1) Analyze why each of the following items is excluded from GDP: 

(a) profits from the stock and bond market 

   (b) transfer payments (c) sale of used goods 

(d) goods and services produced in the home. Explain why the following items are included in GDP: 

  (a) depreciation

 (b) change in business inventories

  (c) indirect taxes 

 

2) Explain what net exports are and why they are included in the definition of GDP.

Answer:

1)

Gross Domestic Product (GDP) refers to the market value of all the final goods and services produced within the geographical boundaries of a country during a specific year. It does not include transfer payments, profits from stock and bond market, sale of second hand or used goods and goods produced at home.  

a) The transfer payments are excluded from the calculation of GDP as they are not made in return of any goods and services produced. They are allocated by government for social welfare.  

b) The profits from stocks and bonds are not included because they are not related to production activities of the economy.  

c) The sale of used goods is not included as their value was already added in the GDP in the year in which they were produced. The commission earned by the dealer who sells used goods is however included in GDP as it is a part of production.  

d) The goods produced at home are not included because they do not have any monetary value. They are produced and consumed at home without being sold at the market. They have no market price.  

However, the depreciation on assets, change in business inventories and indirect taxes are included in GDP.  

a) Depreciation represents the capital required to replace existing machines and equipment. It shows income from the replacement of those assets. So, it is included in GDP.  

b) Inventory shows the produced goods which are not sold in the market. When the business inventory changes, it shows the goods produced but not sold in the current year. It accounts for the production done in the same year. So, it is added in GDP.  

c) Indirect taxes are included in GDP as they are government's income.  

2) Net exports refer to the difference between exports and imports.  

Net exports = Exports - Imports 

Exports represents production of final goods and services that is consumed out of the country and are consumed by other nations. The production for the consumption of other countries is done domestically. So, it adds to the GDP. On the other hand, imports represent the consumption of goods and services produced in other countries. The imported goods are produced in other countries, so are accounted for in those countries' GDP and are subtracted from domestic GDP. They together form net exports as represented in the formula given above. So, their difference is added to GDP.