Calculation of GDP

Questions: 1. Table: GDP Data for Countries A and B Country A Country B $billions $billions Household Consumption 150 150 Government Purchases 250 250 Transfer payments 50 60 Total Gross Fixed Capital Expenditures 50 150 Change in Inventories 50 -50 Exports 40 40 Imports 20 20 Consider the data in table 1 for two countries: A and B. a. Calculate the GDP for both countries. b. Discuss the usefulness of these data in deciding which, if any, of these two countries is likely to be experiencing an economic recession. 2. Obtain Australia's real GDP and CPI data from 1980 to 2015. Calculate the annual growth rates of real GDP and inflation and graph both series together. Is/are there some interesting or salient relationship(s) between those two series? Provide and discuss plausible economic explanation(s), including change in economic events and change in government policy, for the relationship(s) you identified. 3. Obtain Australia's real GDP and unemployment data from 1980 to 2015. Calculate the growth rates of real GDP and unemployment and graph both series together. Is/are there some interesting or salient relationship(s) between those two series? Provide and discuss plausible economic explanation(s), including change in economic events and change in government policy, for the relationship(s) you identified. Answers: (1). a). Calculation of GDP for both Countries GDP can be calculated with the use of following formula: GDP = C + G + I + (X - M) Where, C = Consumption, G = Government spending I = Investment X = Export M= Import The below table shows the calculation of GDP for both countries Country A $billions Country B $billions Household Consumption (C) 150 150 Government Spending or purchase (G) 250 250 Gross Private Investment: Total Gross Fixed Capital Expenditures Change in Inventories 100 50 50 100 150 -50 Exports 40 40 Imports 20 20 GDP 520 520 Working Note: 1. Transfer payments were not used in the calculation of GDP for both countries. It is because these are excluded from the calculation of GDP (Asian Development Bank, 2007). 2. Secondly, change in inventories is positive for country A, therefore the value is added in the investment while it is decreased in the case of country B, so it is reduced from gross investment amount. It is clear from the above table that both country A and B has GDP of 520 billion dollars. b). Calculation of GDP is useful in deciding that if any of the country is likely to be experiencing an economic recession. It is because the GDP or Gross Domestic Product provides a tool to measure the goods and services monetary value, which are produced by a country during a particular year (Sexton, 2007). It is a significant data point that shows whether a country or economy is growing or contracting. For both countries, it is assessed that the GDP is 520 billion dollars. At the same time, it is also evaluated that household consumption is 150 billion dollars, government purchases are 250 billion dollars, investment is 100 billion dollars, and net exports is 20 billion dollars. These indicate positive value of consumer spending, as well as government and investment spending (International Monetary Fund, 2009). Thus, it can be stated that both countries have not potential to experience an economic recession. In addition, if in future periods, the GDP of both countries and any of the country decreases, it is likely that countries or the country can experience an economic recession. The recession can be found in both these countries due to several reasons such as low output growth, high inflation, increase in oil prices, and the debt crises (Clift, 2009). It is because these factors can reduce the household consumption, government spending, and investment. Moreover, there should faster growth in the current GDP in both countries to avoid the situation of recession. It is because the decrease in the GDP growth presents reduction in the income level as well as savings among the people, which can cause to the situation of recession. It can also be stated that due to the decrease in consumer purchasing power in both these countries or any of the country, the company is likely to face the situation of recession (Boone and Kurtz, 2012). (2). Explanation over the Relationship between Real GDP and Inflation GDP, exchange rate, unemployment, inflation, current account balance, etc. are some major indicators to access the economic conditions of county at micro level. The assessment of relationship between real GDP and inflation is performed in the context of Australia by obtaining data regarding these factors. For accessing these two major economic factors, growth rates are calculated for over the last 36 years. Through the application of below formula, data from 1980 to 2015 is used to calculate growth rates of Australian GDP and inflation rate. (Tucker, 2010) By using above formula, GDP volume and CPI index value is used to calculate GDP and inflation growth rate respectively in the context of Australia. The below table depicts growth rate value for these economic indicators, which are obtained through the application of the given formula: Year Annual GDP Growth Rate Annual CPI Growth Rate 1980 7.0 10.1 1981 4.2 9.5 1982 -0.4 11.4 1983 -0.2 10.0 1984 6.5 4.0 1985 5.1 6.7 1986 1.9 9.1 1987 5.7 8.5 1988 4.5 7.2 1989 4.2 7.5 1990 1.4 7.3 1991 -1.3 3.2 1992 3.0 1.0 1993 4.2 1.8 1994 4.6 2.0 1995 3.5 4.6 1996 3.9 2.6 1997 3.9 0.2 1998 4.9 0.9 1999 4.1 1.5 2000 3.5 4.5 2001 2.5 4.4 2002 4.0 3.0 2003 3.0 2.7 2004 3.9 2.3 2005 3.2 2.7 2006 2.7 3.6 2007 4.6 2.3 2008 2.5 4.4 2009 1.8 1.8 2010 2.4 2.9 2011 2.6 3.3 2012 3.6 1.8 2013 2.0 2.5 2014 2.6 2.5 2015 2.5 1.5 (ABS, 2016) On the basis of above