Download National Production

Topic  National
2
Production
LEARNING OUTCOMES
By the end of this topic, you should be able to:

1.
Explain the circular flow of the income model;
2.
Compare gross domestic product (GDP) and gross national product
(GNP);
3.
Illustrate how gross domestic product (GDP) is calculated;
4.
Distinguish the difference between real GDP and nominal GDP; and
5.
Discuss four problems that arise during the measurement of national
production.
INTRODUCTION
Macroeconomic theory began developing and gaining popularity following the
recession in 1929. The economic downturn continued for more than five years
and an unemployment rate of up to 25% was recorded in the United States of
America. This meant that every one out of four persons was unemployed or did
not work and that was indeed a very high rate of unemployment.
Therefore, famous economists, headed by English economist named John
Maynard Keynes, suggested that a macro view be taken to solve problems. This
view is used since the microeconomic theory used prior to this could not
overcome the high unemployment rate. Hence, macroeconomic theory started to
flourish.
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From time to time, other problems which needed to be solved using the macro
view cropped up, such as inflation and deficit. Without inflation and
unemployment, the system of free market economy cannot measure the stability in
the economic activity that is carried out. The existence of such problems helps open
up more room for macroeconomics to grow. In this topic, the focus will be on the
main issue of macroeconomics, which is national production. Let us learn more
about national production in this exciting new topic.
2.1
CIRCULAR FLOW OF INCOME MODEL
The main aim of a countryÊs economic activity is to ensure that all its peopleÊs
needs for goods and services are satisfied. Nothing is more important than
providing shelter, food, clothing, education and recreation for each and every
citizen. Before you continue reading, think for just a moment about how
economic activities are measured.
National production and national output mean the same thing; namely, these
terms refer to the final products/goods and services produced by a country
during a specific period of time, such as a year.
A countryÊs economic activity is usually measured based on the countryÊs overall
output.
Before we look further into the concept of national production, it is important for
you to understand circular flow of the income model as shown in Figure 2.1. The
model shows the simplest economic activity involving two parties, namely, the
household and the firm.
Figure 2.1: Circular flow of income model
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Figure 2.1 shows the circulation of physical goods (products and resources) and
cash between households and firms. Every circulation of physical goods will be
followed by a circulation of cash in the opposite direction.
The circulation of resources (production factors such as land, capital, labour and
entrepreneurs) from households to firms will be followed by cash being
circulated from the firms to the households. Resources possessed by households
that are utilised by firms in the production process will be paid for by the firms.
The circulation of goods from the firms to households will also be followed by
circulation of cash from households to the firms, which represents the payment
for the goods purchased by households from the firms.
2.2
GROSS DOMESTIC PRODUCT (GDP)
ACTIVITY 2.1
We always hear the term „gross domestic product‰ being mentioned in
economic news over the electronic media. What do you understand
about gross domestic product?
Every country has its own method of evaluating its economic activity. One thing
is certain, the process undertaken to do this is certainly not a simple one. The
same goes for Malaysia. Malaysia has its own method of measuring the total
output and the ins and outs of practiced economic activities. Have you ever given
it a thought? How does the Malaysian government measure national production?
One national production concept that Malaysia applies is the Gross Domestic
Product (GDP). What does it stand for?
Gross domestic product (GDP) means the total market value of all final goods
and services produced within the borders of a nation during a specified
period.
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There are four important elements of GDP, as shown in Figure 2.2 below.
Figure 2.2: The four important elements of GDP
The explanation for these four elements of GDP are in the following subtopics.
2.2.1
Total Value of Production
In order to calculate the total value of production, you will have to add the value
of all the goods. For example, the value of an orange is added to the value of a
computer, a car, a washing machine and so on. The GDP values of goods are
based on their market prices. The market price is the price at which an item,
service or asset is exchanged in a market system.
Example 2.1:
If an orange is sold for 30sen and the price of a computer is RM1,000, then the
value of 100 oranges and five computers is RM5,030, which is equivalent to
RM30 for the oranges and RM5,000 for the computers.
