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STUDY UNIT 1
CHAPTER 13
Measuring the performance of
the economy
Learning Outcomes
Once you have studied this chapter you should be able to:
 Explain the five main macroeconomic objectives
 Define the most important national accounting concepts
 Show how the basic national accounting concepts are linked
 Gross domestic product (GDP):
 Define
 Know how its measured
 Calculate
 Alternative ways to determine production and income
 Know how unequal distribution is represented, calculate and interpret it
 Explain a Lorenz curve and the Gini coefficient
Why it is important to measure the
performance of the economy?
Introduction
 In this chapter we focus on the
performance of the economy and how its
measured.
 The emphasis is on understanding the
performance of the economy by
evaluating it against factors such as
macroeconomic objectives
 Macroeconomics also includes an
evaluation of the relative success or failure
of government’s economic policies.
13.1) Macroeconomic Objectives
Economic
growth
Equitable
income
distribution
BOP stability
(external
stability)
Full
employment
Price
stability
1)
Economic growth: An economy has grown if there is a positive change in total
production of goods and services from one period to the next.
2)
Full employment: All the country's FOPs, particularly labour are fully employed.
3)
o
Is this practical? Countries experience unemployment.
o
Therefore employment opportunities should be expanded
Price stability: Involves keeping inflation as low as possible, while at the same time
avoid deflation.
o
4)
5)
Why is deflation bad?
Balance of payments stability (or external stability):
o
In other words, the BOP and exchange rates should be fairly stable.
o
Have necessary foreign exchange (by exporting) to pay for imports
Equitable distribution of income: Ensuring that there are no greater income
disparities between members of the economy.
o
Generates political and social conflict
o
Reduce poverty
Objective 1
13.2) Measuring economic activity (GDP)
 Determining the country's total production of goods and services over a period
 GDP is the total value of all final goods and services produced within the boundaries of a
country in a particular period (usually one year)
 ‘… GDP is the total value …’
 Uses market prices of the various goods and services to obtain the value of production.
 ‘… of All …’
 GDP includes all items produced in the economy and sold in markets
 It therefore measures the market value of not just apples and oranges, but also pears and
bananas, movies and books, hair cuts and health care and so on….
 There are many goods and services that traded but not through official recorded
markets may not appear in the GDP figure. For instance vegetables bought at a
supermarket are part of GDP but vegetables grown in your garden are not; undeclared
incomes from babysitting, illegal/legal transactions carried out on a cash basis and hidden
from the authorities
 These transactions form part of the shadow or black economy – very difficult to measure
 All these affects the value of GDP

‘… Final …’
 When a paper company sells paper to a greetings card company, the paper is
called an intermediate good, and the card is called a final good
 GDP includes only the value of final goods – since the value of the
intermediate good is already included in the prices of final goods
 Adding the market value of the paper to the market value of the card would be
double counting (i.e. incorrectly counting the paper twice)
 The problem of double counting overstates or inflates the value of GDP by
counting certain things more than once – refer to page 235[57].
 See Table 13-1
Table 13-1: Calculating value added (textbook page 235)
•
To avoid the problem of double counting:
o Count the value added by each of the participants in the production process
o Count the value of goods that reach the final destination
o Consider the incomes earned by each factor of production.
 ‘… Goods and Services …’
 GDP includes both tangible goods (food, cars, clothing) and intangible services (doctor’s visits,
house cleaning, hair cuts)
 When you pay to watch a match between Sundowns and Pirates, you are buying a service and the
ticket price is part of GDP
 ‘… Produced …’
 GDP includes goods currently produced (also called current production)
 It does not include transactions involving goods or items produced in the past
 Even when the good produced in the past is sold during the period under consideration, it will not be
included in GDP for current period.
 ‘… Within the Boundaries of a Country …’
 GDP includes all the production within the geographic area of a country, essentially an economy
 It doesn’t matter who produces the goods or who owns the factors of production (German, Chinese)
 For instance, when an American citizen temporarily works in South Africa, their production is part of
South Africa’s GDP
 Similarly, when a South African owns a factory in Lesotho, the production at their factory is not part
of the South African GDP (its part of Lesotho’s GDP)
 ‘… In a Particular Period …’
 GDP measures the value of production that takes place within a specific interval of time (usually
a year or a quarter (three months)
 So GDP measures the economy’s flow of income and expenditure during that interval
 When Stats SA reports GDP for a quarter, it usually presents GDP ‘at an annual rate’ – i.e. GDP
during that quarter multiplied by four
 This conversion helps with easier comparisons between quarterly and annual figures
 Quarterly GDP is often seasonally adjusted – to look beyond regular seasonal changes like the
fact that December holiday shopping season is a high point in many countries
 Further aspects of the definition of GDP (textbook page 237)
 Resale of existing goods is not part of GDP
 GDP is also the same as gross domestic income
 Calculated as gross and not net because of the complexity of estimating depreciation
13.2.1) Three Methods of Calculating GDP
Expenditure
approach
Income
approach
Production
approach

