by the total population of each country to derive a GDP Per Capita value.

Benefits of GDP PPP
GDP PPP (Purchasing Power Parity) is the world-wide accepted way of measuring the value or monitoring the health of an economy. This means that you can compare data from hundreds of different countries, whose economic structures are fundamentally different. 

Before this can be done, the data has to be converted into a purchasing power parity equivalent so that they are comparable. PPP theory proposes that without transaction costs or trade barriers, all goods would cost the same in different markets. By finding a comparable basket of goods, or using a price index (such as the World Price Index), you can compare the purchasing power of one currency compared to others. From this you can convert the data into one price level. However, there are limitations to comparing data in this manner. 

Comparison-wise the previous graph tells you nothing more than that the USA is a bigger country. If you were to divide the GDP by the population of the country, you would find the GDP per person, which is known as GDP per capita. This gives a clearer picture of living standards in each country. By comparing the GDP per capita data, you will find that actually Norway has nearly double the GDP per capita of the USA, roughly $80,000, compared to the USA which is around $50,000.

[1] Diane Coyle: GDP A Brief but Affectionate History
[2] World Economics: Measuring African GDP
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