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What do you mean by economic environment? Explain its importance for managers in
decision making
The economic environment consists of external factors in a business' market and the broader
economy that can influence a business. You can divide the economic environment into the
microeconomic environment, which affects business decision-making such as individual actions of firms
and consumers, and the macroeconomic environment, which affects an entire economy and all of its
participants. Many economic factors act as external constraints on your business, which means that you
have little, if any, control over them. Let's take a look at both of these broad factors in more detail
 Macroeconomic influences are broad economic factors that either directly or indirectly affect the entire
economy and all of its participants, including yourbusiness.These factors include such things as:
 Interest rates
 Taxes
 Inflation
 Currency exchange rates
 Consumer discretionary income
 Savings rates
 Consumer confidence levels
 Unemployment rate
 Recession
 Depression
Microeconomic factors influence how yourbusiness will make decisions. Unlike macroeconomic factors,
these factors are far less broad in scope and do not necessarily affect the entire economy as a whole.
Microeconomic factors influencing a business include:
 Market size
 Demand
 Supply
 Competitors
 Suppliers
 Distribution chain - such as retailer stores
Why Is It Important?
The economic environment of business will play a pivotal role in determining the success or failure of a
business.
Let's first consider some macroeconomic factors. If interest rates are too high, the cost of borrowing
may not permit a business to expand. On the other hand, if unemployment rate is high, businesses can
obtain labor at cheaper costs. However, if unemployment is too high, this may result in a recession and
less discretionary consumer spending resulting in insufficient sales to keep the business going. Tax
rates will take a chunk of your income and currency exchange rates can either help or hurt the exporting
of your products to specific foreign markets.
Now, let's turn our attention to microeconomic factors for a bit. Market size may determine the viability of
entering into a new market. If a market is too small, there may not be sufficient demand and profit
potential. This leads us to the concept of demand and supply. If your product is in high demand but
there is a low supply of it, you are going to make a tidy profit, but if your product is in low demand and
the market is flooded with similar products, you may be facing bankruptcy. The quality and quantity of
your competition will affect how well you do in winning customers in the marketplace. Suppliers are the
arteries pumping vital supplies and resources to you for production. If you have problems with suppliers,
it can clog up those arteries and cause serious problems. Likewise, the type of relationship you have
with your distributors, such as retail stores, may influence how quickly your products leave their shelves.
Summary
The environment in which a business operates is very complex and has a great deal of influence on
how a business performs and whether it will succeed. Macroeconomic factors influence not only a
business but also all participants in an economy and include such things as interest rates, inflation,
unemployment rates, taxes, discretionary spending, periods of growth and recession. Microeconomic
factors also influence the success or failure of a business and include such things as market size,
demand, supply, competitors, suppliers, and distributors.
---------------------------------------------------------------
Decision making is an important job of corporate managers. They have to take decisions
regarding the employment of land, labor, and capital in such a manner that output may be
maximized at least possible cost. Hence, they are always in search of optimum combination
of resources which would maximize corporate profit.
Appropriate decision making is the strength of business. Success in business depends on
proper and correct decision making. Location, scale of operation, quantum of resources to be
employed, marketing etc are some of the important problems calling for decisions in business
where macroeconomics may be applied for better results.
Macro Economic Analysis
Macroeconomics is concerned with the study of aggregate economic variables. It is
concerned with the whole economy and studies the level and the growth of national income,
the levels of employment, the level of private and government spending, the balance of
payments, the consumption & the investment, saving functions and oscillations in business
cycles. The objective of macroeconomics is to maintain macro equilibrium of the economy.
According to Edwin Mansfield, ‘Macro economics deals with the behavior of aggregates like
gross national product and the level of employment. A. koutsoyiannis says, ‘the aggregate
econometric models are relevant for the study and prediction of aggregate magnitudes, such
as total output of any economy, total employment, consumption, investment etc.
In all the economies of the world whether free or controlled, business and macroeconomics
have become same. In the business decisions, tracking of macroeconomic variables has
become an important element. (Macroeconomics, 2002) Managers face difficulty in decision
making, understanding of macroeconomics helps CEO's in running the business. Overall
economic activity, economic policies (industrial policy, trade policy, monetary policy, fiscal
policy), inflation affects the business. Decisions of CEO's or managers are affected by this
aggregate which makes up the overall environment of business. Future demand and
investment depends upon the growth and the state of the economy.
Role of Macroeconomic Analysis in formulation of Business Policies
Macro economics helps the business in in-depth knowledge of macro economic environment
of business relating to industrial policy, licensing policy, economic planning monetary and
fiscal framework and overall economic policy. (Mathur, 2002)The role of macro economics
in business policy formulation is being discussed in the following points:
1. Macro economic policy
Macro economics helps in formulation of economic policy. The subjects of an economic
policy are monetary policy, fiscal policy, incomes policies and policy on balance of payment.
