Economics is a branch of social science focused on the production, distribution, and consumption of goods and services. Analysts estimate that underground economic transactions account for one-third of the total economy in developing countries and slightly more than 10% of the total economy in developed countries. Since all of these steps were used to create something that was sold to the consumer for $3, there would be a lot of double counting if the prices of all of the "intermediate goods" were added into GDP. U.S. Bureau of Economic Analysis: Gross Domestic Product, First Quarter 2011. Due to its cloaked nature, it's difficult to gauge the true extent of the money that changes hands through the underground economy (sometimes referred to as the shadow economy). Capital investments include both fixed assets, such as land, structures or machinery, and technological investments, such as computers and software. And then there's the tough love approach, where the installation of increased tax evasion penalties can discourage underreporting. A drop in government spending will have a negative impact on the country’s overall GDP. She teaches economics at Harvard and serves as a subject-matter expert for media outlets including Reuters, BBC, and Slate. The two primary methods for calculating GDP are the income approach, or the sum of what everyone earned, and the expenditure approach, or the sum of what everyone spent. Similarly, the buyer of the loaf of bread spent $3, which counts in the expenditure column. In addition, goods and services transacted in illegal or otherwise illegitimate markets don't count in GDP. Furthermore, GDP can be adjusted for inflation, called real GDP, or unadjusted, called nominal GDP. The most widely used definition is the sum of consumer spending, government spending, capital investments and net exports. Government purchasesare eq… Finally, governments can stimulate the creation of higher-paying legal jobs, which would theoretically shrink the underground economy. Likewise, if consumers buy fewer homes, then that will have a negative effect on GDP. But because these transactions go unreported, they distort the accuracy of key economic measurements, such as the gross domestic product (GDP), which is calculated by totaling the following four components: Notice how the aforementioned metrics fail to take consider any transactions that occur within the underground economic system. Wealth and assets, for example, also have a significant effect on the standard of living, since people not only buy new goods and services but also get enjoyment from using the goods that they already own. This is significant because a nation's less-than-accurate GDP figure can adversely affect government policies that are influenced by GDP numbers. Reductions in personal income tax rates can encourage individuals to report income more accurately and completely. However, goods and services purchased within the country that have been produced elsewhere, known as imports, do not count. This makes sense in a lot of ways, mainly because an economy's output in a given period of time is equal to the economy's income, and the economy's level of income is one of the main determinants of its standard of living and societal welfare. In the simplified bread example above, the wheat grower would add 10 cents to GDP, the baker would add the difference between the 10 cents of the value of his input and the $1.50 value of his output, and the retailer would add the difference between the $1.50 wholesale price and the $3 price to the end consumer. Thirdly, a government may legalize certain underground economic activities, such as gambling and prostitution, as a way to legitimately tax the associated income, and increase revenue. Fortunately, there are a number of steps governments can take reduce the effect that underground economic activity has on skewing GDP numbers.

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