TRADE AND GDP

NILKANTH ATHALYE
ECO: 2
Twin Themes of Economics
1. Scarcity of resources ( factors of production )
2. Efficiency ( cost , value and distribution )
The Three Problems
1. What should be produced ?
2. How should it be produced ?
3. For whom should it be produced ?
A parable for the Modern Economy
• One does not have to produce each and every
good and /or service that he would like to
consume.
• People depend on each other for goods and
services.
• This interdependence improves the lives of all
the involved people.
• Each one benefits by specializing in what he or
she does best and then trade with the others.
Absolute and Comparative Advantage
• A producer that requires a smaller quantity if inputs
to produce a good is said to have an absolute
advantage in producing that good / service.
• Economists use the term comparative advantage
when describing the opportunity cost of two
producers. The producer who gives up less of other
goods to produce Good X has the smaller
opportunity cost of producing Good X and is said to
have a comparative advantage in producing it.
Comparative advantage and trade
1. The gains from specialization and trade are not on
absolute advantage but on comparative advantage.
2. When each person specializes in producing the
good for which he or she has a comparative
advantage, total production in the economy rises.
3. This increase in the size of the economic pie can
be used to make everyone better off.
4. By trading, each one gets a good price that is lower
than the opportunity cost to be paid for that good.
GDP : GROSS DOMESTIC PRODUCT
• GDP is the market value of all final goods and
services produced within a country in a given
period of time.
• GDP excludes most items produced and sold
illicitly, such as illegal drugs.
• GDP also excludes most items that are
produced and consumed at home, and
therefore never enter the marketplace. Thus
vegetables you buy at the store are a part of the
GDP, but which you grow in your kitchen garden are
not.
Composition of GDP and the
identities
• The Identity – an equation that is always true
– of the GDP is as under :
• Y = C + I + G + NX , where
• Y = GDP
• C = Domestic Consumption
• I = Investments ( Domestic Savings )
• G = Government Purchases ( Spending )
• NX = Net Exports ( Exports - Imports )
Savings and Investments
1. Y = C + I + G + NX , in an Open Economy
2. Y = C + I + G , in a Closed Economy
3. Thus, I = Y – C – G
4. But ( Y – C – G ) is the Total Income after paying
for consumption and government purchases i.e.
Saving ( S )
5. Hence, Saving always equals Investment ( S = I )
6. S=Y–C–G
7. S = ( Y – T – C ) + ( T – G ) , where ( T ) are Taxes.
8. National Saving = Private Saving + Public Saving.
Real and Nominal GDP
• Nominal GDP uses current prices to place a
value on the economy’s production of goods and
services.
• Real GDP uses constant prices belonging
to the base year to place a value on the
economy’s production of goods and services.
• GDP Deflator = (Nominal GDP / Real
GDP ) x 100
Other measures of National Income
1. GNP = Gross National Product
2. NDP = Net Domestic Product
3. NNP = Net National Product
Business Cycles
• No economy grows in a smooth and even
pattern.
• Business cycles are fluctuations in total national
output, income and employment usually lasting
for a period of 2 to 10 years, marked by wide
spread and simultaneous expansion or
contraction in many sectors of the economy.
• The cycle tends to repeat over time, more or less
with the same time frame / pattern , but also can
be irregular in many cases.
Seasons of the Business Cycle
1. Peak ( contraction )
2. Recession ( downturn )
3. Depression ( extreme low )
4. Trough ( bottoming out )
5. Recovery ( upturn )
6. Boom ( extreme high )
7. Peak
Recession

• A recession is a recurring period of decline in

total output, income and employment, usually
lasting from 6 to 12 months and marked by
contraction in many sectors of the economy.
• A recession that is large in both scale and
duration is called a depression.
Aggregate Demand
• Aggregate Demand is the total quantity of
output that is willingly bought at a given level
of prices, other things held constant. It is the
desired spending in the following four product
sectors:
1. Consumption
2. Domestic private investment
3. Government spending on goods and services
4. Net exports.
The Multiplier
• The multiplier is the impact of a unit change in
exogenous expenditures on the total output.
• Simply stated, the multiplier is the ratio of the
change in the total out put to the change in the
investment.