Economic policy should be such that it promotes the business environment and provides
impetus to business activities. (Mathur, 2002)
2. Economic planning
A serious attempt towards self sustained growth of business is only possible by efficient
planning. Planning is now a days synonymous with growth and development. Identification
of priority areas, estimation of resources and coordination among various sectors of economy
can be done through proper planning. Planning directs the growth in desirable corners.
3. Solving macro paradoxes
Macro economics helps in solving macro paradoxes like paradox of thrift related to savings,
paradox of assumption by commercial banks that all depositors would not withdraw their
money on any particular day and their right to withdrawal.
4. Tracing effect of government policy on business
Macro economics helps in tracing the implications of government policy changes on existing
business activity.
5. Help in solving problem of general unemployment
Effective demand is the focal point of macro economics. Reduction in effective demand
brings economic depression and thereby general unemployment. Hence, the level of effective
demand should be increased in order to increase the level of employment. (Mathur, 2002)
6. Analysis of trade cycles
Macro economics tries to know about the behavior and occurrence of booms and slumps and
their implication on business activity. This analysis is very useful for a free enterprise
economy. Business cycles are bound to occur. Macro economics helps the business in facing
booms and slumps so that negative impact is minimized.
7. Macro analysis helps in development of micro analysis
In the deductive method process of logic goes from general to particular. We go on deducting
to draw specific conclusions. Many of micro economic conclusions are outcome of macro
conclusion. The assumption that consumer is rational has been decided only after knowing
about the behavior of a group. A medico is allowed to specialize in some part of human body
from surgical view point only when he has understood the anatomy and physiology of human
body.
8. Inability of micro economics to study some areas
Micro economics is not able to study monetary problems, fiscal problems, financial sector
problems, foreign exchange regulation problems and inflationary and recessionary situations
problems. Business needs to be protected from these ticklish problems and therefore, needs
the help of macro economics.
9. Macro economic models
Macro economics helps in building or constructing macro economic models. The major
objective function of a macro economic model is to maintain the macro equilibrium in the
country at the full employment level. The role of government through its monetary and fiscal
operations becomes important as independent variables i.e. these policies are used to explain
the dependent variable i.e. maintaining macro equilibrium.
Macroeconomic Variables and Business Decisions are highly linked
Business depends on the growth rate, when economic growth slows down; the overall
economic environment becomes unfavorable to business. In a period of slow growth, the
aggregate demand is very much reduced and the business has no choice but to curtail its
operations. (Misra & Puri, 2007) Business depends on the inflation rate. Inflation of a mild
sort increase aggregate demand which, in turn, opens up fresh opportunities for business
growth. In such an environment, not only the demand for existing goods increases but the
business can also introduce new items for which demand may be created through dynamic
marketing. Savings and investment in a country determine its business potential. Investment
can be undertaken in directly productive activities or in infrastructure.
Excessive current account deficit in a country's balance of payments is not desirable for
business activity. Such a situation leads to a shortage of foreign exchange, which in turn
forces restriction on imports. (Misra & Puri, 2007)This may have serious implications for the
efficiency in production. In the interest of business the current account position has to be
comfortable.
In addition, the net inflows from external assistance and direct foreign investment should be
fairly large, but this should not be allowed to result in an overvalued exchange rate.
In case the situation is otherwise, the country's exports will fall and the business firms will
feel seriously constrained account of it.
Phase of economy is highly significant for the business. From the point of view of business,
the prosperity phase of business cycle is ideal. In this phase, the economy expands in
response to growing aggregate demand and the business firm has many options. There is
expectation of rise in prices which induces managers to expand the scope of their activities.
A company can introduce new products in this period and markets can be created for these
products.
Forces of recession get strengthened during recession. The recession usually gets reflected in
the form of stock market crash and some fall in prices. The aggregate demand gradually
declines and thus incentive for investment is killed. (Misra & Puri, 2007) At this time
managers abandon new projects, resulting in a sharp reduction in demand for capital
equipment.
Since, finance is a basic requirement of business, the level of development of the financial
system is of crucial importance for business. The basic function of financial markets - both
money and capital market is the collection of savings and their transfer to business
enterprises for investment purposes and thereby stimulating capital formation which in turn
accelerates and process of business growth. The effective channel of domestic savings and
obtaining finance from abroad are the important activities in the transfer process. In the
transfer process, the principal activity is allocation of funds from the savings surplus to the
savings deficit units. Financial markets, if they are well developed, allocate financial
resources efficiently among the various business enterprises. (Misra & Puri, 2007)
2. What is GDP? explain different methods of GDP computation
GDP can be determined in three ways, all of which should, in principle, give the same result. They are the
production (or output) approach, the income approach, or the expenditure approach.
