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Measuring Economic Performance Readings • Lequiller François and Derek Blades, 2006, Under standing NATIONAL ACCOUNTS, Organization for Economic Cooperation and Development, Chapter 1 and 2. Link • Bureau of Economic Analysis “Introduction to the National Income and Product Accounts” Link Economic Growth • Rate of Increase of Production. • If Qt is a measure of production, the simple net growth rate is qt qt 1 q gt qt 1 qt • Implying 1 g qt 1 q t What is Economic Growth in a world of many goods? • We need to combine the many goods produced or consumed in an economy into one measure. + + + + =? (Simple) Average Growth • If there are K goods then we could calculate the average growth rate of each type of good. g q AVERAGE g g g ... g K q1 q2 q3 qK • Problem: Taking the simple average of the growth of different types of goods may give a distorted picture of average growth, since different goods are of different importance in the economy. Weighted Average Growth • Instead we could construct a weighted average g qWGTD _ AVGE w g w g w g ... w g 1 q1 2 q2 3 q3 K qK where the weights add to 1. w w w ... w 1 1 2 3 K • An even weight is wk =1/K but we could adjust the weights to be indicate the importance of each good in the economy. g qWGTD _ AVGE K w g k k 1 qk K w k 1 k 1 Measuring the Economy • National accounts are the core statistical measure of the economy. • Accounts cover many features of the economy but organizing concept is Gross Domestic Product (GDP) All goods sold in an economy share a common unit of measure: the price at which they are sold. Sum up the value of goods Gross Domestic Product (GDP) • “GDP combines in a single figure, and with no double counting, all the output (or production) carried out by all the firms, non-profit institutions, government bodies and households in a given country during a given period, regardless of the type of goods and services produced, provided that the production takes place within the country’s economic territory.” L & B p. 15 GDP is a measure of production • Value added at production establishment i Value Addedi =Sales + inventories -raw materials, semi-processed inputs and energy costs. • GDP is the sum of VA across establishments. GDP iValue Addedi Economic Concept • Value Added is production at firm level due to the combination of capital equipment and workers. • Value added is not equal to profits because the costs of worker and capital are not deducted. Link • Accounts are created by national statistical agencies • UN System of National Accounts is the “internationally agreed standard set of recommendations” used by most countries. • Annual data for many countries available at Link the UN Production Approach Sub-aggregates • Divide production establishments into sectors usually along the line of – Primary: Natural Resources (Agriculture, Forestry, Fishing, Mining, Quarrying) – Secondary: Goods production (Manufacturing, Construction, Utilities) – Tertiary: Intangibles Production by Sector Hong Kong Census and Statistics Other Activities (ISIC J-P) Transport, storage and communication (ISIC I) Wholesale, retail trade, restaurants and hotels (ISIC G-H) Construction (ISIC F) Added Manufacturing (ISIC D) Value Mining & Utilities Kong: Agriculture, hunting, forestry, fishing (ISIC A-B) Hong 60 50 40 30 20 10 0 2010 1970 Table 035 (GDP) by Economic Activity at Current Price HK$ Mn Economic Activity 2009 r Agriculture, fishing, mining and quarrying 1,090 Manufacturing 28,227 Electricity, gas and water supply, and waste management 34,961 Construction 50,146 Services 1,436,427 Import/export, wholesale and retail trades Import and export trade 365,880 305,458 Accommodation and food services 48,787 Transportation, storage, postal and courier services 99,048 Transportation and storage Postal and courier services Information and communications 93,936 5,112 46,808 Financing and insurance 235,581 Real estate, professional and business services 173,583 Real estate Professional and business services 86,833 86,749 Public administration, social and personal services 279,453 Ownership of premises 187,286 GDP at basic prices Taxes on products GDP at current market prices 1,550,851 55,967 1,622,322 Demand • • If we add up the value added at all stages of production we derive the value to the end user. Sum of Final Demand Aggregates equals Sum of