Question

Write a short essay that describes how the GDP and CPI measurements are calculated. In your essay, do the following:

• Describe the four categories in the GDP. Provide examples of each category.
• Describe how the CPI is calculated. Use the link here for your research, but feel free to use additional resources.
  • US Bureau of Economic Analysis
• Do you think the GDP is a good indicator of the strength of the US economy? Why or why not?
• Do you think the CPI is a good indicator of inflation? Why or why not?
• Click the link below to go to the website of the Bureau of Labor Statistics and locate data on the US CPI. Use the link here for your research, but feel free to use additional resources.
  • US Bureau of Labor Statistics

Answer 1

What is Gross Domestic Product?

Gross domestic product (GDP) is the monetary measure of the final goods and services produced by a country’s economy during a specified period of time. In other words, Gross domestic product is the total value of every good that is produced and every service that is provided in the country. It doesn't matter if the goods or services are produced by citizens or foreigners living in the country. Their location is important irrespective of their citizenship.

GDP can be calculated in three ways - Production (or output or value-added) approach, the income approach, or the speculated expenditure approach all of which should principally give the same result. Here we will discuss only the Expenditure approach.

GDP can be measured by the expenditure incurred in the economy.

Expenditure method
The Expenditure method to estimate GDP is to calculate the sum of the final uses of goods and services ( excepting intermediate consumption) measured in purchasers' prices.

Components of GDP by expenditure
GDP (Y) is the sum of
1. consumption (C),
2. investment (I),
3. government spending (G)
4. and net exports (X – M).

Y = C + I + G + (X − M)
Here is a description of each GDP component:
1. Consumption
In the United States, the largest contributor to GDP under the expenditure method is consumer spending, which holds a major share in U.S. GDP. Consumption is further split into
a. purchases of durable goods (such as Mobile and computers), b. nondurable goods (such as food and clothing)
c. services.

2. Investment

Business investment encompasses capital expenditures incurred by firms. Capital expenditure includes assets with useful lives of more than one year each, such as buildings, plants, equipment, production facilities etc.

3. Government Spending

The third component of GDP is government spending. It represents expenditures by state, local and federal authorities on a. a. defense such as fighter planes and
b. nondefense goods and services, such as health care and education.

4. Net Exports

Net exports is the difference between volume of goods and services exported by the United States to the rest of the world minus goods and services imported by the United States.

GDP is not a good indicator of the strength of the economy

GDP is a to an extent is a good measure of the strength of US economy but it doesn't indicate

a. The inequality of income in the US economy which is measured by GINI co-efficient.

b. US economy cannot be compared with another economy whose population is different from the population of US.

c. Welfare of US economy cannot be measured GDP.

d. Quality of life of people cannot be measured by GDP.

What is Consumer Price Index?

Consumer Price Index is a barometer for measuring changes in the purchasing power of a currency and the rate of inflation. It indicates the current prices of a basket of goods and services in terms of the prices during the same period in a previous year, to demonstrate the effect of inflation on purchasing power.

The Bureau of Labor Statistics surveys the prices of 80,000 consumer items to calculate the Consumer Price index. It encompasses the prices of a cross-section of goods and services commonly bought by primarily urban households. They represent nearly 87% of the U.S. population.

Many (but not all) price indices use weighted averages using weights that sum to 1 or 100.

The formula used to calculate the Consumer Price Index for a single item is as follows:

The base year is determined by the Bureau of Labour Statistics.

The prices of 85,000 items that are available at 22,000 stores, and 35,000 rental units are added together and averaged. They are weighted as follows : Housing account for 41.4%, Food and Beverage account for 17.4%, Transport accounts for 17.0%, Medical Care accounts for 6.9%, Other: 17.3 %. Taxes (43%) are not included in CPI computation.

Is Consumer Price Index good indicator of Inflation?

Though Consumer price index is widely used and useful it suffers from following shortcomings

a. The CPI method fails to track changes in product quality, which can increase the value and price of goods.

b.New Products enter the market but they don't become part of CPI

c. Different weights given to the different product may turn out to be wrong with change in facts and circumstances.