The most direct of the three is the production approach, which sums the outputs of every class of
enterprise to arrive at the total. The expenditure approach works on the principle that all of the product
must be bought by somebody, therefore the value of the total product must be equal to people's total
expenditures in buying things. The income approach works on the principle that the incomes of the
productive factors ("producers," colloquially) must be equal to the value of their product, and determines
GDP by finding the sum of all producers' incomes.[6]
Example: the expenditure method:
GDP = private consumption + gross investment + government spending + (exports − imports), or
Note: "Gross" means that GDP measures production regardless of the various uses to which that
production can be put. Production can be used for immediate consumption, for investment in new
fixed assets or inventories, or for replacing depreciated fixed assets. "Domestic" means that GDP
measures production that takes place within the country's borders. In the expenditure-method
equation given above, the exports-minus-imports term is necessary in order to null out expenditures
on things not produced in the country (imports) and add in things produced but not sold in the country
(exports).
Economists (since Keynes) have preferred to split the general consumption term into two parts;
private consumption, and public sector (or government) spending.[citation needed] Two advantages of
dividing total consumption this way in theoretical macroeconomics are:
 Private consumption is a central concern of welfare economics. The private investment and
trade portions of the economy are ultimately directed (in mainstream economic models) to
increases in long-term private consumption.
 If separated from endogenous private consumption, government consumption can be treated
as exogenous,[citation needed] so that different government spending levels can be considered within
a meaningful macroeconomic framework.
Production Approach[edit]
" # Estimating the Gross Value of domestic Output out of the many various economic activities;
1. Determining the intermediate consumption, i.e., the cost of material, supplies and services
used to produce final goods or services; and finally
2. Deducting intermediate consumption from Gross Value to obtain the Net Value of Domestic
Output.
Symbolically,
Gross Value Added = Gross Value of output – Value of Intermediate Consumption.
Value of Output = Value of the total sales of goods and services + Value of changes in the
inventories.
The sum of Gross Value Added in various economic activities is known as GDP at factor cost.
GDP at factor cost plus indirect taxes less subsidies on products is GDP at Producer Price.
For measuring output of domestic product, economic activities (i.e. industries) are classified into
various sectors. After classifying economic activities, the output of each sector is calculated by any of
the following two methods:
1. By multiplying the output of each sector by their respective market price and adding them
together and
2. By collecting data on gross sales and inventories from the records of companies and adding
them together
Subtracting each sector's intermediate consumption from gross output, we get GDP at factor cost.
We, then add gross value of all sectors to get Gross Value Added (GVA) at factor cost. Adding
indirect tax minus subsidies in GDP at factor cost, we get GDP at Producer Prices.
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207402181 ee-ass1

  • 1. Get Homework/Assignment Done Homeworkping.com Homework Help https://www.homeworkping.com/ Research Paper help https://www.homeworkping.com/ Online Tutoring https://www.homeworkping.com/ click here for freelancing tutoring sites What do you mean by economic environment? Explain its importance for managers in decision making The economic environment consists of external factors in a business' market and the broader economy that can influence a business. You can divide the economic environment into the microeconomic environment, which affects business decision-making such as individual actions of firms and consumers, and the macroeconomic environment, which affects an entire economy and all of its participants. Many economic factors act as external constraints on your business, which means that you have little, if any, control over them. Let's take a look at both of these broad factors in more detail  Macroeconomic influences are broad economic factors that either directly or indirectly affect the entire economy and all of its participants, including yourbusiness.These factors include such things as:  Interest rates  Taxes  Inflation
  • 2.  Currency exchange rates  Consumer discretionary income  Savings rates  Consumer confidence levels  Unemployment rate  Recession  Depression Microeconomic factors influence how yourbusiness will make decisions. Unlike macroeconomic factors, these factors are far less broad in scope and do not necessarily affect the entire economy as a whole. Microeconomic factors influencing a business include:  Market size  Demand  Supply  Competitors  Suppliers  Distribution chain - such as retailer stores Why Is It Important? The economic environment of business will play a pivotal role in determining the success or failure of a business. Let's first consider some macroeconomic factors. If interest rates are too high, the cost of borrowing may not permit a business to expand. On the other hand, if unemployment rate is high, businesses can obtain labor at cheaper costs. However, if unemployment is too high, this may result in a recession and less discretionary consumer spending resulting in insufficient sales to keep the business going. Tax rates will take a chunk of your income and currency exchange rates can either help or hurt the exporting of your products to specific foreign markets. Now, let's turn our attention to microeconomic factors for a bit. Market size may determine the viability of entering into a new market. If a market is too small, there may not be sufficient demand and profit potential. This leads us to the concept of demand and supply. If your product is in high demand but there is a low supply of it, you are going to make a tidy profit, but if your product is in low demand and the market is flooded with similar products, you may be facing bankruptcy. The quality and quantity of your competition will affect how well you do in winning customers in the marketplace. Suppliers are the arteries pumping vital supplies and resources to you for production. If you have problems with suppliers, it can clog up those arteries and cause serious problems. Likewise, the type of relationship you have with your distributors, such as retail stores, may influence how quickly your products leave their shelves. Summary The environment in which a business operates is very complex and has a great deal of influence on how a business performs and whether it will succeed. Macroeconomic factors influence not only a business but also all participants in an economy and include such things as interest rates, inflation, unemployment rates, taxes, discretionary spending, periods of growth and recession. Microeconomic