data, below graph is developed and used to identify the relationship between the GDP and inflation growth rates: From the above graph, it can be stated the relationship of GDP and inflation in Australia is quite variant within the period from 1980 to 2015. It is identified from the above graph that in few years, GDP of this country depicts downwards trend, while inflation rate grew strongly over the same time period. Within the year 1982 and 1983, the growth rate of GDP was negative but on the other side, inflation rate grew by 11.35 and 10.04 percent respectively (ABA, 2016). It shows extreme level of negative relationship between the GDP and inflation rate. The government policy of liberalize economic system has influenced this relationship at the greater extent. For boosting production level in this country, government adopted expansionary policy to enhance the money supply and to reduce the unemployment. It made the borrowing cheap that encougred businesses and customers to spend more. Due to increase in consumer spending, demand of goods and services raised that created shortage in supply side. This situation laid to the decrease in the volume of production and increase in the prices. In long run, expansionary monetary policy of government influences the price level in the economy that leads to the situation of high inflation (McTaggart et al., 2012). Due to increase in prices, demand declines that tend businesses to produce less, which causes decrease in employment opportunities and to GDP rate. Hence, monetary of government is Australia has played critical role in influencing the price level in the economy that consequently influences demand and supply. Apart from this, it is also identified from the obtained series of Australian GDP and inflation growth rates that there is positive relationship has occurred between these two indicators within the few years. In 1996, fiscal measures were used by the government. Expansionary fiscal policy of Australian government has played critical role in increasing the GDP and decreasing the inflation growth rates significantly. For stimulating economic growth, government reduced taxes rates for the businesses and individuals. This situation laid to the increase in investment among businesses to produce more and disposable income. In the short run, it caused increase in employment opportunities that boosted the economic growth and declined the rate of inflation (Mankiw, 2014). During 1997 to 1999, GDP rate grew, while inflation rate declined at the significant level. In long run, expansionary fiscal policy caused the increase in price level as it caused upwards shift in the aggregate demand in the economy. Due to the tax cut, disposable income of people raised that caused increase in spending power that pushed the demand on the upward side. Increase in demand played critical role in increasing the level of prices in the economy (Veldkamp, 2011). In the year 2000 and 2001, inflation rate increased significantly in Australian economy than the GDP. This indicates the importance of governments monetary and fiscal policies in influencing the relationship of a nations major economic indicators and to manage the macroeconomic activities in the significant manner. The government and central bank (Reserve Bank of Australia) of Australia has used monetary and fiscal policies as tool to manage the macroeconomic environment and to boost the economic growth over time (RBA, 2016). From the obtained growth rates, it is also identified that the relationship between the growth rate for the inflation and GDP has changed highly frequently. This is observed that after the global financial crisis of 2008, the relationship between inflation and GDP became highly volatile. In few years, inflation rate of this country declined in compare to the GDP, whereas sometime, opposite situation has occurred. This indicates that global financial crisis has reduced the influence of government policies that caused to the volatility in the relationships of GDP and inflation (Economy Watch, 2010). The other major economic event is currency devaluation. The value of Australian dollar has declined significantly due to which, exports increased significantly than the imports. It caused increased in real GDP and demand both. This situation caused demand pull inflation. An increase in export than the import in an economy improves current account balance and reduces balance of payment defic it. The same situation is observed from the obtained data set for the Australian economy. The growth rates of GDP and inflation shows movement in the same direction after the financial crisis (Convict Creations, 2015). Thus, it can be stated on the basis of obtained series for the two major economic indicators that economic events and government policies has great influence on the relationship of two factors. (3). Explanation over the Relationship between Real GDP and Unemployment Real GDP and unemployment are the major macroeconomic indicators of a country. By analyzing relationship of these factors, economic health of a country can be analyzed significantly. For evaluating the relation of these two factors in the context of Australian economy, data regarding real GDP volume and number of jobless person in an economy is obtained to calculate growth rates (Mankiw, 2014). Data is obtained for the 1980 to 2015 as it is effective to understand the relationship trend among the real GDP and unemployment variables of the economy of this country. Growth rates are calculated by using the given formula: The below table depicts growth rates for the Australian real GDP and unemployment, which are calculated through the above formula: Year Annual