CHAPTER 1: Measuring the performance of

the economy

How is the economy performing? What are our economic prospects? Are things going to improve and, if so, when?

How do we get the answers to these questions?

What are SA’s macroeconomic objectives

• economic growth• full employment• price stability• balance of payments stability• equitable distribution of income

HOW ARE WE DOING?

Current State of Affairs

Measuring the level of economic activity: gross domestic product

Gross domestic product (GDP): the total value of all final goods and services produced within the boundaries of a country in a particular period (usually one year).

‘value’ – obtained by using prices‘final’ – must avoid double counting

What is the total value added of these four transactions?

• A farmer produces 1000 bags of wheat which he sells to a miller at R10 per bag, yielding a total of R10 000.

• The miller processes the wheat into flour, which he then sells to a baker for R12 500.

• After baking bread with the flour, the baker sells it to a shop for R18 000.

• The shop subsequently sells the bread to final consumers for R21 000.

R61 500

‘final’

Double counting avoided by counting sales where a good/service reaches its final destination.

Intermediate goods and services do not form part of GDP.

Use of a product determines final or intermediate product.

Flour bought by consumers??? Final or intermediate?

Incomes earned by owners of FOP

• R10 000 - farming stage• R2 500 (R12 500 minus R10 000) - milling stage• R5 500 (R18 000 minus R12 500) - baking stage• R3 000 (R21 000 minus R18 000) - final selling

stage. • Total - R21 000 (R10 000 + R2 500 + R5 500 +

R3 000)

3 different ways of calculating GDP

1. the production method (value added)

2. the expenditure method (final goods and services)

3. the income method (incomes of the factors of production)

Further aspects of GDP definition

• Domestic - “within the boundaries of a country”

• “during a particular period in time” - new goods and services.

• Gross: total

Market prices, basic prices and factor cost (or income)

3 sets of prices that can be used to calculate GDP…omarket pricesobasic prices o factor cost (or factor income)

DifferencesIndirect taxes and subsidies Amount paid differs from cost of production and income earned by FOP.

EFFECT?: Indirect taxes make market prices higher than basic prices or factor cost.

Subsidies have opposite effect - market prices lower than basic prices or factor cost.

Two types of tax and subsidy on production Taxes/subsidies on products: taxes payable

per unit (e.g. VAT, taxes on imports/exports).

Other taxes/subsidies on production: taxes on production not linked to specific goods or services (eg payroll taxes, recurring taxes on land, buildings or other structures and business and professional licenses).

Factor Prices (cost), Basic Prices and Market Prices

GDP at market prices - taxes on products + subsidies on products = GDP at basic prices

GDP at basic prices - other taxes on production + other subsidies on production = GDP atfactor cost (or factor income) GDP at factor cost + other taxes on production - other subsidies on production = GDP at basic prices

GDP at basic prices + taxes on products - subsidies on products = GDP at market prices

GDP @ current prices and constant prices

GDP at current prices = nominal GDPGDP at constant prices = real GDP

Comparing nominal GDP (2014) with nominal GDP (2015) is NOT helpful!

WHY???

SOLUTION…GDP @ current prices GDP at constant prices (real GDP).

Base year chosen - each year’s GDP was also expressed at 2005 prices.