  • 3. factors also influence the success or failure of a business and include such things as market size, demand, supply, competitors, suppliers, and distributors. --------------------------------------------------------------- Decision making is an important job of corporate managers. They have to take decisions regarding the employment of land, labor, and capital in such a manner that output may be maximized at least possible cost. Hence, they are always in search of optimum combination of resources which would maximize corporate profit. Appropriate decision making is the strength of business. Success in business depends on proper and correct decision making. Location, scale of operation, quantum of resources to be employed, marketing etc are some of the important problems calling for decisions in business where macroeconomics may be applied for better results. Macro Economic Analysis Macroeconomics is concerned with the study of aggregate economic variables. It is concerned with the whole economy and studies the level and the growth of national income, the levels of employment, the level of private and government spending, the balance of payments, the consumption & the investment, saving functions and oscillations in business cycles. The objective of macroeconomics is to maintain macro equilibrium of the economy. According to Edwin Mansfield, ‘Macro economics deals with the behavior of aggregates like gross national product and the level of employment. A. koutsoyiannis says, ‘the aggregate econometric models are relevant for the study and prediction of aggregate magnitudes, such as total output of any economy, total employment, consumption, investment etc. In all the economies of the world whether free or controlled, business and macroeconomics have become same. In the business decisions, tracking of macroeconomic variables has become an important element. (Macroeconomics, 2002) Managers face difficulty in decision making, understanding of macroeconomics helps CEO's in running the business. Overall economic activity, economic policies (industrial policy, trade policy, monetary policy, fiscal policy), inflation affects the business. Decisions of CEO's or managers are affected by this aggregate which makes up the overall environment of business. Future demand and investment depends upon the growth and the state of the economy. Role of Macroeconomic Analysis in formulation of Business Policies Macro economics helps the business in in-depth knowledge of macro economic environment of business relating to industrial policy, licensing policy, economic planning monetary and fiscal framework and overall economic policy. (Mathur, 2002)The role of macro economics in business policy formulation is being discussed in the following points: 1. Macro economic policy Macro economics helps in formulation of economic policy. The subjects of an economic policy are monetary policy, fiscal policy, incomes policies and policy on balance of payment. Economic policy should be such that it promotes the business environment and provides impetus to business activities. (Mathur, 2002) 2. Economic planning A serious attempt towards self sustained growth of business is only possible by efficient planning. Planning is now a days synonymous with growth and development. Identification of priority areas, estimation of resources and coordination among various sectors of economy can be done through proper planning. Planning directs the growth in desirable corners. 3. Solving macro paradoxes
  • 4. Macro economics helps in solving macro paradoxes like paradox of thrift related to savings, paradox of assumption by commercial banks that all depositors would not withdraw their money on any particular day and their right to withdrawal. 4. Tracing effect of government policy on business Macro economics helps in tracing the implications of government policy changes on existing business activity. 5. Help in solving problem of general unemployment Effective demand is the focal point of macro economics. Reduction in effective demand brings economic depression and thereby general unemployment. Hence, the level of effective demand should be increased in order to increase the level of employment. (Mathur, 2002) 6. Analysis of trade cycles Macro economics tries to know about the behavior and occurrence of booms and slumps and their implication on business activity. This analysis is very useful for a free enterprise economy. Business cycles are bound to occur. Macro economics helps the business in facing booms and slumps so that negative impact is minimized. 7. Macro analysis helps in development of micro analysis In the deductive method process of logic goes from general to particular. We go on deducting to draw specific conclusions. Many of micro economic conclusions are outcome of macro conclusion. The assumption that consumer is rational has been decided only after knowing about the behavior of a group. A medico is allowed to specialize in some part of human body from surgical view point only when he has understood the anatomy and physiology of human body. 8. Inability of micro economics to study some areas Micro economics is not able to study monetary problems, fiscal problems, financial sector problems, foreign exchange regulation problems and inflationary and recessionary situations problems. Business needs to be protected from these ticklish problems and therefore, needs the help of macro economics. 