Tuesday, January 22, 2008

Measuring GDP...

1. GDP can be measured as total income in the economy. Is that before tax? If yes, are all kinds of taxes included?
2. Why are inventories included in final goods?
-Guo

To answer your questions, remember that GDP is a measure of the total value of all production in the economy. When we measure this production by adding up income, we want to include all income earned in the production process, including that earned by the Government via taxes. So yes, we wish to include all taxes. Typically we do this by including income before taxes are deducted (i.e. gross income rather than net income), except for indirect taxes paid by firms which we add back to correctly calculate GDP.

Inventories are included as a way to match production correctly. Recall that Y=C+I+G+NX. If a good is produced in year1 but consumed in year 2, it is included in I (inventories, a part of investment) in year 1. When it is consumed in year 2, inventories decline by the value of the good, while consumption increases by the value of the good; these cancel out, so there is no net effect on GDP.

Of course if the good is sold for more than its value as inventory, then GDP will also increase in year 2, but only by the increased value of the good when it was sold. We can think of this as the value of the service of selling the good, which rightly belongs in year 2's GDP, not year 1's.

6 comments:

TIM said...

Thank you very much! I just thought, as a typical intermediate good, it can always be assumed within the current period, and its value is included in the final good. But some intermediate products are used to produce final products during several periods. In order to match production with time period correctly, the most accurate way is to divide the value of that intermediate product into two parts. One is the proportion that is already expensed within the current period(depreciation) which can be counted into GDP by including it in the final products it generates. The other part doesn't involve in generating new products, but since it is produced in the current period, this part can be treated as the value of final product. That is the way to count inventory value in GDP. And this logic can also be applied to other investment like building. But because only a tiny proportion of its initial value is consumed, when calculating GDP, the first part of value is direcly included in the total value of the building which is actually double counted but not very important. And this is also the reason for the way to calculate NNP. Am I right?

TIM said...
This comment has been removed by the author.
TIM said...

And by the way, when calculating NNP to subtract depreciation, is this depreciation same with the depreciation in accounting? I mean, do we subtract depreciation value when it really wears out or during the process it wears out?

James Yetman said...

You don't want to confuse intermediate goods with capital goods. Intermediate goods are used up as a result of production; capital goods depreciate over time.

Think of all the full stock of intermediate goods being a part of the firm's inventory. Each time intermediate goods are used in the production process, the value of inventory of intermediate goods declines. But the value of inventory of (partially or fully) completed goods increases.

In contrast, depreciation is an adjustment we make to the profit of the firm to adjust for the declining value of capital assets over time.

Strictly we'd want to measure depreciation based on how quickly the capital goods are deteriorating. In reality, we're likely to simply use the accounting definition of depreciation.

TIM said...

Ok, thanks!

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