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## Limitations of GDP

Limitations of using GDP statistics GDP statistics are widely used for comparing economic performance of developing countries, but they can be criticised for several reasons. Differences in the distribution of income Although two countries may have similar GDP per capita, the distribution of income in each country may be very

GLOBAL ECONOMICS

## Limitations of GDP

EconomicsOnline • January 29, 2020 • 2 min read

## Limitations of using GDP statistics

GDP statistics are widely used for comparing economic performance of developing countries, but they can be criticised for several reasons.

### Differences in the distribution of income

Although two countries may have similar GDP per capita, the distribution of income in each country may be very different.

### Differences in hours worked

As when comparing a country over time, the number of hours worked to generate a given level of income may be quite different. For example, workers in the UK tend to work longer hours than those in France, and this would falsely inflate the GDP figures in the UK relative to France. Wider measures of economic welfare usually include an adjustment of GDP to take into account the value derived from leisure.

### International price differences

International prices will also vary, which is significant because purchasing power is based on price in relation to income. To solve this problem, GDP statistics can be re-calculated in terms of purchasing power. The purchasing power of a currency refers to the quantity of the currency needed to purchase a given unit of a good or common basket of goods and services. Purchasing power is determined by the relative cost of living and inflation rates in different countries. Purchasing power parity means equalising the purchasing power of two currencies by taking into account cost of living differences.

For example, if we simply convert GDP in Japan to US dollars using market exchange rates, relative purchasing power is not taken into account, and the validity of the comparison is weakened. By adjusting rates to take into account local purchasing power differences, known as PPP adjusted exchange rates, international comparisons are more valid.

### Difficulty of assessing true values

The true value of public goods such as defence and transport infrastructure and, and merit goods, such as healthcare and education, is largely unknown. This means it is difficult to compare two countries with very different spending on these goods and assets.

### Hidden economies

Similarly, the existence of a large hidden economy may make comparisons based on GDP very misleading. For example, comparing the official GDP of the UK and Russia may be misleading because of the size of the hidden economy in Russia. To avoid tax, transactions may go unrecorded and excluded from official statistics.

### Currency conversion

GDP figures for different countries must be converted to a common currency, such as the US dollar, and this may give misleading figures. Exchange rates against the US dollar may not be accurate for countries whose international trade is relatively small. In such cases converting to US dollars may significantly under-value national output. This is why converting to purchasing power parity is preferable to converting to US dollars.

See: Measures of Economic Welfare

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## The Marshall-Lerner condition

Source : www.economicsonline.co.uk

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## International Business - Political Economy and Economic Development - Chapter 3

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Gross National Income

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A common measure of economic development is a country's gross national income (GNI) per head of population. GNI is regarded as a yardstick for the economic activity of a country; it measures the total annual income received by residents of a nation. GNI per person figures can be misleading because they don't consider differences in the cost of living.

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GNI's relation to purchasing power parity?

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To account for differences in the cost of living, one can adjust GNI per capita by purchasing power. Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct comparison of living standards in different countries.

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### Terms in this set (12)

Gross National Income

A common measure of economic development is a country's gross national income (GNI) per head of population. GNI is regarded as a yardstick for the economic activity of a country; it measures the total annual income received by residents of a nation. GNI per person figures can be misleading because they don't consider differences in the cost of living.

GNI's relation to purchasing power parity?

To account for differences in the cost of living, one can adjust GNI per capita by purchasing power. Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct comparison of living standards in different countries.

What are the conditions required to encourage innovation and entrepreneurship?

It has been argued that the economic freedom associated with a market economy creates greater incentives for innovation and entrepreneurship than either a planned or a mixed economy. In a market economy, any individual who has an innovative idea is free to try to make money out of that idea by starting a business (by engaging in entrepreneurial activity). Similarly, existing businesses are free to improve their operations through innovation. To the extent that they are successful, both individual entrepreneurs and established businesses can reap rewards in the form of high profits. Thus, market economies contain enormous incentives to develop innovations.

Why are democratic regimes more conducive to economic growth than dictatorships?

Some totalitarian regimes have fostered a market economy and strong property rights protection and have experienced rapid economic growth. However, there is no guarantee that a dictatorship will continue to pursue such progressive policies. Dictators are rarely benevolent. Many are tempted to use the apparatus of the state to further their own private ends, violating property rights and stalling economic growth. Totalitarian states, by limiting human freedom, also suppress human development and therefore are detrimental to progress. Given this, it seems likely that democratic regimes are far more conducive to long-term economic growth than are dictatorships, even benevolent ones.

Explain how geography of a nation influences its economic development.

The influential Harvard University economist Jeffrey Sachs argues that by virtue of favorable geography, certain societies are more likely to engage in trade than others and are thus more likely to be open to and develop market-based economic systems, which in turn promotes faster economic growth. He also argues that, irrespective of the economic and political institutions a country adopts, adverse geographical conditions, such as the high rate of disease, poor soils, and hostile climate that afflict many tropical countries, can have a negative impact on development.

Why does education lead to economic development?

Nations that invest more in education will have higher growth rates because an educated population is a more productive population. A survey of 14 statistical studies that looked at the relationship between a country's investment in education and its subsequent growth rates concluded investment in education did have a positive and statistically significant impact on a country's rate of economic growth.

Discuss the three main reasons for the spread of democracy.

There are three main reasons for the spread of democracy. First, many totalitarian regimes failed to deliver economic progress to the vast bulk of their populations. Second, new information and communication technologies have broken down the ability of the state to control access to uncensored information. Third, in many countries the economic advances of the past quarter-century have led to the emergence of increasingly prosperous middle and working classes who have pushed for democratic reforms.