9. Macro economic models Macro economics helps in building or constructing macro economic models. The major objective function of a macro economic model is to maintain the macro equilibrium in the country at the full employment level. The role of government through its monetary and fiscal operations becomes important as independent variables i.e. these policies are used to explain the dependent variable i.e. maintaining macro equilibrium. Macroeconomic Variables and Business Decisions are highly linked Business depends on the growth rate, when economic growth slows down; the overall economic environment becomes unfavorable to business. In a period of slow growth, the aggregate demand is very much reduced and the business has no choice but to curtail its operations. (Misra & Puri, 2007) Business depends on the inflation rate. Inflation of a mild sort increase aggregate demand which, in turn, opens up fresh opportunities for business growth. In such an environment, not only the demand for existing goods increases but the business can also introduce new items for which demand may be created through dynamic marketing. Savings and investment in a country determine its business potential. Investment can be undertaken in directly productive activities or in infrastructure. Excessive current account deficit in a country's balance of payments is not desirable for business activity. Such a situation leads to a shortage of foreign exchange, which in turn forces restriction on imports. (Misra & Puri, 2007)This may have serious implications for the
  • 5. efficiency in production. In the interest of business the current account position has to be comfortable. In addition, the net inflows from external assistance and direct foreign investment should be fairly large, but this should not be allowed to result in an overvalued exchange rate. In case the situation is otherwise, the country's exports will fall and the business firms will feel seriously constrained account of it. Phase of economy is highly significant for the business. From the point of view of business, the prosperity phase of business cycle is ideal. In this phase, the economy expands in response to growing aggregate demand and the business firm has many options. There is expectation of rise in prices which induces managers to expand the scope of their activities. A company can introduce new products in this period and markets can be created for these products. Forces of recession get strengthened during recession. The recession usually gets reflected in the form of stock market crash and some fall in prices. The aggregate demand gradually declines and thus incentive for investment is killed. (Misra & Puri, 2007) At this time managers abandon new projects, resulting in a sharp reduction in demand for capital equipment. Since, finance is a basic requirement of business, the level of development of the financial system is of crucial importance for business. The basic function of financial markets - both money and capital market is the collection of savings and their transfer to business enterprises for investment purposes and thereby stimulating capital formation which in turn accelerates and process of business growth. The effective channel of domestic savings and obtaining finance from abroad are the important activities in the transfer process. In the transfer process, the principal activity is allocation of funds from the savings surplus to the savings deficit units. Financial markets, if they are well developed, allocate financial resources efficiently among the various business enterprises. (Misra & Puri, 2007) 2. What is GDP? explain different methods of GDP computation GDP can be determined in three ways, all of which should, in principle, give the same result. They are the production (or output) approach, the income approach, or the expenditure approach. The most direct of the three is the production approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.[6] Example: the expenditure method: GDP = private consumption + gross investment + government spending + (exports − imports), or Note: "Gross" means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new
  • 6. fixed assets or inventories, or for replacing depreciated fixed assets. "Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports). Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending.[citation needed] Two advantages of dividing total consumption this way in theoretical macroeconomics are:  Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption.  If separated from endogenous private consumption, government consumption can be treated as exogenous,[citation needed] so that different government spending levels can be considered within a meaningful macroeconomic framework. Production Approach[edit] " # Estimating the Gross Value of domestic Output out of the many various economic activities; 1. Determining the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services; and finally 2. Deducting intermediate consumption from Gross Value to obtain the Net Value of Domestic Output. Symbolically, Gross Value Added = Gross Value of output – Value of Intermediate Consumption. Value of Output = Value of the total sales of goods and services + Value of changes in the inventories. The sum of Gross Value Added in various economic activities is known as GDP at factor cost. GDP at factor cost plus indirect taxes less subsidies on products is GDP at Producer Price. For measuring output of domestic product, economic activities (i.e. industries) are classified into various sectors. After classifying economic activities, the output of each sector is calculated by any of the following two methods: 1. By multiplying the output of each sector by their respective market price and adding them together and 2. By collecting data on gross sales and inventories from the records of companies and adding them together Subtracting each sector's intermediate consumption from gross output, we get GDP at factor cost. We, then add gross value of all sectors to get Gross Value Added (GVA) at factor cost. Adding indirect tax minus subsidies in GDP at factor cost, we get GDP at Producer Prices.
