Download GDP and The Measurement of Progress

GDP and The Measurement of
Progress
What is GDP
Gross Domestic Product (GDP) is the market value of all
final goods and services produced within a country in a
year.
GDP per capita GDP divided by population
Gross National Product is the market value of all final goods
and services produced by a country’s permanent residents,
wherever they may be located, in a year.
Breaking it down
1. Market value – goods are measured in terms of their market prices. A car ($30,000) adds more than a pen ($1).
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2. Final goods – only final goods and services are counted.
These goods are sold to final users and then consumed or
held in personal inventories. Intermediate goods are goods
that are bundled or processed with other goods and services. These are not counted in GDP until they are sold in
the fully assembled good or service.
A microprocessor sold by Intel to HP for inclusion in a
desktop computer doesn’t count. It gets counted in the
price of the computer when it is sold to a person or business.
A John Deere tractor sold that is used to harvest soy beans
does count though. The tractor is a finished good and not
really considered part of a soybean. Machinery and equipment sold to businesses is considered part of final output
and is included in GDP.
3. Goods and services – haircuts and carwashes (services)
count just like new computers or new textbooks.
4. Produced – new stuff or services count, but not used goods
that have already been produced in an earlier period.
5. Within a country – for US GDP the good has to be
produced within the geographic area of the U.S. Buying
a Ford produced in Mexico does not count (at least the
part produced in Mexico). Buying a Toyota produced in
Ohio does count (at least the part that was produced in
the USA).
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6. in a given period of time – that usually means within a
year or quarter.
• Tell us how much is produced in a year, not the sum total
of our wealth
• Wealth would be the value of a nation’s entire stock of
assets, which accumulate and depreciate over time.
• Compiled quarterly by the Bureau of Economic Analysis
(BEA) which is part of the U.S. Department of Commerce
in Washington, D.C.
Growth rates
This tells us how rapidly output is growing or falling over time.
GDPt − GDPt−1
× 100 = GDP growth rate for year t
GDPt−1
Example: GDP for the 3rd quarter of 2013 was $15,681.0 billion.
For the 2nd quarter it was $15,583.9. Second quarter growth is
estimated to be:
15681.0 − 15583.9
× 100 = 0.62 per quarter
15583.9
To make this comparable to yearly growth, multiply by 4. 4
quarters × 0.62/quarter = 2.49
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This is often approximated using a slightly different calculation that works well when growth rates are relatively low. Continuously Compounded Annual Rate of Change
[ln(GDPt ) − ln(GDPt−1 )] × 100) × number of obs per yr =
The function ln is the natural logarithm. In terms of our example that would be
[ln($15, 681.0) − ln($15, 583.9)] × 100 × 4 = 2.485
This is probably the most widely used way of calculating growth
rates based on time series data, though there are others. Just
be aware that growth rates that you calculate may not match
exactly those computed by others since there are small variations
in the formulae.
Nominal vs Real GDP
Economists usually are more interested in increases in production than increases in prices because only increases in production
are true increases in the standard of living. To measure increases
in production, we look at growth rates of real GDP.
Nominal GDP is calculated based on prices at the time of
sale.
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Real Variables variables such as real GDP that have been adjusted for changes in prices by using the same set of prices
in all time periods. A real variable is one that corrects for
inflation, namely a general increase in prices over time.
Real GDP is the market value of all final goods and services
produced within a country in a year that has been adjusted
for changes in prices, that is for any inflation that may have
occurred.
Price Index A measure of the overall level of prices in the economy.
GDP Deflator a price index used to compute inflation. It is
found by dividing nominal GDP by the real GDP in any
given year.
Nominal GDP
× 100
(1)
GDP Deflator =
Real GDP
Measuring Real GDP–at least in principle
To measure real GDP in any given year you first select a base
year that establishes the prices you will be using. Then, you
evaluate the goods and services produced in the year using the
prices from the base year. It doesn’t matter much what prices
we use to calculate real GDP, so long as we use the same prices
in all years.
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Figure 1: Example from Cowen
For example, lets calculate the GDP Deflator for 2010. We
can easily find 2010 nominal GDP and 2010 real GDP (using
2005 dollars) from the U.S. Bureau of Economic Analysis. Here
are the numbers:
Real GDP Growth
If pressed to choose a single indicator of current economic performance, most economists would probably choose real GDP
growth. Figure 2 shows the annual percentage changes in real
GDP for the United States from 1948 to 2009. U.S. real GDP
growth was high during the 1960s, but rising inflation and the
1973 and 1979 oil price shocks lowered growth in the 1970s
and early 1980s. The farther apart the time periods are that
you want to compare, the less precise these comparisons be6
Figure 2: Real GDP growth for the USA, 1948-2009
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come. The main reason has to do with the introduction of new
goods (computers) that don’t exist in periods long past. Quality
changes have to be accounted for as well. There are some tricks
that can be used to account for these changes, but clearly there
is room for errors to creep in and compound over time.