2.2.2
What are the Final Goods and Services
Produced?
The GDP calculations only take into account the market price of the final goods
and services. Final goods and services are those that are actually used or
consumed by individuals, households, firms or the government and will not be
used as components in producing other goods and services. In other words, they
are not intermediate goods and services.
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Example 2.2:
Proton Waja (MalaysiaÊs national car) is the final product but the tyre it uses is
an intermediate good. GDP only considers the goods that are being sold in the
market. Therefore, goods produced for your own consumption are not taken
into account by GDP.
2.2.3
Where are They Being Produced?
Only goods and services produced within the boundaries of a country will
become part of the GDP of that country. Therefore, goods and services produced
in Malaysia are part of MalaysiaÊs GDP.
Example 2.3:
Nike, an American company, produces clothing in Malaysia. The value of the
clothing produced in Malaysia is part of MalaysiaÊs GDP and not the GDP of
the United States.
Petronas, a Malaysian oil company, produces oil in Vietnam and contributes
towards VietnamÊs GDP and not ours.
2.2.4
When are They Produced?
GDP concerns only the production of new goods and services during a particular
period. Usually, the period is every three months or a year. Only the final
products and services produced during that period of time will be taken into
consideration for the GDP. GDP not only measures the total value of production,
but it also calculates the total revenue and total expenditure of a country.
Example 2.4:
In Malaysia, Bank Negara uses the quarterly data to detect any changes in
short-term economic activities. Economists, on the other hand, use annual
data to evaluate the growth in long-term economic activities.
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EXERCISE 2.1
True (T) or False (F) Statements
1.
National production means goods and services produced within
the borders of a nation during a specified period. __________
2.
In measuring the value of production, GDP values production
during a certain time frame only. Usually, the period is every six
months or three years. __________
3.
Gucci is an American brand. The value of clothing they produce in
Malaysia is part of AmericaÊs GDP and not ours. __________
4.
Goods and services produced in Singapore are counted as part of
SingaporeÊs GDP. __________
5.
In order to calculate national production value, GDP values the
goods based on market price. __________
2.3
GROSS NATIONAL PRODUCT (GNP)
How about gross national product (GNP)? What do you understand about it?
How is it different from GDP? Let us continue to find out the answers.
Another concept used to measure the production of a country is the Gross
National Product (GNP). In other words, GNP does not take into account the
value of output produced by a foreign firm even though the production
operation is carried out within the country.
Gross national product (GNP) means total market value of final goods and
services produced by a countryÊs nationals using their own resources,
regardless of whether the production operations are carried out within or
outside the country.
For example, the value of clothing produced by Nike in Malaysia is not included
in the calculations for MalaysiaÊs GNP. Instead, it is used in the calculations of
AmericaÊs GNP.
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Similarly, the petroleum produced by Petronas in Vietnam is not added into
VietnamÊs GNP. Instead it is added to ours. Here is a simple formula for GNP:
GNP = GDP + income earned by domestic residents through foreign
investments - income earned by foreign investors in the domestic market
ACTIVITY 2.2
While walking in shopping malls, you must have seen business premises
of branded goods like Gucci, Laura Ashley, Guess, Dorothy Perkins,
Topshop, Nike and such.
After studying the concepts of GDP and GNP, in your opinion, what are
the contributions made by these businesses towards MalaysiaÊs economic
growth?
EXERCISE 2.2
1.
State the difference between GDP and GNP.
2.
A product was made in 2002 but sold in 2003. Which year will it be
accounted into for the purpose of calculating the GDP?
3.
For a developing nation like Malaysia, which value would be
higher, GDP or GNP?
2.4
METHOD OF CALCULATING GDP
Generally, there are three approaches for measuring GDP, namely expenditure
approach, production approach and income approach. Although the methods are
different, they give the same value. Let us look at these approaches further in the
following subtopics.