  • 7. Income approach[edit] Countries by 2012 GDP (nominal) per capita.[7] over $102,400 $51,200–102,400 $25,600–51,200 $12,800–25,600 $6,400–12,800 $3,200–6,400 $1,600–3,200 $800–1,600 $400–800 below $400 unavailable GDP (PPP) per capita (World bank, 2011). " [S]um total of incomes of individuals living in a country during 1 year ." Another way of measuring GDP is to measure total income. If GDP is calculated this way it is sometimes called Gross Domestic Income (GDI), or GDP(I). GDI should provide the same amount as the expenditure method described below. (By definition, GDI = GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.) This method measures GDP by adding incomes that firms pay households for factors of production they hire- wages for labour, interest for capital, rent for land and profits for entrepreneurship. The US "National Income and Expenditure Accounts" divide incomes into five categories:
  • 8. 1. Wages, salaries, and supplementary labour income 2. Corporate profits 3. Interest and miscellaneous investment income 4. Farmers' income 5. Income from non-farm unincorporated businesses These five income components sum to net domestic income at factor cost. Two adjustments must be made to get GDP: 1. Indirect taxes minus subsidies are added to get from factor cost to market prices. 2. Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product. Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is: GDP = compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production and imports GDP = COE + GOS + GMI + TP & M – SP & M  Compensation of employees (COE) measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.  Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.  Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses. The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor (basic) prices. The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I). Total factor income is also sometimes expressed as: Total factor income = Employee compensation + Corporate profits + Proprietor's income + Rental income + Net interest[8] Yet another formula for GDP by the income method is:[citation needed] where R : rents I : interests P : profits
  • 9. SA : statistical adjustments (corporate income taxes, dividends, undistributed corporate profits) W : wages Note the mnemonic, "ripsaw". Expenditure approach[edit] " All expenditure incurred by individuals during 1 year . " In economics, most things produced are produced for sale and then sold. Therefore, measuring the total expenditure of money used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP. Note that if you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Sweater-knitting is a small part of the economy, but if one counts some major activities such as child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of production. Similarly, if there is a long term shift from non-market provision of services (for example cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then this trend toward increased market provision of services may mask a dramatic decrease in actual domestic production, resulting in overly optimistic and inflated reported GDP. This is particularly a problem for economies which have shifted from production economies to service economies. Components of GDP by expenditure[edit] Components of U.S. GDP GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M). Y = C + I + G + (X − M) Here is a description of each GDP component:  C (consumption) is normally the largest GDP component in the economy, consisting of private (household final consumption expenditure) in the economy. These personal expenditures fall under one of the following
  • 10. categories: durable goods, non-durable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses but does not include the purchase of new housing.  I (investment) includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment. In contrast to its colloquial meaning, 'Investment' in GDP does not mean purchases offinancial products. Buying financial products is classed as 'saving', as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds orstocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products.  G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.  X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.  M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic. A fully equivalent definition is that GDP (Y) is the sum of final consumption expenditure (FCE), gross capital formation (GCF), and net exports (X – M). Y = FCE + GCF+ (X − M) FCE can then be further broken down by three sectors (households, governments and non-profit institutions serving households) and GCF by five sectors (non-financial corporations, financial corporations, households, governments and non-profit institutions serving households). The advantage of this second definition is that expenditure is systematically broken down, firstly, by type of final use (final consumption or capital formation) and, secondly, by sectors making the expenditure, whereas the
  • 11. first definition partly follows a mixed delimitation concept by type of final use and sector. Note that C, G, and I are expenditures on final goods and services; expenditures on intermediate goods and services do not count. (Intermediate goods and services are those used by businesses to produce other goods and services within the accounting year.[9] ) According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, "In general, the source data for the expenditures components are considered more reliable than those for the income components [see income method, below]."[10] Examples of GDP component variables[edit] C, I, G, and NX(net exports): If a person spends money to renovate a hotel to increase occupancy rates, the spending represents private investment, but if he buys shares in a consortium to execute the renovation, it is saving. The former is included when measuring GDP (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP. If a hotel is a private home, spending for renovation would be measured as consumption, but if a government agency converts the hotel into an office for civil servants, the spending would be included in the public sector spending, or G. If the renovation involves the purchase of a chandelier from abroad, that spending would be counted as C, G, or I (depending on whether a private individual, the government, or a business is doing the renovation), but then counted again as an import and subtracted from the GDP so that GDP counts only goods produced within the country. If a domestic producer is paid to make the chandelier for a foreign hotel, the payment would not be counted as C, G, or I, but would be counted as an export. GDP real grow th rates for 2010. A "production boundary" delimits what will be counted as GDP.
