Economics has yet to come up with better measures of economic performance of an economy and well-being of the society than total output and output per capita.
The total output sets the constraint on how much a country’s population can consume, invest, export, and allocate to government spending including defense of the country.
The material well-being of the country is measured by the output per capita, which is simply the total output divided by the population. We will use the gross domestic product (GDP) as a measure of total output.
The most used way of measuring total output of a country is gross domestic product (GDP). GDP is all final goods and services valued at market prices and produced within domestic borders of a country in a given period.
A country produces many different products and services.
According to a source, as of 2016, Amazon alone carried 12 million products alone excluding books, media, beverages and services.
If we included products available from marketplace sellers this figure would jump to 354 million plus products.
The challenge, therefore, is that we should find a way to aggregate these different products and services into a single value.
How? Imagine a very small date farmer, Abdullah, producing two types of dates, Ajwa and Anbara – 1,000 kilograms of Ajwa with market price of 6 SAR per kilogram and 1,500 kilograms of Anbara, with market price of 5 SAR per kilogram in 2022.
We cannot add 1,000 kilograms of Ajwa to 1,500 kilograms of Anbara to conclude that Abdullah produced 2,500 kilograms of dates in 2022.
That would be wrong because Ajwa dates are not the same as Anbara dates; they are essentially two different products!
Instead, we should calculate total SAR values for each type of date produced at their market prices, that is, 6,000 SAR for Ajwa and 7,500 SAR for Anbara, and then add these SAR amounts together to conclude that total SAR value of Abdullah’s production is 13,500 SAR in 2022.
A country produces many different products and services. According to a source, as of 2016, Amazon alone carried 12 million products alone excluding books, media, beverages and services. If we included products available from marketplace sellers this figure would jump to 354 million plus products.
The challenge, therefore, is that we should find a way to aggregate these different products and services into a single value. How? Imagine a very small date farmer, Abdullah, producing two types of dates, Ajwa and Anbara – 1,000 kilograms of Ajwa with market price of 6 SAR per kilogram and 1,500 kilograms of Anbara, with market price of 5 SAR per kilogram in 2022.
We cannot add 1,000 kilograms of Ajwa to 1,500 kilograms of Anbara to conclude that Abdullah produced 2,500 kilograms of dates in 2022. That would be wrong because Ajwa dates are not the same as Anbara dates; they are essentially two different products! Instead, we should calculate total SAR values for each type of date produced at their market prices, that is, 6,000 SAR for Ajwa and 7,500 SAR for Anbara, and then add these SAR amounts together to conclude that total SAR value of Abdullah’s production is 13,500 SAR in 2022.
GDP ideally aims at to be all inclusive. However, there are products that GDP excludes because of challenges associated in measuring them.
items that sold illicitly are not part of the total output because we cannot measure them. Tomatoes grown by Abdullah in a greenhouse in his garden for home consumption and Mohammed’s homemade medicines against common cold are also excluded because it is impossible to measure them.
Mohammed’s stay-at-home wife Reema’s services such as housekeeping and cooking are excluded, again, there comes the issue of impossibility of measuring them. These exclusions might lead a way to an inconsistent result.
Imagine that Reema dies and after her death, Mohammed hires a housekeeper and pays her to do the housekeeping and cooking that Reema was doing before her death. Since now the housekeeper’s services are measurable (after all Mohammed writes a check to the housekeeper or deposit the amount to the bank account of the housekeeper directly) the total output would increase even though the housekeeper’s services are the exact substitute of Reema’s in quantities.
Now we learn what GDP is, we can confidently declare that in 2020, Saudi Arabia’s GDP was 2,638 billion SARs, or USD 700.1 billion, which includes all the date farmers’ dates, date cake bakers’ cakes, all the housekeepers’ services, Lucid Sedan cars, and so on, all produced in 2020 and all as final goods and services within the borders of the country.
It is a common practice to compare one country’s GDP with another country (or with a group of countries) to get a sense of one’s country’s relative aggregate economic position in the sample of countries chosen. We will do such comparisons later. However, for the fun of it, let’s compare GDP of Saudi Arabia with Apple, Inc.’s revenue. After all, Apple’s revenue is a part of GDP of the United States. In 2020, all final goods and services sold by Apple, Inc. was USD 275.5 billion, almost 40% of 2020 GDP of Saudi Arabia.
Three Approaches to GDP: Production, Expenditure, and Income
In the production approach to GDP is To understand these three approaches let’s assume that the economy consists of only a single date farm producing only Anbara dates. Our farmer is, again, Abdullah. He produces 1,500 kilograms of Anbara dates and sells them at a fruit stand in front of his farm. That’s it – this country’s GDP is SAR value of 1,500 kilograms of Anbara dates, which at 5 SAR per kilogram, 7,500 SAR.