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Expenditure Approach
Firstly, let us learn the definition of „Expenditure Approach‰.
Expenditure approach sums up the total expenditure in a country (of
individuals, firms and government). The total is derived from the final
demand for goods and services.
There are four groups that purchase final goods and services, namely,
households, firms, government and overseas consumers.
The expenditure of these four groups can be divided into four categories,
namely, personal consumption expenditures, gross investment, government
purchases of final goods and services, and net exports. Figure 2.3 shows the four
categories of expenditure.
Figure 2.3: Four categories of expenditure
The description for each category of expenditure is explained in Table 2.1.
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Table 2.1: Description of Four Categories of Expenditure
Expenditure
Description
Personal consumption
expenditures
This category includes expenditures by households on
final goods and services. This includes expenses for food,
laundry, rental and so on.
Gross Investment
This category refers to investment by firms on capital
equipment like machines, and buildings, and addition to
inventories. Production that cannot be sold also adds on
to the inventory and thus, is included in investment.
Purchase of shares and bonds are not considered as
investments since these are not purchase of final goods or
services.
Gross Investment = Net investment + Depreciation of
capital assets.
Government purchases of
final goods and services
This category refers to central and local government
purchases of goods and services from the private sector.
In order to function effectively, the government has to
purchase goods and services produced by firms.
For example, government buys computers, paper, pens
and ammunition. All these goods are necessary for the
government to function effectively.
Net exports
This category reflects total exports minus total imports
(X – M). If the total value of exports exceeds total imports,
then the net exports is a positive value. Instead, if the
exports value is less than the imports value, then the net
exports is a negative figure.
Some goods produced locally cannot be sold in the
country. Similarly, some goods required by the people
are not produced locally and therefore, need to be
imported from overseas.
Therefore, the total expenditure for the final goods and services produced by a
country is the sum after adding all the four categories as listed below.

Personal consumption expenditures
=
C

Investment
=
I

Government purchases of final goods and services =
G

Net Exports
X–M
=
Total Expenditure = C + I + G + (X – M) = GDP
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Total expenditure represents the value/sum received by the firms that produce
the final goods and services.
2.4.2
Production Approach
By looking at Figure 2.4, what can you describe about production approach?
Figure 2.4: Production approach
According to the production approach, all the values of final goods and services
from the various economic sectors are added. Figure 2.4 shows examples of
sectors found in Malaysia. For your information, in Malaysia, the economic sector
can be divided into three groups, namely, the main sector, the industrial sector
and the service sector. The information on the value of production in each of
these sectors is obtained through census.
This approach uses the concept of adding up all the values to avoid the problem
of counting a value twice.
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What does the problem of counting a value twice stand for?
The problem of counting a value twice is a situation whereby the value of a
good is counted more than once when measuring the GDP.
What is the impact of this problem? This problem can cause the GDP to be over
estimated and the value will not reflect the actual figure. To make it easier for
you to understand, let us refer to Example 2.5. Table 2.2 is your guide to the
example.
Table 2.2: Value Added Method
Process
Value Added (RM)
Value Added (RM)
Firm I – Cotton to thread
Firm II – Thread to cloth
Firm III – Cloth to dress
TOTAL
100
150
230
100
50
80
230
Example 2.5:
Assume that there are three steps to produce a dress. In the first process,
cotton is processed into thread and sold to Firm II for RM100. At this stage, a
value of RM100 is produced (assuming that the cotton is obtained for free).
Firm II then produces cloth using the thread and sells it to Firm III for RM150.
This process adds a value of RM50 to the original RM100.
Subsequently, cloth is made into a dress in this third stage of production. This
dress is then sold by Firm III to consumers for the price of RM230. Therefore,
a value of RM80 has been added on to the price for which the cloth was
purchased.
According to the production approach, only the final value of production is
taken into account when calculating the national income. In this case, only the
final figure of RM230 is taken. If the values of the intermediate goods are
considered (example, the 100 + 150 + 230), this would mean the values are
added twice and the national income would be over estimated.