  • 12. "One of the fundamental questions thatmustbe addressed in preparing the national economic accounts is how to define the production boundary–thatis,what parts of the myriad human activities are to be included in or excluded from the measure ofthe economic production."[11] All output for market is at least in theory included within the boundary. Market output is defined as that which is sold for "economically significant" prices; economically significant prices are "prices which have a significant influence on the amounts producers are willing to supply and purchasers wish to buy."[12] An exception is that illegal goods and services are often excluded even if they are sold at economically significant prices (Australia and the United States exclude them). This leaves non-market output. It is partly excluded and partly included. First, "natural processes without human involvement or direction" are excluded.[13] Also, there must be a person or institution that owns or is entitled to compensation for the product. An example of what is included and excluded by these criteria is given by the United States' national accounts agency: "the growth of trees in an uncultivated forest is not included in production, but the harvesting of the trees from that forest is included."[14] Within the limits so far described, the boundary is further constricted by "functional considerations."[15] The Australian Bureau for Statistics explains this: "The national accounts are primarily constructed to assist governments and others to make market-based macroeconomic policy decisions, including analysis of markets and factors affecting market performance, such as inflation and unemployment." Consequently, production that is, according to them, "relatively independent and isolated from markets," or "difficult to value in an economically meaningful way" [i.e., difficult to put a price on] is excluded.[16] Thus excluded are services provided by people to members of their own families free of charge, such as child rearing, meal preparation, cleaning, transportation, entertainment of family members, emotional support, care of the elderly.[17] Most other production for own (or one's family's) use is also excluded, with two notable exceptions which are given in the list later in this section. Non-market outputs that are included within the boundary are listed below. Since, by definition, they do not have a market price, the compilers of GDP must impute a value to them, usually either the cost of the goods and services used to produce them, or the value of a similar item that is sold on the market.  Goods and services provided by governments and non-profit organizations free of charge or for economically insignificant prices are included. The value of these goods and services is estimated as equal
  • 13. to their cost of production. This ignores the consumer surplus generated by an efficient and effective government supplied infrastructure. For example, government-provided clean water confers substantial benefits above its cost. Ironically, lack of such infrastructure which would result in higher water prices (and probably higher hospital and medication expenditures) would be reflected as a higher GDP. This may also cause a bias that mistakenly favors inefficient privatizations since some of the consumer surplus from privatized entities' sale of goods and services are indeed reflected in GDP.[18] x  Goods and services produced for own-use by businesses are attempted to be included. An example of this kind of production would be a machine constructed by an engineering firm for use in its own plant.  Renovations and upkeep by an individual to a home that she owns and occupies are included. The value of the upkeep is estimated as the rent that she could charge for the home if she did not occupy it herself. This is the largest item of production for own use by an individual (as opposed to a business) that the compilers include in GDP.[18] If the measure uses historical or book prices for real estate, this will grossly underestimate the value of the rent in real estate markets which have experienced significant price increases (or economies with general inflation). Furthermore, depreciation schedules for houses often accelerate the accounted depreciation relative to actual depreciation (a well built house can be lived in for several hundred years – a very long time after it has been fully depreciated). In summary, this is likely to grossly underestimate the value of existing housing stock on consumers' actual consumption or income.  Agricultural production for consumption by oneself or one's household is included.  Services (such as chequeing-account maintenance and services to borrowers) provided by banks and other financial institutions without charge or for a fee that does not reflect their full value have a value imputed to them by the compilers and are included. The financial institutions provide these services by giving the customer a less advantageous interest rate than they would if the services were absent; the value imputed to these services by the compilers is the difference between the interest rate of the account with the services and the interest rate of a similar account that does not have the services. According to the United States Bureau for Economic Analysis, this is one of the largest imputed items in the GDP.[19] GDP vs GNI[edit] GDP can be contrasted with gross national product (GNP) or, as it is now known, gross national income (GNI). The difference is that GDP defines its
  • 14. scope according to location, while GNI defines its scope according to ownership. In a global context, world GDP and world GNI are, therefore, equivalent terms. GDP is product produced within a country's borders; GNI is product produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNI non-identical. Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNI; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNP but not its GDP. To take the United States as an example, the U.S.'s GNI is the value of output produced by American-owned firms, regardless of where the firms are located. Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets. Gross national income (GNI) equals GDP plus income receipts from the rest of the world minus income payments to the rest of the world.[20] In 1991, the United States switched from using GNP to using GDP as its primary measure of production.[21] The relationship between United States GDP and GNP is shown in table 1.7.5 of theNational Income and Product Accounts.[22] International standards[edit] The international standard for measuring GDP is contained in the book System of National Accounts (1993), which was prepared by representatives of the International Monetary Fund, European Union, Organization for Economic Co-operation and Development, United Nations and World Bank. The publication is normally referred to as SNA93 to distinguish it from the previous edition published in 1968 (called SNA68) [23] SNA93 provides a set of rules and procedures for the measurement of national accounts. The standards are designed to be flexible, to allow for differences in local statistical needs and conditions. This section
  • 15. requires expansion. (August 2009) National measurement[edit] Within each country GDP is normally measured by a national government statistical agency, as private sector organizations normally do not have access to the information required (especially information on expenditure and production by governments). Main article: National agencies responsible for GDP measurement Interest rates[edit] Net interest expense is a transfer payment in all sectors except the financial sector. Net interest expenses in the financial sector are seen as production and value added and are added to GDP. Nominal GDP and adjustments to GDP[edit] The raw GDP figure as given by the equations above is called the nominal, historical, or current, GDP. When one compares GDP figures from one year to another, it is desirable to compensate for changes in the value of money – i.e., for the effects of inflation or deflation. To make it more meaningful for year-to-year comparisons, it may be multiplied by the ratio between the value of money in the year the GDP was measured and the value of money in a base year. For example, suppose a country's GDP in 1990 was $100 million and its GDP in 2000 was $300 million. Suppose also that inflation had halved the value of its currency over that period. To meaningfully compare its GDP in 2000 to its GDP in 1990, we could multiply the GDP in 2000 by one-half, to make it relative to 1990 as a base year. The result would be that the GDP in 2000 equals $300 million × one-half = $150 million, in 1990 monetary terms. We would see that the country's GDP had realistically increased 50 percent over that period, not 200 percent, as it might appear from the raw GDP data. The GDP adjusted for changes in money value in this way is called the real, or constant, GDP. The factor used to convert GDP from current to constant values in this way is called the GDP deflator. Unlike consumer price index, which measures inflation or deflation in the price of household consumer goods, the GDP deflator measures changes in the prices of all domestically produced goods and services in an economy including investment goods and government services, as well as household consumption goods.[24] Constant-GDP figures allow us to calculate a GDP growth rate, which indicates how much a country's production has increased (or decreased, if the growth rate is negative) compared to the previous year.