Value Added Expenditure Approach • Purchase of Final goods by end users are divided into two categories: 1. Consumption: Household expenditure (durables, nondurables & services); government (nondurables & services) expenditure; nonprofit expenditures 2. Investment: Inventories, Fixed Investment (equipment, structures) Some Asian Expenditure Shares: 2010 People’s Republic of China 1 90 0.9 80 0.8 70 0.7 60 0.6 50 0.5 40 0.4 30 0.3 20 0.2 10 0.1 0 1 0 2 Japan 3 4 5 Republic of Korea 6 7 8 9 -10 Household consumption expenditure General government final consumption expenditure Gross fixed capital formation Changes in inventories Source: United Nations Main Aggregates Database 10 Reconciliation • Some demand for domestically produced value added comes from abroad, some domestic demand is satisfied by overseas goods. GDP = Consumption + Investment + Exports – Imports Exports – Imports = External Balance = Trade Balance = Net Exports <> 0 Value Added and Income • Production establishments are where income is generated. Funds raised can be paid for labor and finance costs, left over money is profit income. • Sum of domestic value added (GDP) is equal to wage payments plus financial and profit income referred to as “operating surplus and mixed income.” GDP Equivalence http://stats.oecd.org/Index.aspx Dataset: 1. Gross domestic product Country Korea Measure Tril. Won Gross Domestic Product B1_GA: Gross domestic product (output) B1G: Gross value added at basic prices D21_D31: Taxes less subsidies on products DB1_GA: Statistical discrepancy B1_GE: Gross domestic product (expenditure) P3_P5: Domestic demand B11: External balance of goods and services DB1_GE: Statistical discrepancy B1_GI: Gross domestic product (income) D1: Compensation of employees B2G_B3G: Gross operating surplus & mixed income D2_D3: Taxes less subsidies on production and imports DB1_GI: Statistical discrepancy 2009 1,065 959 106 .. 1,065 1,026 39 -1 1,065 494 453 119 0 Table 1.10. Gross Domestic Income by Type of Income [Billions of dollars] Line 2 3 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 1 26 Compensation of employees, paid Wage and salary accruals Supplements to wages and salaries Taxes on production and imports Less: Subsidies /1/ Net operating surplus Private enterprises Net interest and miscellaneous payments, domestic Business current transfer payments (net) Proprietors' income with IVA and CCA Rental income of persons with CCA Corporate profits with IVA and CCA, domestic Taxes on corporate income Profits after tax with IVA and CCA Net dividends Undistributed corporate profits withwith IVA and CCA Current surplus of government enterprises /1/ Consumption of fixed capital Private Government Gross domestic income Addendum: Statistical discrepancy CCA: Capital Consumption Adjustment 2010 7980.6 6417.5 1563.1 1054 57.3 3673.5 3689.2 747.6 136.7 1036.4 350.2 1418.2 411.1 1007.1 615.3 391.8 -15.7 1874.9 1540.9 334 14525.7 0.8 • Using GDP to Measure Economic Performance • Measuring stick of value is prices of goods in terms of money, but arbitrary changes in the stock of money arbitrarily change prices/the measure of value over time. • Comparing value across time requires abstracting from those arbitrary changes in value. Value vs. Volume • Consider the sales of a hypothetical single good k (for example, k = apples). • Dollar Value of sales (called vk) is the product of the volume of goods sold (called qk) measured in the goods natural units (i.e. bushels of apples) and the dollar price per good (called pk) vk = pk*qk • Growth of value can be decomposed into growth of volume and growth in prices. (1 g ) (1 g )(1 g ) vk pk qk Aggregate Growth • Growth of volume measures true/real growth in the production of goods as opposed the change in the arbitrary measure of value. • To measure economy wide growth we could average the growth of production across all the different goods produced. Growth Rates of Products and Ratios Zt X tYt X t Yt Z t X tYt (1 gtX )(1 gtY ) Z t 1 X t 1Yt 1 X t 1 Yt 1 1 gtZ 1 gtX gtY gtY gtX gtZ gtX gtY Xt Zt Xt Zt Yt Yt Z t 1 X t 1 Yt 1 Xt X t 1 Yt Yt 1 (1 gtX ) (1 gtY ) (1 gtX ) (1 gtZ )(1 gtY ) 1 gtZ gtY gtY gtZ gtZ gtX gtY Share of Value • We could measure total value for the economy. • Divide our economy into K categories of goods indexed by k = 1,…, K. • Value of sales of good k, vk. GDP is represented as the sum of value across goods GDPt Vt v v v ... v 1 t 2 t 3 t K t • The weight of k in the economy could be defined as k v k which add up to 1 across sectors. w K V k Vt vt k 1 Aggregate Growth • Macroeconomic aggregates such as GDP and its sub-totals are the sum of values of sales (or purchases) from different firms. Vt vi pi qi i i • We also decompose the growth of the aggregates into growth in prices (inflation) and growth in volume (output). (1 g ) (1 g )(1 g ) V t P t Q t How statistical agencies calculate volume growth. 