Ahmed Kanary

Economics
P. 169
1.

*this graph is from Oxford IB Economics Textbook*

The graph above presents the circular flow model of

production and income. Gross Domestic Product or, GDP,
is used to measure the total value of all final goods and
services produced in a country in one year. It is
calculated in three different ways. The first is called the
income method. This measures the value of all the
incomes earned in the economy. This method measures
the value of the arrow marked as number (2) in the
graph above. The second method is the output method:
This measures the actual value of the goods and
services produced. This is calculated by summing all of
the value added by all the firms in an economy. When
we say value added it means that at each stage of a
production process we deduct the costs of inputs, so as
not to double count the inputs. The data is usually
grouped according to the different production sectors in
the economy. The output method measures the value of
the arrow marked as number (3) in the graph above. The
third method is The expenditure method: This measures
the value of all spending on goods and services in the
economy. This is calculated by summing up the spending
Ahmed Kanary

by all the different sectors in the economy. This includes

the governmental spending, investments by firms,
consumer spending, and the difference between exports
and imports. All these values are taken and added
together. The expenditure method measures the value
of the arrow marked as number (4) in the figure above.
1b. GDP is estimated by calculating the sum of
consumption, investment, government spending and
exports, minus the imports. While the total economic
activity is often reliably measured using GDP, such a
complex estimate is subject to various limitations, which
may affect its reliability as a basis for comparison
between countries, especially where a large gap in
between is present. GDP per Capita is frequently more
trustworthy that GDP itself. GDP per capita consists of
all Gross National Product divided by the population of
the country in question. If a nation has a higher GDP per
capita, then its people are generally wealthier and enjoy
a higher standard of living, than those in a country with
low GDP per capita. Although often accurate, GDP per
capita also covers some limitations. A large amount of
economic activity may not be recorded, such as informal
or black markets. This creates a large gap between
undeveloped/developing nations, where much currency
flows through illegal trade, and developed countries,
where almost all-economic activity is considered. It is
also essential to differentiate between Nominal and Real
GDP. This is important to be able to reliably compare not
between different countries, but between time frames of
one nations economy. If a single countrys GDP was
compared with that of the previous year for the same
country, then one could observe that prices have risen.
If prices have risen, this constitutes inflation, which
exaggerates the GDP. As a result GDP rises, although
economic activity and growth remain unchanged. This
limitation is solved by taken inflation into account. Real
GDP is received by adjusting the Nominal GDP for
inflation. Nominal GDP constitutes the value at current
prices. This deletes any mistakes that have occurred
Ahmed Kanary

due to changes in price over time. Another factor, which

may be utilized to compare countries, is their GNI or
Gross National Income. GNI is efficient as a basis for
comparison as it shows the GDP, which is internally
produced.