Expenditure approach: The final market price which measures the
spending on final goods and services by different participants

Income approach: Measures the total income earned by all factors of
production.

Production approach: Measures the total value added by all participants
in the economy.

All these three methods essentially measure the same thing but at
different points in the circular flow

Total spending = Total income = Total production (remember in chapter 3).
NB - The final figure for GDP should be the same irrespective of the
method used
Example
Value of sales
Value added
Income earned
Farmer
R 10 000
R 10 000
R 10 000
Miller
R 12 500
R 2 500
R 2 500
Baker
R 18 000
R 5 500
R 5 500
Shop keeper
R 21 000
R 3 000
R 3 000
R 61 500
R 21 000
R 21 000
Expenditure
Approach
Production
Approach
Income
Approach
 Expenditure Approach (the final market price to final consumer) = R21 000
 Production Approach (Value Added) = Sales Price – Purchase Price R21 000
 Income Approach (sum of all production factors) = R 21 000
SUMMARY (see textbook page 236-237)
13.2.2) Price measurement of GDP
 Measurement at market prices, basic prices and factor cost (or income)
 Three sets of prices used to calculate GDP:

Market prices: Used when calculating GDP according to the
expenditure approach

Basic prices: Used when calculating GDP according the production
(value added) method

Factor costs (or factor income): Is used according to the income
approach
 The differences between market prices, basic prices and factor cost (or
factor income) are due to various taxes and subsidies on goods and
services.

Indirect taxes makes market prices of goods and services higher

Subsidies have the opposite → make market price lower
Distinction between taxes and Subsidies on
products
• Taxes on products = Tax payable per unit of a particular product e.g. VAT, tax
and duties on imports and exports).
• Other taxes on production = Tax on production - Not linked to a particular
product (tax on land, licenses etc.).
• Subsidies on products = Direct subsidies per unit exported to encourage
exports or products used domestically
• Other subsidies on production = Grants not linked to particular goods and
services (subsidies on employment).
• Further reading on textbook page 238
13.2.2) Price measurement of GDP Cont.….
Our focus is on moving from GDP @factor cost to GDP
@market price, and vice versa. Therefore:
• GDP @market price = GDP @factor cost + taxes — subsidies
Likewise
• GDP @factor cost = GDP @market price — taxes + subsidies
Textbook page 238
13.2.3) Current prices and constant prices
 Constant prices (Real GDP)

An inflation adjusted measure that reflects the value of all goods and services produced
in a given year, expressed in base-year prices

Often referred to as 'Inflation-corrected' GDP

Unlike nominal GDP, real GDP removes changes in price levels, and provide a more
accurate figure

Current prices (Nominal GDP)

Measure GDP using the current price level during that year

Over time, the general level of prices (inflation) rise, leading to an increase in nominal
GDP even if the volume of goods an services produced is unchanged. Refer to Box 13-1
page 239