In the expenditure approach to GDP, we focus on the sales at the fruit stand. Consumers in every day of the year come and buy Anbara dates from Abdullah. Also, bakers want some of Anbara dates produced by Abdullah. So does the government. Some foreigners would like to purchase Abdullah’s Anbara dates. Even Abdullah might want to keep some of Anbara dates as inventories. The total purchases by consumers, bakers, government, and foreigners represents the expenditure approach. If all 1,500 kilograms of Anbara dates purchased by these different groups through Abdullah’s stand, GDP measured with the production approach and with the expenditure approach will be the same, 1,500 kilograms of Anbara dates, or 7,500 SAR.
Goods might be durable goods such as Lucid Sedan automobiles. Goods might be nondurable goods such as Anbara dates. Services are intangible such as Mohammed’s housekeeper’s housework and cooking activities or services of the car dealer Abdullah benefited in purchasing the secondhand Lucid Sedan.
is the spending on the goods that would be used in the future to produce more goods and services. In finance, such spending is called capital expenditure – spending on equipment, inventories, structures and so on.
Inventory part of investment is a little bit tricky. For example, if Abdullah keeps some of Anbara dates unsold in his inventory, we assume that Abdullah has purchased these unsold Anbara dates to sell them in the future.
Most of the companies depending on their business dynamics hold optimal inventory, i.e., desired inventory.
However, depending on the general economic conditions, during the periods of economic slowdown the actual inventory level might exceed the desired level, whereas during the periods of economic boom, the actual inventory level might be less than the desirable inventory level.
If for example, Abdullah’s based on his business judgement sets his optimal (desired) inventory level to be 500 kg Anbara dates each year.
If the economy experiences boom, Abdullah might observe that his actual inventory of Anbara dates is 250 kg, less than the desired level.
If, on the other hand, the economy is slowing down, Abdullah might observe that his actual inventory level of Anbara dates is 500 kg, more than the desired level.
One final note! Investment component of GDP has nothing to do with purchasing financial assets such as stocks, bonds, CDs, commercial papers and so on.
refer to purchases of goods and services by a government. Salaries of public servants as well as spending on public works such as roads and hospitals are included by the government purchases component of GDP.
However, we should be careful about what counts as government purchases.
Imagine that our date cake baker Mohammed’s father, Azam, is a retiree from a government job.
The retirement benefits (pension payments) Azam gets each month from the government are not counted in government purchases
because for these payments the government does not receive goods and services in exchange from Azam.
And finally, we have net exports (NX) as the last component of GDP within the framework of the expenditure approach to GDP.
Net exports equal the foreigners’ purchases of domestically goods, i.e., exports minus the domestic purchases of foreign goods, i.e., imports. This subtraction is needed because the other components of GDP, namely, consumption, investment, and government purchases include goods that are imported.
If we did not perform this subtraction our GDP would include goods outside the domestic borders of the economy, which would be wrong! The very definition of GDP tells us that we only count goods produced with the domestic borders of the economy in GDP.
The income approach to GDP looks at how this 7,500 SAR is distributed to the factors of date production.
Abdullah pays to the date pickers 3,500 SAR as wages, to the owner of the land of his farm, 1,500 SAR as rent, and takes 2,500 SAR as his profit. Once again, wage plus rent plus profit add up to $7,500 SAR.
The income approach to GDP focuses on how the GDP of particular year is distributed to factors of production, namely, employees (wage earners and salaried employees), physical capital (profit), and land (rent). However,
in real life there is a much more detailed list of factors of production. It is nearly impossible to know the payments that go to components of the detailed list.
Many official statistical agencies, aggregates the factors of production in two broad categories, employees, and employers. Payments to employees, or factor cost associated with employees is called compensation of employees.
Factor costs associated with employers is called gross operating surplus, fancy way of saying “gross profit”. And since it is gross, gross operating surplus includes interest charges by creditors, rent charges by landowners and charges by other asset holders, such as consumption of fixed capital and other rental charges.
Since, gross operating surplus also includes consumption of fixed capital, which is the “wear and tear” in physical capital used in production, or if you are familiar with finance, or accounting, consumption of fixed capital is also called depreciation.
Thus, official statistical agencies provides consumption of fixed capital as a separate item in a way that calculation of GDP becomes: GDP = Compensation of Employees + Gross Operating Surplus + Indirect Taxes less Subsidies.
In the United States of America, on the other hand, this formula of GDP is constructed a little differently, GDP = Compensation of Employees + Net Operating Surplus + Consumption of Fixed Capital + Indirect Taxes less Subsidies.
“Indirect takes less subsidies” category of General Authority for Statistics of Saudi Arabia and the United States includes sales and property taxes paid by businesses. In sum, one of the fundamental theorems of national income accounting tells us that production equals expenditure equals income!
Qatar
Saudi Arabia
United Arab Emirates