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Income Approach
How do we use the income approach in measuring GDP? Measuring GDP using
the income approach means to sum up the incomes that firms pay households for
the factors of production they hire, for example, labour, land, capital and
entrepreneurs. This approach divides income into five categories as explained in
Table 2.3.
Table 2.3: Five Categories of Income Approach
Income Approach
Explanation
Compensation of
employees
Compensation of employees means wages paid to employees. It
includes net wages and salaries added to fringe benefits paid by
the employer such as health insurance, social security
contributions and gratuities/pension fund contributions.
Net interest
Net interest means the interest payments on deposits made by
banks to the customers/households. This payment must deduct
the interest paid by customers/households for loans taken.
Rental income
Rental income means total rent collected for the use of land and
other input. It includes payment of house rental and estimated
rental which should be paid by those who live in their own
homes.
Corporate profits
Corporate profits means the measure of profit earned by the
household sector for supplying entrepreneurship services
through corporations. The corporate profits paid as dividends
and profits that are not divided are considered income.
ProprietorsÊ income
A proprietor is someone who owns his own business. His
income includes the total of all four sources of income stated
above.
ProprietorsÊ income is difficult to divide into compensation of
employees, rental income and profits. Therefore, it is combined
into a single category named proprietorsÊ income.
We can conclude that the national income is measured by adding the total of all
income above, as shown in the following formula.
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National Income
Compensation of employees
+ Net interest
+ Rental income
+ Corporate profits
+ ProprietorsÊ income
= GDP
SELF-CHECK 2.1
Give the meanings of each method below using your own words.
Income Approach Category
Meaning
Compensation of employees
Net interest
Rental income
Corporate profits
ProprietorsÊ income
2.5
ADJUSTING FACTOR COST TO MARKET
PRICE
In the process of calculating the GDP, the expenditure approach values the goods
and services at market rates whereas the income approach values them based on
the factor cost of production used to produce the goods and services.
Indirect taxes and subsidies are two elements that differentiate market prices
from the factor cost. Sales tax causes the value of market prices to be more than
the factor cost whereas subsidies make the factor cost higher than market prices.
In order to adjust the factor cost to market prices, indirect taxes have to be added
and subsidies have to be deducted as shown in the following formula.
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Factor Cost + (Indirect Taxes – Subsidies) = Market Price
Let us look at Example 2.6, which shows you how to calculate the value of GDP
for county X at market price.
Example 2.6:
Information below concerns the national income of X.
GDP at factor cost [GDP (fc)] =
Indirect taxes
=
Subsidies
=
RM100 million
RM25 million
RM7 million
What is the value of GDP for country X at market price?
Answer
GDP (mp) =
=
=
GDPfc + indirect taxes – subsidies
RM100 million + RM25 million – RM7 million
RM118 million
Therefore, GDP at market price for country X is RM118 million.
EXERCISE 2.3
2.6
1.
State THREE methods for calculating GDP.
2.
How can the value of factor cost be adjusted to market value?
ECONOMIC ACTIVITIES THAT ARE NOT
INCLUDED
ACTIVITY 2.3
What is your opinion on the traditional agricultural production that is
being carried out in the villages? This refers to farmers who do not sell
their agricultural produce and instead consume them for their
household needs. How can these economic activities be measured?
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In measuring the GDP, only the production value from economic activities that
are productive, legal and marketed are considered. There are economic activities
that are unproductive, illegal and not marketed. The following subtopics explain
four examples of activities which are not included in the calculation of GDP.
2.6.1
Traditional Farmer’s Agricultural Produce
In traditional farming, some of the output produced is used for farmersÊ own
consumption. Although this economic activity is productive, it is not marketed.
Therefore, this type of farming on a smaller scale is not included in the
calculation of GDP. Figure 2.5 shows paddy planting as an example of traditional
farming.