Per capita growth
If the population is growing rapidly, a county may experience
GDP growth, but citizens may become worse off. Growth in real
GDP per capita is usually the best reflection of changing living
standards.
Cyclical changes in GDP
Fluctuations in real GDP around its average long-term trend
are referred to as the business cycle.
Potential GDP This is a measure of what the economy is capable of producing at normal levels of employment and productivity. Essentially, this is used as the benchmark for the
long-run trend for GDP.
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Recession significant, widespread declines in real income and
employment.
Boom significant economic growth above the long-term trend.
NBER National Bureau of Economic Research–a research organization based in Cambridge, Massachusetts, is considered
the most authoritative source on identifying U.S. recessions.
The official NBER definition of a recession is as follows:
A recession is a significant decline in economic activity spread across the economy, lasting more than
a few months, normally visible in real GDP, real
income, employment, industrial production, and
wholesale-retail sales.
Notice that the blue line is moving downward during each
recession, which means output is falling.
Ways of measuring GDP
1. National Spending Approach
Y = C + I + G + NX
2. Factor Income Approach
Y = Wages + Rent + Interest + Profit
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Figure 3: Real GDP for USA, 1965-2013. Recessions are indicated by the
grey bars. There have been 7 recessions since 1965, the last one being the
most severe.
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Figure 4: Real GDP growth for USA, 1965-2013. Recessions are indicated
by the grey bars. There have been 7 recessions since 1965, the last one being
the most severe. Average growth over the period is about 4%.
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Spending Approach
The national spending identity: Y = C + I + G + NX where:
Y = Nominal GDP (the market value all final goods and services)
C = The market value of consumption goods and services
I = The market value of investment goods, also called capital
goods
G = The market value of government purchases
NX = Net exports, defined as the market value of exports minus the market value of imports
We explain each of these factors more in turn.
Consumption
Consumer spending on final goods and services.
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Investment
Investment is private spending on tools, plant, and equipment
that are used to produce future output. It also included spending on new houses.
Government Purchases
Spending by all levels of government on final goods and services.
G does not include transfer payments, which are a large
part of what government does: transfer money from one citizen
to another citizen. About 21% of the spending of the federal
government, for example, is for Social Security payments. Unemployment and disability insurance, various welfare programs,
and Medicare are also large transfer programs.
Net Exports
exports minus imports. Importing reduces GDP. The good is
purchased in the U.S. but is produced elsewhere; we only measure purchased goods produced here. Exporting increases our
GDP. If a good is produced in the U.S. and purchased abroad,
then it should count towards our output.
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Figure 5: U.S. GDP by components in 2007
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Factor Income Approach
When a consumer spends money, the money is received by workers (employee compensation = wages + benefits), landlords (rent),
owners of capital (interest), and businesses (profit). Thus, we
have yet another way of calculating GDP: We can add up all the
spending or we can add up all the receiving. The first method
is called the spending approach, while the second is called the
factor income approach.
The factor income approach:
Y = Wages + Rent + Interest + Profit
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Shortcomings of GDP as measure of output
and well-being
GDP measures the market value of final goods and services. But
there are many goods and services for which we do not know the
market value. So, what are its shortcomings in measuring overall
economic well-being of a country?
1. Does not count the underground economy. Only counts
things traded though regular channels in markets.
2. It does not count production of things that have no price.
Mow your own yard? It doesn’t count unless you hire someone to do it for you. In either case production occurs, but
it only gets counted if you pay someone else to do it for
you.
3. Leisure does not count. Leisure is good. More is better.
But since no one pays you to enjoy it, it does not count
toward a nation’s GDP.
4. GDP doesn’t count bad stuff. Pollution, for example, is a
bad that is produced every year, but this bad is not counted
in the GDP statistics. “GDP statistics also do not count the
destruction of water aquifers, the accumulation of carbon
dioxide in the atmosphere, or changing supplies of natural
resources. Similarly, GDP statistics do not count the loss
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of animal or plant species as economic costs, unless those
animals and plants had a direct commercial role in the economy. Other bads are also not counted in GDP. The bad of
crime, for example, is not counted in the GDP statistics.”
(Cowen and Tabarrok, 2011, p. 108)
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Bibliography
Cowen, Tyler and Alex Tabarrok (2011), Modern Principles of
Economics, 2nd edn, Worth, New York.
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