1. Construct representative market basket of each category of goods, k. For example, if k were apples, the market basket could consist of a certain number of Red apples, Green apples, Fuji apples depending on how many of each of these are purchased. 2. Sample goods of type k at time t and at time t-1 to assess the price level of the market basket at each time period. k k pt , pt 1 Example • If for category k = the typical family purchases 2 bushels of red apples, 1 bushel of green apples and 1.5 bushels of Fuji apples in a given year, the statistical agency could price this market basket t-1 t Price/Bushel: Red Apples Price/Bushel: Green Apples Price/Bushel: Fuji Apples 100 80 140 490 100 90 160 530 p Apples Building Blocks for Volume Growth Value and Inflation Vectors k t 3. For every type of good at time t, measure v and construct an inflation vector representing the growth rate of prices. ptk pk k 1 gt pt 1 4. Convert the dollars spent on good k into their purchasing power measured at time t-1 prices. vtk k p t 1 k pt vtk k t k t 1 p p • Conceptually, if we think of value of good k as the product of price and quantity vk = pk*qk we can think of value divided by the inflation vector as the quantity of goods produced at time t measured at the value in terms of the previous period prices. k t k t k t k t v p q k k k k pt 1 k pt 1 pt 1qt p pt Volume Growth≡ gtQ 5. Sum the inflation adjusted values across the types of goods and divide by value in Q previous period 1 gt vt1 ptk1 2 v 1 t pt pt21 3 v 2 t pt pt31 K .... v 3 t ptK1 pt K t p Vt 1 K 1 gtQ k v t k 1 ptk1 ptk Vt 1 Volume Growth cont. • Conceptually, the numerator of volume growth is the sum of goods produced at time t valued at the price prevailing at time t-1 while the denominator is the sum of goods produced at time t-1 valued at the price prevailing at time t1. The yardstick of value, dollar prices in time t-1 prices, are the same in the numerator and denominator. 1 1 2 2 3 3 K K p q p q p q .... p q t 1 t t 1 t t 1 t t 1 t 1 gtQ Vt 1 pt11qt11 pt21qt21 pt31qt31 .... ptK1qtK1 Volume Growth cont. • Conceptually, we can also think net volume growth as a weighted average of the growth rate of quantities of each type of good. p q p q p q .... p q g 1 K K Vt 1 p q p q p q .... pt 1qt 1 1 1 t 1 t 1 1 t 1 t 1 Q t 2 2 3 3 t 1 t t 1 t 2 2 3 3 t 1 t 1 t 1 t 1 K K t 1 t p q p q p q .... p q Vt 1 Vt 1 Vt 1 1 1 t 1 t 2 2 t 1 t 3 3 t 1 t K K t 1 t p q p q p q .... p q Vt 1 Vt 1 1 1 t 1 t 2 2 t 1 t 3 3 t 1 t K K t 1 t • We can rewrite the numerator as gtQ 1 1 2 2 K K 1 1 2 2 K K p q p q .... p q p q p q .... p q t 1 t t 1 t t 1 t t 1 t 1 t 1 t 1 t 1 t 1 • Collect terms Vt 1 1 1 1 2 2 2 K K K p ( q q ) p ( q q ) .... p ( q q Q t 1 t t 1 t 1 t t 1 t 1 t t 1 ) gt Vt 1 • Rewrite gtQ 1 1 2 2 K K ( q q ) q q q q pt11qt11 t 1 t 1 pt21qt21 ( t 2 t 1 ) .... ptK1qtK1 ( t K t 1 ) qt 1 qt 1 qt 1 Vt 1 • Note that g by Vt-1 . q t k (q q ) and divide through k qt 1 k t k t 1 1 1 2 2 K K 1 2 p q p q p q Q q q qK t 1 t 1 t 1 t 1 t 1 t 1 gt gt gt .... gt Vt 1 Vt 1 Vt 1 • Define as a weight k t 1 w k k t 1 t 1 p q Vt 1 • By construction, the weights add up to one, so volume growth is a weighted average of the growth of production of each type of good g w g w g w g .... w g Q t 1 q1 t 1 t 2 q2 t 1 t 3 q3 t 1 t K qk t 1 t Notes on Price Indices: New Goods • Weights change as production structure of the economy changes k t p k t 1 • Market baskets used to construct p don’t need to stay the same over long-periods. • K categories of goods don’t need to stay the same over long periods. • New goods can be introduced as long as matched goods are compared in every t and t-1 period. Notes on Price Indices: Quality • Some categories of goods (computers, cars) observe marked changes in quality over time. • Price growth rates for these components often reflect the price growth for certain characteristics (e.g. MHz,GB