Figure 2.5: Traditional farming: Paddy planting
Source: http://images.google.com.my
2.6.2
Illegal Activities
Although activities such as drug trafficking, prostitution, gambling or black
market trade are all productive and generate a lot of money, they are not
included in the calculation of GDP. This is because these activities are illegal.
2.6.3
Productive Activities that are Not Paid
Are you aware that there are productive activities that are not paid for? For
example, housework done by a housewife is not paid for and thus, difficult to be
valued. Therefore, it is not included in the calculations of GDP. However, if the
job is given to a maid and she is paid for the work done, then it will be accounted
for in the GDP.
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Non-cash Rewards
It is quite normal for a company manager to receive partial benefits in the form of
something other than cash, for example, free hotel stay or transportation.
Although this increases his real income, it is still not included in the calculations
for GDP.
Besides those activities that are not included in the measurement of GDP, there
are also limitations of the GDP concept in terms of social welfare. As we know,
an increase in GDP is a good thing and it is one of the main objectives of the
macroeconomic policy. However, can we use the GDP concept as a measure of
welfare? A decrease in crime levels in one country definitely improves social
welfare but crime levels are not measured in GDP. If the crime levels decreased,
society would be better off, but a decrease in crime is not an increase in output,
thus it is not reflected in GDP. Similarly in the case of pollution, GDP does not
reflect losses. It simply shows that GDP is higher, when more output is produced
despite the effects of pollution on society.
2.7
REAL GDP AND NOMINAL GDP
The value of GDP for a country changes from time to time. The same goes for
prices that keep fluctuating from time to time. Information pertaining to the
increase in production is important. Thus, the element of change in pricing has to
be set aside from the national production value. The isolated data which shows
the price difference is more meaningful to economists and policy-makers as it
reflects the actual economic activities.
There are two types of GDP; real and nominal. Let us check out their definitions.
Real GDP means the GDP value does not have any element of price change in
its calculations. The GDP is measured based on fixed prices.
Nominal GDP means measuring the value of all the goods and services
produced expressed in current prices. Price change will affect the GDP value.
To make it easier for you to understand these two concepts, let us refer to Table
2.4. Imagine that country X only produces two goods, namely food and clothing.
Table 2.4 shows the quantity and prices for these two items for the year 2001 and
2002.
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Table 2.4: Quantity and Prices
Year
Quantity (Unit)
Price
Food
Clothing
Food
Clothing
2010
5
10
RM20
RM15
2011
7
12
RM22
RM15
Based on the information in Table 2.4, the nominal GDP value, which is the value
of goods produced for a specific year for a country during 2010 and 2011, is
stated as follows:
Year 2010 (5 Food RM20) + (10 Clothing  RM15) = RM250.
Year 2011 (7 Food  RM22) + (12 Clothing  RM15) = RM334.
While the Real GDP for the year 2010 based on the price for 2010 is:
(5 Food  RM20) + (10 Clothing  RM15) = RM250.
Since the price used is the same, which is the price for the year 2010, the values of
real GDP and nominal GDP are the same at RM250. Based on the pricing for
2010, the real GDP value for 2011 is:
(7 Food  RM20) + (12 Clothing ×RM15) = RM320.
Comparatively, the value of real GDP for the year 2011 is lower than the nominal
GDP value for the same year. This is owing to the increase in food prices from
2010 to 2011.
Real GDP can be measured using a constant price at any year. In the year 2011,
the real GDP can also be measured based on the 2011 pricing.
The rate of growth in real GDP between 2010 and 2011 can be calculated as
follows:
(RM320 – RM250) / RM250  100 = 28%.
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The value of 28% shows the average growth rate for both food and clothing for
country X.
EXERCISE 2.4
1.
State the types of activities that are not included in the calculation
of national production.
2.
What is the difference between real GDP and nominal GDP?