  • 16. Real GDP growth rate for year n = [(Real GDP in year n) − (Real GDP in year n − 1)] / (Real GDP in year n − 1) Another thing that it may be desirable to account for is population growth. If a country's GDP doubled over a certain period, but its population tripled, the increase in GDP may not mean that the standard of living increased for the country's residents; the average person in the country is producing less than they were before. Per- capita GDP is a measure to account for population growth. Cross-border comparison and PPP[edit] The level of GDP in different countries may be compared by converting their value in national currency according to either the current currency exchange rate, or the purchasing power parity exchange rate.  Current currency exchange rate is the exchange rate in the international foreign exchange market.  Purchasing power parity exchange rate is the exchange rate based on the purchasing power parity (PPP) of a currency relative to a selected standard (usually the United States dollar). This is a comparative (and theoretical) exchange rate, the only way to directly realize this rate is to sell an entire CPI basket in one country, convert the cash at the currency market rate & then rebuy that same basket of goods in the other country (with the converted cash). Going from country to country, the distribution of prices within the basket will vary; typically, non-tradable purchases will consume a greater proportion of the basket's total cost in the higher GDP country, per the Balassa-Samuelson effect. The ranking of countries may differ significantly based on which method is used.  The current exchange rate method converts the value of goods and services using global currency exchange rates. The method can offer better indications of a country's international purchasing power and relative economic strength. For instance, if 10% of GDP is being spent on buying hi-tech foreign arms, the number of weapons purchased is entirely governed by current exchange rates, since arms are a traded product bought on the international market. There is no meaningful 'local' price distinct from the international price for high technology goods.  The purchasing power parity method accounts for the relative effective domestic purchasing power of the average producer or consumer within an economy. The method can provide a better indicator of the living standards of less developed countries,
  • 17. because it compensates for the weakness of local currencies in the international markets. For example, India ranks 10th by nominal GDP, but 3rd by PPP. The PPP method of GDP conversion is more relevant to non-traded goods and services. There is a clear pattern of the purchasing power parity method decreasing the disparity in GDP between high and low income (GDP) countries, as compared to the current exchange rate method. This finding is called the Penn effect. For more information, see Measures of national income and output. Per unit GDP[edit] GDP is an aggregate figure which does not consider differing sizes of nations. Therefore, GDP can be stated as GDP per capita (per person) in which total GDP is divided by the resident population on a given date, GDP per citizen where total GDP is divided by the numbers of citizens residing in the country on a given date, and less commonly GDP per unit of a resource input, such as GDP per GJ of energy or Gross domestic product per barrel. GDP per citizen in the above case is pretty similar to GDP per capita in most nations, however, in nations with very high proportions of temporary foreign workers like in Persian Gulf nations, the two figures can be vastly different. GDP Per Capita (Current USD) 2008 2009 2010 2011 2012 USA 46,760 45,305 46,612 48,112 49,641 Source:Helgi Library [25], World Bank GDP Per Capita (Current USD) 2008 2009 2010 2011 2012 United Kingdom 43,147 35,331 36,238 38,974 39,090 Source:Helgi Library [25], World Bank
  • 18. Standard of living and GDP[edit] GDP per capita is not a measurement of the standard of living in an economy; however, it is often used as such an indicator, on the rationale that all citizens would benefit from their country's increased economic production. Similarly, GDP per capita is not a measure of personal income. GDP may increase while real incomes for the majority decline. The major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely, and consistently. It is measured frequently in that most countries provide information on GDP on a quarterly basis, allowing trends to be seen quickly. It is measured