MarginofSafety

When considering the effect of depreciation on the measurement of a country’s economic activity, most economists believe it:

A) must be included in the calculation in order to provide the most accurate assessment of the country’s economic position.

B) is difficult to accurately quantify and is generally excluded from the calculation.

C) may or may not be included in the calculation as long the calculation is clearly identified as a “gross” or “net” number.

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Depreciation is an estimate of an asset’s usage based on accounting conventions and not the actual amount consumed. Because it is difficult to reliably calculate, depreciation is generally excluded from productivity measures.

MarginofSafety

Gross Domestic Product (GDP) typically understates a country’s productivity because it does not fully account for:

A) depreciation / depletion of assets.

B) any productive assets physically located in other countries.

C) the country’s shadow economy.

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Transactions that are intentionally hidden from authorities (for whatever reason) cannot be included in a measure of productivity, thus resulting in an understatement of a country’s productivity.

MarginofSafety

Which of the following would NOT be included in the calculation of Gross Domestic Product (GDP) for the United States?

A) Profits of a factory in located in California that is owned by a Japanese corporation.

B) Rental income from apartment buildings located in Texas.

C) Profits from a customer service center located in India that is owned by a U.S. corporation.

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The GDP calculation includes only counts those goods and services produced within the geographic boundaries of the country.

MarginofSafety

James Willingham, CFA, is an equity portfolio manager and partner in a large investment firm in New York. The firm hires a group of new college graduates each year for its internship program, in which the interns rotate through each of the investment departments of the firm for a six week period to gain insight into the different areas of the firm’s operations. The interns attended top universities around the country and have studied the basic theories of finance, but for the most part have no practical experience working with investments.
Willingham, as head of the domestic equity desk, is responsible for the supervision of the interns while they are in his department. Over the past several years, Willingham has noticed that although the interns are selected from a highly qualified pool of candidates, they seem to not have a firm working knowledge of some of the basic economic principles necessary to successfully manage an investment portfolio. Willingham has written a sample case study for the interns to analyze to strengthen their skills when assessing equities for investment. He feels that it will provide knowledge that will be useful as they rotate through each of the departments of the firm.
The case study begins with a review of the most common measures of economic activity: gross domestic product (GDP), gross national income (GNI) and net national income (NNI). Willingham believes it is very important to understand the differences in the composition of the three measures in order to meaningfully compare and contrast the reported results among different countries. He formulates sample data for a country in order for each of the interns to practice calculating the different measures of a country’s productivity.

Sample Data (year ending 12/31/05)

NNI	$45,000,000
Net property income from abroad	$7,250,000
Deprecation	$3,875,000
Indirect taxes	$2,465,000
Subsidies	$2,935,000

Willingham also expects the interns to have a full working knowledge of the three components of GDP: output, expenditure, and income. He believes that knowing the interrelationship of these three measures, how they are derived, and how they should be interpreted is crucial for assessment of a country’s economy as well as the effect it can have on an individual stock.Among the three most widely used measures of economic activity:

A) GDP understates economic activity to the greatest degree because the production of the underground economy is not included in the measure.

B) GNI is theoretically the most accurate, although not widely used because of the difficulty in quantifying the economic cost of depreciation.

C) GDP only counts production from within a country’s geographic boundaries, while GNI includes productivity of a country’s citizens regardless of where assets are located.

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There is typically very little difference between GDP and GNI, in spite of the fact that they are two distinct measures of a country’s productivity. (Study Session 4, LOS 19.a)

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Calculate the GDP based upon the information given above:

A) $48,375,000.

B) $37,750,000.

C) $41,625,000.

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Working backwards: NNI + depreciation − net property income from abroad = GDP
$45,000,000 + $3,875,000 − $7,250,000 = $41,625,000. (Study Session 4, LOS 19.a)

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Utilizing the information given above, which of the following measures of productivity should produce the highest number, all other things being equal?

A) GDP at market prices.

B) GDP at factor cost.

C) GNI.

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This can be solved intuitively and without calculations. GNI equals GDP plus net property income from abroad, so assuming a positive income number, GNI will be higher than GDP at either factor cost or market prices. NNI is simply GNI minus depreciation, so GNI will be higher than NNI. (Study Session 4, LOS 19.a)

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Assume that a United States-owned company operates a production facility in India, and produces $25,000,000 of goods per year at that location. Which of the following statements regarding the production of the facility is most accurate?

A) The production of the facility in India would not be included in the GDP measure for India.

B) The production of the facility in India would not be included in the GDP measure for the United States.

C) The production of the facility in India would not be included in the GNI measure for the United States.

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GDP only counts the goods and services produced within the geographic boundaries of a country. (Study Session 4, LOS 19.a)

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In order to convert GDP at factor cost to GDP at market prices, which of the following adjustments should be made to GDP at factor cost?

Indirect Taxes

Subsidies

A) Add Subtract

B) Subtract Subtract

C) Subtract Add

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GDP at factor cost is the net of taxes and subsidies, so an adjustment must be made for consistent comparison. Beginning with GDP at factor cost, add back indirect taxes and subtract subsidies to arrive at GDP at market prices. (Study Session 4, LOS 19.b)

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Which of the following statements regarding the measurement of the productivity of a country is most accurate?

A) Income is presented as an index, with a base year’s income set equal to 100, and subsequent years expressed as a percentage of the base year.

B) Output is considered to be the most reliable of the three measures, while expenditure is considered to be the least reliable.

C) The most comprehensive measure of a country’s expenditure component is derived by adding all consumption, investment, and export of goods and services.

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Total Final Expenditure (TFE) is used as a proxy for the expenditure component, and is the sum of consumption, investment, and export of goods and services. (Study Session 4, LOS 19.a)

MarginofSafety

Gross Domestic Product (GDP), a measure of a country’s output, is best defined as the:

A) total goods and services produced by a country’s citizens in one year, adjusted for the shadow economy.

B) total market value of all final goods and services produced in a country in one year.

C) total goods and services produced by a country’s citizens in one year.

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GDP is the sum of all economic value produced in one year in a country, regardless of who owns the assets. It does not account for depreciation or the productivity of the country’s shadow economy.