2.8
NATIONAL PRODUCTION DATA USAGE
National production data reflects a countryÊs overall economic activities. It is
very useful for many parties. As for Malaysia, these parties can be the
government, policy-makers and Bank Negara. What is the usage of this data?
Figure 2.6 shows five main usages of national production data.
Figure 2.6: National production data usage
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Let us take a further look at these five main uses of national production data.
(a)
To Measure Economic Performance
The economic growth rate can be calculated by comparing the current
national production data with that of the previous year. The information
regarding the economic growth rate helps the government make
comparisons with other countries.
(b)
To Facilitate Policy-makers in Planning
Policy-makers need the national production data to draft economic policies
for the coming years. The national production is an important guide that
provides details about a countryÊs economic performance and therefore, is
vital for planning purposes.
(c)
To Show or Indicate the Success or Failure of Government Policies
The government is able to evaluate the effectiveness of an economic policy
that has been implemented based on information about national
production. It also allows the government to look at any economic
problems that may have arisen, and find ways to solve these problems.
(d)
To Measure the PeopleÊs Standard of Living
The national production data is used to measure the standard of living of
citizens . Normally, the value of Real GNP or Real GDP per capita is used
as a measuring yardstick. With this data, one can compare the peopleÊs
standard of living from time to time or compare it with that of other
countries.
(e)
To Evaluate Contributions of Economic Sectors toward the CountryÊs
Economy
Based on the production approach, the contributions made by each
economic sector towards the overall economic growth can be evaluated.
The government can identify the sectors that are considered the backbone
of the countryÊs economy. Based on each sectorÊs performance, the
government can also assess the success or failure of its policies with regard
to each sector.
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FACTORS AFFECTING NATIONAL
PRODUCTION LEVEL
The national production level of a country fluctuates all the time. The national
production of developed nations such as United States of America and Japan are
higher compared with the national production of developing countries such as
Sri Lanka and Thailand. There are two types of factors which can affect the
national production level; internal and external.
2.9.1
Internal Factors
Among the internal factors that affect the level of national production are natural
resources such as petroleum and gas. Countries that are rich in natural resources
are bound to have a higher national production level compared to countries that
have no natural resources.
Energy or labour factors play an important role in contributing towards national
production. Countries that have hardworking and capable employees, for
example, Japan, will definitely increase the national production level compared
to nations with lazy and unproductive labourers.
Besides these, total capital owned by a country also affects the level of national
production. Countries that have less capital cannot afford to produce large
output compared to countries that have more capital.
The level of technology also determines the national production level. Countries
that have knowledge and technological advancement are able to produce goods
and services using faster and more efficient methods.
2.9.2
External Factors
Foreign investment plays an important role in increasing the national income and
economic growth of a country. Foreign investment, whether direct or indirect,
contributes towards a countryÊs economic growth and income level.
Did you know that terms of trade also affect the income of a country? What does
this stand for?
„Terms of trade‰ refers to the ratio of the amount a country receives for its
export commodity to the amount it pays for its import commodity.
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Terms of trade are good if they show that a country is receiving a higher import
quantity compared to its export quantity. This means it has to pay less for the
products it imports, that is, it has to give up less exports for the imports it
receives.
Receiving assistance from other countries can also improve the recipient
countryÊs standard of living. For example, assistance provided by international
organisations and developed nations can help reduce the rate of poverty in poor
countries. The national production of developing countries can be improved with
the help of other countries.
EXERCISE 2.5
1.
What are the uses of national production data?
2.
Discuss factors that affect the income level of a country.
2.10
PROBLEMS IN CALCULATING NATIONAL
PRODUCTION
ACTIVITY 2.4
The process of calculating national production is not an easy one.
Often, unforeseen problems arise and make matters more difficult.
Before you start reading, try to identify problems that you usually read
about in the newspapers.
The calculation of national production is a very complicated process and many
problems can arise during this process. Figure 2.7 shows you four problems that
usually arise during the process of calculating national production.
