Macro-Economic Analysis

Measuring the Level of Economic Activity

Gross National Product (GNP) and the Gross Domestic Product (GDP) are the two most widely used aggregates of the level of macroeconomic activity.

• Gross National Product (GNP): The GNP is the value of all goods and services produced by the resources owned by the nation. Though GNP does not differentiate between resources owned by the citizens of the country within the country and abroad, it does not include the value of goods and services produced totally by resources owned by foreigners.
• Gross Domestic Product (GDP): The gross domestic product measures the value of the products produced within the country irrespective of the ownership of resources used in the production. A high degree of correlation is generally observed between the GNP and the GDP though their definitions imply that GNP is more related to the nation's income than the GDP. While GNP is more useful in predicting sales of consumption goods, GDP is more related to the nation's production and hence useful in predicting the sales of intermediate products.

GNP and GDP are both used to estimate the level of economic activities and the future sales of consumption goods and services. Apart from these, these are three types of economic indicators: leading indicators, coincidental indicators, and lagging indicators.

• Leading indicators: These indicators are highly sensitive to the changes in the economic environment and foretell the changes in economic activity i.e., they rise or fall ahead of similar changes in the economic activity. These indicators are used for projecting the future trends in economic activity.
• Coincidental indicators: These changes move in tandem with the level of economic changes and are therefore, used to assess the current state of the economy.
• Lagging indicators: These indicators move after the change in economic activity has occurred. They are useful in assessing and comparing the various economic statistics and the actual level of economic activity.

For valuation based on discounting future cash flows, the leading economic indicators are the most relevant of all the three types of indicators. Though there are a few prominent indicators, which would help in predicting the future trends of the economy, each one of them may have some erratic behavior too. An aggregate of a few of these indicators would serve as a better indicative measure.

Leading Indicators

• New orders of manufacturers (consumer goods and materials industries).
• Supply of money.
• Contracts and orders for plant and equipment.
• Consumer price index.
• Average weekly initial claims for unemployment insurance.

Coincident Indicators

• Employees on non-agricultural payrolls.
• Industrial production.
• Personal income less transfer payments.