The difference between real GDP and nominal GDP is the inflation rate in the market
When comparing the performance of the economy over
time, the growth rate should be calculated in real GDP.
Why?
Because real GDP considers only changes in the
quantities, whereas nominal GDP is also influenced by
price changes (inflation)
13.3) Other measures of production,
income and expenditure
 There are also other measures of income that are used by
Stats SA to arrive at a more complete picture of what is
happening in the economy
 These other measures differ from GDP by including or
excluding certain categories of income
13.3.1) Gross national income (GNI)
Gross national product (GNP)
 GNI refers to the total income earned by permanent residents or production factors of a
country
 GNP differs from GDP by including income that domestic citizens earn abroad and
excluding income that foreigners earn in the domestic country
 GNI and GNP are equal, only difference is that while GNI looks at the income, GNP
looks at the production of permanent residents of a country
 GNI is a better measure of the income or standard of living of the domestic citizens
while GDP is a best measure of overall economic activity
 GNI = GDP + primary income receipts – primary income payments
 In some countries GNI is greater that GDP. WHY?? Page 242
13.3.2) Expenditure on GDP
 The spending of the four major sectors of the economy
(Households, firms, government, and the foreign sector (Recall from
CHAPTER 3)
 Therefore, GDP = expenditure on GDP or alternatively
 GDP = C + I + G + X – Z
 Expenditure on GDP in South Africa: Table 13-3 (Read page 242-243)
13.3.3) Gross Domestic Expenditure (GDE)
 Refers to the total value of spending within the borders of the
country
 It includes imports but excludes exports, since spending on
exports occurs in the rest of the world
 Therefore, GDE = C + I + G
Summary on textbook page 244
SUMMARY
(study guide page 8)
Remember that the
signs change if you
are moving in the
opposite direction
Cheat sheet!
GROSS
DOMESTIC
EXPENDITURE
−Z
+X
GROSS
−D
+D
NET
DOMESTIC
−FP
+FI
+Z
−X
PRODUCT
−t
+s
+FP
−FI
NATIONAL
@Market Price
PRODUCT
+t
−s
@Factor Cost
Objective 2
13.4) Employment and Unemployment
 Pertains to full employment
 This is a complicated task.
 In addition, there are two definitions of unemployment:
 Strict (narrow) definition, where to be regarded as unemployed one has to have
taken steps recently to find work.
 Expanded definition, where the mere desire to find employment is sufficient for
one to be regarded as unemployment. Also includes discouraged work-seekers
 Unemployed: Number of people willing and who have the ability to work, yet cannot
find work at the time of measurement
 Employed: Number of people with employment at the time of measurement
 Unemployment rate = number of unemployed / economically active population
 Excludes fulltime students, the retired, children and those not actively looking
for a job
To be discussed in detail in chapter 21……
Objective 3
13.5) Measuring Prices (CPI)
 Pertains to price stability
 Increase in prices result in decrease in the purchasing power of money.
 To measure the purchasing power of the rand we use the consumer price
index (CPI) which represents the cost of the “shopping basket” of goods
and services of a typical or average South African household.
 The rate of inflation – percentage rate of change in the general price
level from one period to the next.
To be discussed in detail in chapter 20……
Objective 4
13.6) Links with the rest of the world (BOP)
 Pertains to Balance of Payment Stability
 BOP: refers to the record of transactions with the rest of the world.
 The BOP has two main accounts

Current account (CA) - Exports and Imports, and income and payments to the rest
of the world

Financial account (FA) - Purchases and flows of assets like bonds and shares in and
out of a country
 Surplus and deficit

CA surplus means exports exceed imports while deficit means that imports exceed
exports