GDP Growth Rate Annual Unemployment Growth Rate 1980 7.0 1.1 1981 4.2 0.4 1982 -0.4 54.8 1983 -0.2 1.9 1984 6.5 -9.1 1985 5.1 -5.8 1986 1.9 11.0 1987 5.7 -5.4 1988 4.5 -9.2 1989 4.2 -11.1 1990 1.4 39.9 1991 -1.3 28.5 1992 3.0 7.6 1993 4.2 -3.1 1994 4.6 -15.8 1995 3.5 -7.0 1996 3.9 6.9 1997 3.9 -8.4 1998 4.9 -8.5 1999 4.1 -5.1 2000 3.5 -5.4 2001 2.5 11.5 2002 4.0 -8.0 2003 3.0 -7.2 2004 3.9 -8.7 2005 3.2 2.2 2006 2.7 -7.4 2007 4.6 -3.3 2008 2.5 7.6 2009 1.8 22.2 2010 2.4 -9.3 2011 2.6 7.2 2012 3.6 5.9 2013 2.0 8.9 2014 2.6 5.4 2015 2.5 -3.8 (ABS, 2016) On the basis of the data of above table, below line graph is obtained to understand the relationship of these macroeconomic variables more effectively in the Australian context. From the above graph, it can be stated that there is negative relationship exist between GDP and unemployment rates in the context of Australian economy. In the year 1980, government developed liberalizes trade policy that laid to the development of free economy. Due to this, trade activities within this country increased significantly (Igan et al., 2013). In this situation, firms are tended to produce more for satisfying the demand in the economy. It caused increment in the job opportunities. The influence of this policy of Australian government on the relationship between the GDP growth rate and unemployment is clearly depicted in above graph. In the growing phase, aggregate demand raises that causes increase of production level in the economy and consequently job opportunities (Gwartney et al, 2014). The other policy of Australian government was deregulation of banking industry as it also caused decrease in GDP and increase in unemployment after the year 1982. For boosting economic growth, government eased entry of international banks and permitted them to set interest rates. This economic event made the banking industry of Australia highly competitive that caused decline in interest rates. Due to this, availability of cheap finance increased that encouraged businesses to invest and produce more. In short run, high production generated job opportunities that caused increase in demand. In long run, this situation became responsible for causing recession. Higher demand than the supply caused high prices that created cost push inflation in the economy (McEachern, 2013). In the recession phase, trade and demand both declined at considerable level that tended businesses to produce less. For surviving in the recession period, businesses adopted cost reduction activities and job cut is one from them. This caused decline in GDP that has reduced generation of employment opportunities (Tucker, 2010). The government policy of decreasing interest rate caused negative relationship between the GDP and unemployment in long run. In addition to this, privatization policy of the Australian government has also played crucial role in influencing the relationship between GDP and unemployment rates. Privatization in an economy causes competition for the resources that causes generation of several job opportunities. The same situation occurred in Australian economy during 1993 to 2000 due to privatization. In this period, GDP grew slightly, whereas significant decline incurred in unemployment rates (Carlin and Soskice, 2014). In this way, privatization economic event in Australian economy also caused negative relation between the GDP and unemployment variables. Similarly, negative relationship is also determined from the obtained data for the unemployment and GDP rates. After the global economic financial crisis, government of Australia adopted expansionary fiscal policy that also influenced GDP and unemployment level in this country. In this policy, government reduced tax rated for the corporate and individuals. This causes increase in the disposable income that contributes in increasing consumption. It leads to the upward movement in the aggregate demand. Fiscal policy of government in Australia caused increase in the real GDP, which means increase in the production level (Aoki and Yoshikawa, 2011). For producing more, they demanded more workers that caused decline in the unemployment level. It boosted the economic growth and this situation laid to the decline in job losses. In addition to this, expansionary monetary policy also played crucial role in generating negative relationship between GDP and unemployment level of this country. After the recession period of 1991 and 2008, government of Australia has focused in increasing money supply by reducing the interest rate. Monetary policy facilitated reduction in the cost of borrowings that encouraged people to spend more (Commonwealth of Australia, 2016). In this situation, aggregate demand raised that caused increases in GDP and reduction in demand deficient unemployment. Thus, it can be stated that GDP and unemployment has negative relations with the each other. Government policies have contributed in boosting economic growth and reducing unemployment. It created negative relationship between the real GDP and unemployment level of this country. References Aoki, M. and Yoshikawa, H. (2011) Reconstructing macroeconomics: a perspective from statistical physics and combinatorial stochastic processes. UK: Cambridge University Press. Asian Development Bank (2007) Key Indicators 2007, Volume 38. Asian Development Bank. Australian Bureau of Statistics (2016) Statistics. Boone, L. E. and Kurtz, D. L. (2012). Contemporary Marketing, 2013 Update. USA: Cengage Learning. Carlin, W. and Soskice, D. (2014) Macroeconomics: Institutions, instability, and the financial system. USA: Oxford University Press. Clift, J. (2009) Finance Development, June 2009. International Monetary Fund.