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Figure 2.7: Four problems in calculating national production
These four problems are further discussed as follows:
(a)
Gathering Information
Gathering information or data is difficult as there are some parties, such as
small-time businessmen and farmers, who do not keep detailed records of
their economic activities. The production values obtained from them are
usually estimated figures. Mistakes happen when classifying this
information, which could cause some confusion in the calculating process.
(b)
Counting Twice/Double Counting
The difficulty in distinguishing final goods from intermediate goods might
lead to the problem of double counting. A product can be classified as
either a final or an intermediate good depending on its usage. For example,
flour purchased by a housewife is considered a final product. However,
flour purchased by a baker is considered an intermediate product.
(c)
Determining the Prices of Goods
Usually, prices of goods differ from one area to another. In addition, prices
of certain goods are always changing, for example, the price of palm oil,
which changes everyday. Thus, the difficulty arises in determining the
prices that should be taken into account in calculating national production.
(d)
Devaluation (Depreciation)
It is difficult to calculate devaluation because there are no detailed records
on it for some economic activities. Besides this, there are many different
methods of calculating devaluation and each method gives a different
figure.
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TOPIC 2
NATIONAL PRODUCTION
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ACTIVITY 2.5
Based on your understanding of the problems that usually arise in
calculating national production, identify if there are any problems that
were not mentioned and list them down.
2.11
BUSINESS CYCLE
Lastly, before we end this topic, let us learn about the business cycle for national
production. Can you still remember the meaning of „business cycle‰, which you
came across in the Topic 1?
Business cycle can be defined as a periodic fluctuation in the rate of economic
activity, as measured by levels of employment, prices and production.
Usually, a business cycle lasts for a period of between two and ten years,
accompanied by expansion and contraction of various sectors in an economy.
Let us look at Figure 2.8 which shows you a business cycle.
Figure 2.8: Business cycle
Based on Figure 2.8, you can see that there are five stages of the business cycle;
peak, trough, recovery, growth (expansion) and recession (contraction). The
points between the stages are indicated by peaks and troughs. The most
important phases in a business cycle are growth (expansion) and recession
(contraction). An economy is said to have achieved a full cycle when the
economy has gone through the five stages. For example, a business cycle that
starts at the peak is complete when it ends at the next peak.
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40 
TOPIC 2
NATIONAL PRODUCTION
Recession starts at the peak and ends at the trough. Recession occurs when the
value of real national production drops for two quarters of a year in a row. The
main characteristics of a recession include a decrease in demand for labour, and
reduction in spending by consumers. Recession is also reflected in the drop in
firmsÊ profits. Since consumer spending decreases during recession, all the firmsÊ
unsold products increase and this will raise the firmsÊ inventories.
Expansion, on the other hand, begins at the trough and ends at the peak. The
early stage of expansion is called recovery. This happens when national
production actually increases for six months continuously. A growth in the
economy reflects the increase in business sector confidence, a hike in investment
and a demand for labour. As income increases, peoplesÊ spending power
increases too. FirmsÊ profits also will increase but inventories will be reduced.
EXERCISE 2.6
1.
There are many problems that have to be dealt with in the
calculation of national production. Explain the usual problems
that arise.
2.
Define business cycle and discuss the five phases in a business
cycle.

This topic has discussed important economic variables, namely, topics related
to national production. The circular flow of the income model is used to
explain the relationship between income and expenditure.

There are three approaches for measuring Gross Domestic Product (GDP),
namely, expenditure approach, production approach and income approach.
Although these three approaches are different, they give the same GDP value.
Besides that, the difference between the Real GDP and Nominal GDP has also
been explained.

This topic has also discussed the use of national production data, factors that
affect the national production level and problems faced in calculating
national production. The topic ends with an explanation of the business cycle
and its five phases.
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TOPIC 2
NATIONAL PRODUCTION
Business cycle
National production
Circular flow
Nominal GDP
Expenditure approach
Problems
Gross domestic product (GDP)
Production approach
Gross national product (GNP)
Real GDP
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