FA surplus means there’s a net inflow of foreign capital (i.e. more funds flowed
into the country than flowed out), while a deficit implies a net outflow.
 Unrecorded transactions are all errors and omissions that occur in compiling the
individual components of the BOP. Ensures that the BOP balances.
 Gold and other foreign reserves:
 Foreign reserves reflects the sum of the balances of the above mentioned
 Gold entails gold reserves which can be used to obtain foreign currency
Objective 5
13.7) Inequality: the distribution of income
Inequality in South Africa (source: World Bank (2018, South Africa Poverty and Inequality Assessment Report)
 The top 1% of South Africans own 70.9% of the country’s wealth while the bottom 60% only controls 7% of
the country’s assets.
 Previously disadvantaged South Africans hold fewer assets, have fewer skills, earn lower wages, and are
still more likely to be unemployed.
 More than half of South Africans (55.5%) or 30-million people live below the national poverty line of R992
per month.
13.7.1) Measuring inequality
 Pertains to equitable income distribution
 Data from population censuses, tax returns and other sources are used in estimating the
distribution of income.
 There are three measures of inequality (Lorenz Curve, Gini Coefficient, Quantile ratio).
 Lorenz Curve
 Illustrates the degree of inequality in the distribution of income
 Ranks individuals or households in the economy from poorest to richest which is done
on a cumulative basis, see below.
 The cumulative percentages of the population are plotted along the horizontal
axis.
 The diagonal serves as a reference point. It indicates a perfectly equal
distribution of income.
 The degree of inequality is shown by the deviation from the diagonal.
 The greater the distance between the diagonal and the Lorenz curve, the
greater the degree of inequality.
 In Figure 13-1
This area is
called the area
of inequality
 Gini Coefficient
 Can vary between 0 and 1.
 The Gini coefficient is sometimes also multiplied by 100 to obtain the Gini
index, which varies between 0 and 100.
 If incomes are distributed perfectly equally, the Gini coefficient is zero.
 In practice the Gini coefficient usually ranges between about 0,30 (highly
equal e.g. Ukraine, Norway) and about 0,70 (highly unequal e.g. South
Africa, Namibia)
 Quantile Ratio
 The ratio between the percentage of income received by the highest x per cent
of the population and the percentage of income received by the lowest y per
cent of the population.
Test Your Knowledge
Question 1
Use the information below to calculate GDP according to the:
1) Production method;
2) Income method; and
3) Expenditure method.
Dr Ray uses natural materials to manufacture beauty products in the effort to reduce
wrinkles. In November 2010, Dr Ray sells his output to L'Oréal for R45 000, he pays out wages
of R15 000, R1 500 interest on a loan, and rental of R10 000 for their site. L'Oréal pays R14
000 rent, R3 000 interest on their account at the Beauty Bank and carries a wage bill of R30
000. L'Oréal sells the beauty products to Edgars for R160 000. Edgars sells these natural
beauty products to consumers, such as the Glam Guru, for R240 000. Edgars pays out wages
of R12 500 and pays R4 000 interest on their account.
Question 2
Question 3
Use the table above to answer the following information:
1. Calculate nominal GDP for the year 2001
2. Calculate nominal GDP for 2002
3. By how much did nominal GDP increase between 2001 and 2002?
Revise
 Page 4-9 Study Guide
 More exercises on eFundi
 Home work 1 on eFundi under ‘Resources’ —
‘Class Preparation’ folder!!! Due by next week
Tuesday 23 July @10h00 via email.
Important Concepts
•
Economic growth
•
Full employment/
unemployment
•
Price stability/inflation
•
Balance of payments (or
external) stability
•
•
•
•
•
•
•
Distribution of income
Gross domestic product (GDP)
Final and intermediate goods
Value added
Production method
Expenditure method
Gross domestic expenditure
(GDE)
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Income method
Market prices
Basic prices
Factor cost
Current prices
Constant prices
Nominal GDP
Real GDP
Gross national income (GNI)
Net primary income payments
Consumption of fixed capital
Lorenz curve
Gini coefficient
Gini index
Thank You