What must be done to net domestic product at factor cost in order ...

[iveyjurea]

What must be done to net domestic product at factor cost in order to transform it to gross domestic product? Explain why these adjustments are necessary.
 
  What will be an ideal response?

Question 2

Which of the following is NOT an assumption of perfectly competitive markets?
 
  A) many buyers and many sellers
  B) no restriction on entry
  C) complete information about prices
  D) new entrants have higher costs

[BUTTHOL369]

Answer to Question 1

Several adjustments must be made to net domestic product at factor cost in order to set it equal to GDP. First, indirect taxes must be added and subsidies must be subtracted. These changes are necessary because GDP is measured using market prices whereas net domestic product at factor cost measures what the goods and services cost to produce. The price can be different than the cost when there are taxes and subsidies present. Thus taxes must be added to the cost and subsidies subtracted in order to determine the price that was actually paid. (For instance, a DVD might cost 20 but a 1 sales tax makes the price 21.) Then, the second adjustment is that depreciation also needs to be added. Depreciation is the wear and tear on capital when it is used and when it becomes obsolete. GDP includes expenditure on investment and some investment is used to replace the capital stock that has depreciated. So, when calculating GDP using the income approach, depreciation must be included. But depreciation is not included in net domestic product at factor cost because that amount includes only payments made (as income) to the inputs that helped produce the products and no payment is made for the depreciation of capital. So the addition of depreciation (as well as the adjustments for taxes and subsidies) is necessary in order to convert net domestic product at factor cost into GDP.

Answer to Question 2

D