HD, etc.). These are referred to as hedonic price indices. Candyland 2010 2010 2009 vk pk qk vk pk qk KitKat 1200 8 150 810 6 135 M&M 1500 10 150 540 4 135 Inflation vector Volume Growth Weight k ptk ptk1 gtq KitKat 1⅓ 10 M&M 2.5 10 9 .6 9 .4 wtk1 Contribution to Growth • Each sub-component contribution to the growth rate is the product of its importance in expenditure at time t-1 and the size of its own k qk growth rate wt 1 gt • For each component k, this contribution can be calculated as: Cg % w g 100% k t 1 k qk t 1 t ptk1qtk ptk1qtk1 100% Vt 1 vtk ptk1 ptk Vt 1 vtk1 100% Volume Levels • To compare the level of aggregate quantities at different points in time, total up the growth that appears in between periods. Q 1. Calculate the growth rateg t for all periods using the prices from the immediately previous periods to adjust current values. 2. Choose a reference period, ref, preferably in a recent period and set a constant price series equal to value in that period QREF VREF Chained Index 3. Define the constant price series recursively in all periods using the equation Qt (1 g ) Qt 1 Q t The relationship between the levels of the chain volume index at any two points t and t+T is the product of the growth between the two points. Qt T QREF (1 gtQ1 ) (1 gtQ 2 ) (1 gtQ3 ) .... (1 gtQT ) Nondurable Goods 2000 1500 1000 500 Chained Dollars Current Dollars 20 09 20 07 20 05 20 03 20 01 19 99 19 97 0 19 95 Billion US$ 2500 Implicit Price Deflator • An estimate of the price level is the ratio of the value to the quantity in chained dollars. Implicit GDP Pt Vt REF $ REF $ 100 Qt price At current In chained (2009) market prices dollars deflator 2009= Year HK$ million HK$ million 100 2000 1,317,650 1,168,506 112.8 2001 1,299,218 1,174,317 110.6 2002 1,277,314 1,195,936 106.8 2003 1,234,761 1,231,886 100.2 2004 1,291,923 1,336,185 96.7 2005 1,382,590 1,430,815 96.6 2006 1,475,357 1,531,255 96.3 2007 1,615,574 1,629,092 99.2 2008 1,677,011 1,666,664 100.6 2009r 1,622,322 1,622,322 100.0 2010r 1,743,858 1,735,399 100.5 GDP per Capita Singapore Average Growth Rate 2001-2010 7.00% 6.00% 5.00% 4.00% % • Population changes over time • To assess income levels over time, we divide by population Link 3.00% GDP per Capita 2.00% GDPt [Chain] Population 1.00% 0.00% GDP Grow th GDP per Capita Comparing GDP across Countries We want to compare output in two countries though those are measured in different currencies. Exchange Rates • Exchange Rate: S - # of domestic currency units purchased for 1 US$. • An increase in S is a depreciation of domestic currency and a decrease in S is an appreciation. Convert sums into another economy’s currency • Nj is a number measured in country j’s currency (e.g. GDP) that you want to convert it into the reference country’s currency. Link Exchange Rate Conversion Sr N Nj Sj r$ j China (RMB) Hong Kong (HK$) RMB HKG GDP GDP per Capita 12,120.52 210,006.31 S 8.19 7.78 S RMB GDPHKG S HKG HK $210, 006.31 8.19 =RMB221,265.39 7.78 Exchange Rate Method • Exchange Rate Method can be a useful measure if you are going to convert income in one area and spend it in another. – Ex. Your Swiss food company projects that it can at most get a 20% share of the market for Mexican processed foodstuffs. Converting the size of Mexico’s processed food expenditures from Pesos to Swiss Francs is useful info for estimating profits. . • But macro aggregates are often used to give an idea of living standards, here exchange rates are not as useful because they are highly variable and not so representative.. Link GDP per Capita (Current Prices) Exchange Rate Conversion 350000 330000 310000 290000 HK$ 270000 250000 230000 210000 190000 170000 150000 2003 2004 2005 2006 Hong Kong 2007 Singapore 2008 2009 2010 Big Mac Index • Economist magazine reports big differences in the x-rate converted prices of McDonalds in different countries. • Big Mac is a bundle of different goods and services which can be a reasonable sample. Economist Magazine PPP: Purchasing Power Parities • PPP is the relative price of goods in one country measured in its own currency compared to the price of a reference country. • Example: If Big Macs were only good and cost HK$18.90 in HK and US$3.71 in USA, then PPPHK =5.0943HK$/US$ • Problem: Many goods Market Basket Index? • Construct an international market basket of goods produced and purchased around the world. For country j, PPPj could be the relative price of the market basket relative to price of the market basket in US$. • Problem: Judging the cost of living by the cost of the international market basket may not be fair if customers in the local market can buy the types of goods which are cheaper at home. Link • Major project to compare prices internationally implemented by the World Bank with the help of UN and national statistical agencies. • ICP has been implemented by UN Statistical Office since 1968. PPP’s 1. Divide expenditures into k = 1,..,K (in 2005, K = 155) “basic heading” categories of goods. 