Is privatization by itself enough to guarantee economic growth? Why? Explain using an example.

As privatization has proceeded around the world, it has become clear that simply selling state-owned assets to private investors is not enough to guarantee economic growth. If the newly privatized firms continue to receive subsidies from the state and if they are protected from foreign competition by barriers to international trade and foreign direct investment, they will have little incentive to restructure their operations to become more efficient. For privatization to work, it must also be accompanied by a more general deregulation and opening of the economy. For example, when Brazil decided to privatize the state-owned telephone monopoly, Telebras Brazil, the government also split the company into four independent units that were to compete with each other and removed barriers to foreign direct investment in telecommunications services. This action ensured that the newly privatized entities would face significant competition and thus would have to improve their operating efficiency to survive.

Source : quizlet.com

## Measuring a Nation's Economic Development with GNP

In this article, we'll show you how to read the GNP map and how it's still a useful tool in measuring a nation's economic development and overall demand.

ECONOMICS MACROECONOMICS

## Measuring a Nation's Economic Development with GNP

By RICHARD CLOUTIER Updated September 30, 2021

Reviewed by ROBERT C. KELLY

Gross national product (GNP), a term used as a measure of a country's economic growth and wealth, is often misleading. There are certain situations wherein using GNP is useful, but if used improperly, it can confuse and deceive. In this article, we'll show you how to properly read the GNP map to make sure you arrive at your data destination safely.

## Goods and Services

GNP includes the aggregate value of goods, such as cars, houses, food, and drinks, as well as the value of services such as legal and medical fees that are produced and purchased by a nation during a given time period. The market value of these outputs is added together to calculate GNP.

Here are some important characteristics that should be noted about the input data:

GNP is calculated using the value of the final (and only final) goods and services produced. For example, timber is sold to a paper manufacturer. The paper manufacturer makes paper from the timber. The paper is then sold to a book manufacturer, who then sells the book to a publisher, who sells it to a bookstore, who finally sells it to an individual buyer. In order to avoid double-counting, only the final book price is used to calculate GNP. The value of the intermediary transactions is embedded in the final cost.

GNP uses only the values of output currently produced. Therefore it excludes sales of used items and existing houses. For example, GNP includes new cars on dealers' lots but not the used cars selling on the same lot.

## GNP vs GDP

Another term, gross domestic product (GDP), is closely related to GNP, but there are differences between the two. Whereas GNP is the final value of goods and services produced by domestically owned means of production (using domestic labor and resources), GDP is the final value of goods and services produced within a given country's border. Part of GNP, therefore, is earned overseas, while some domestic production is added to GDP only.

Example - GNP versus GDP Honda manufactures cars in the U.S., but is incorporated in Japan.1﻿ The cars it produces in the U.S. are added to U.S. GDP, but not U.S. GNP, as these cars use domestic factors of production (labor and resources), but are produced by a foreign nation. Conversely, the values are added to Japan's GNP, but not Japan's GDP. Another example involves U.S. company Intel, which manufactures silicon chips in Ireland.2﻿ The production from that facility is added to U.S. GNP, but not U.S. GDP. When U.S. residents earn more abroad than foreigners earn in the U.S., GNP exceeds GDP and vice versa.

Nominal GNP measures the total value of all output produced using the prices of that time period. For example, the nominal GNP for 2000 is calculated using the 2000's price level (as measured by the consumer price index), while the nominal GNP for 2005 uses 2005's price level. The difference between these two figures is the rate of inflation during the time period. (Keep reading about inflation in "All About Inflation" and "Curbing the Effects of Inflation.")

## Supply and Demand

While GNP measures the total supply of output produced during a given period, it then must also equal total demand (assuming there are no savings in an economy).

The total demand for domestic output is made up of five components: consumption, government spending, investment, net exports, and net factor payments. Because GNP must equal total demand for output, it can then be expressed mathematically by:

\text{GNP}=\text{C}+\text{G}+\text{I}+\text{NX}+\text{NFP}

GNP=C+G+I+NX+NFP

The calculation is broken up as follows:

Consumption (C) is the actual consumption spending of the household sector. It consists of food, clothing and all consumer spending. Consumption is by far the largest component of GNP and accounts for approximately two-thirds of total demand.

Goods and services (G) are the next largest component of government purchases. These items include salaries for government employees, national defense, and state and local government spending. Government transfer payments, such as unemployment compensation, are not included.

Investment spending (I) is not what we commonly think of when we discuss investing. It does not include the purchases of stocks and bonds. Rather, investment spending includes business spending that will improve the ability to produce in the future. Inventory spending, capital improvements, and building machinery are included in this category. Investment in housing construction is also included.

The net exports (NX) component is equal to exports (goods and services purchased by foreigners) minus imports (goods and services purchased by domestic residents). For some time the U.S. has been buying more foreign goods and services than it sells abroad, which creates a trade deficit, thereby reducing its GNP.

Finally, net factor payments (NFP) are the net amount of payments that an economy pays to foreigners for inputs used in producing goods and services, less money the economy receives for selling the same factors of production.

## Breaking the GNP Measuring Stick

While GNP measures production, it is also commonly used to measure the welfare of a country. Real GNP growth is seen as an improvement in living standards. Unfortunately, GNP is not a perfect measure of social welfare and even has its limitation in measuring economic output. Improvements in productivity and in the quality of goods are difficult to calculate. For example, personal computer prices have dropped dramatically since their introduction, yet their capabilities have vastly improved.

Source : www.investopedia.com

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