2. All j = 1,..J countries (in 2005, J = 146) report total expenditure in domestic currency of all k categories v . j ICP Handbook PPP’s cont. 3. Sample prices of representative goods from each category in each country. 4. Construct average of those prices (relative to “anchor” economy) for each country j basic heading type of good k . p k j p k ANC Note: Measured in # of j country Currency units per anchor country currency units. Example. If Japan = j and anchor is USA, and 1 kg. rice is 400 yen in Japan and $2 k in USA : pJPN p k ANC 200 PPP in Anchor Currency. 4. Define quantity of good of type k valued q k j v k j p k j 5. Calculate price of j’s market basket in j’s prices relative to price of j’s market basket in anchor country prices. v1j v 2j ... v Kj PPPjAC $ v1j 1 j p p1ANC v 2j p 2 j 2 p ANC Numerator in j currency, denominator in ... v Kj p 2j 2 p ANC • Conceptually PPP is the cost of the goods purchased by consumers in their country relative to the cost of those same goods in anchor country terms. AC $ j PPP 1 p q p q ... p q p AC $ j PPP 1 ANC 1 1 j j 1 j q p 2 j 2 ANC 2 j K j q ... p 2 j K j K ANC q K j 1 2 K p p p 2 K ANC ANC w1j ANC w ... w j j 1 2 K pj pj pj ,......, wnj v nj Vj WDI provides PPP data for many countries using US$ as anchor currency Hong Kong PPP per Category PPP Xrate Classification Name 2005 1101 Food and non-alcoholic beverages 8.81547906 1102 Alcoholic beverages and tobacco 10.1680743 1103 Clothing and footwear 6.11435997 1104 Housing, water, electricity, gas and other fuels 9.09847987 1105 Furnishings, household equipment and household maintenance 7.61334163 1106 Health 2.9312812 1107 Transport 9.40016616 1108 Communication 6.83789147 1109 Recreation and culture 5.24897067 1110 Education 3.25951882 1111 Restaurants and hotels 8.98215569 1112 Miscellaneous goods and services 5.61784877 1501 Machinery and equipment 7.5934365 1502 Construction 4.15019416 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 • Constructing accurate PPP’s takes a long time. Last completed project from 2005. Link GDP in Intl$ • PPP’s are used to construct comparable measures of GDP for multiple countries by converting them into international dollars. GDPj [ Intl $] Per capita GDP in international dollars is headline way of comparing living standards. GDPj PPPjINTL $ GDP per capita, PPP (current international $) 2005 Hong Kong SAR, China $35,677.92 China $4,114.57 India $2,299.76 Indonesia $3,216.81 Malaysia $11,754.53 Korea, Rep. $22,783.27 Thailand $6,750.94 Singapore $45,374.24 GDP per Capita, PPP Constant 2005 International $ 60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Singapore Hong Kong • Developing countries tend to be relatively cheap with PPP’s being lower than exchange rates. • OECD countries tend to have more similar price structures, though they tend to be relatively more expensive. • High income, non-OECD countries tend to be relatively cheap. • Compare values measured in different currencies using the PPP and exchange rate method. PPP 2010 China Hong Kong Korea Japan Singapore PPP 3.94638098 5.34545752 827.345987 111.389068 1.04012836 PPP/XR 0.582922 0.688032 0.71566 1.268959 0.762831 XR 6.770269 7.769167 1156.061 87.77988 1.363508 PPP vs. Exchange Rate Conversion • Exchange rates are easily available so exchange rate is a “quick and dirty” comparison. – Measures how many US dollars someone could buy with average income. • However, money goes farther in some countries as many types of goods are relatively cheap (especially in developing countries). – PPP conversion measures how much the goods purchased by the average person would cost in the US. Better measure of living standards. GDP in US$ by Conversion Method 2005 GDP per Capita $7,000 40000 $6,000 35000 $5,000 30000 25000 $4,000 US/Intl$ US/Intl$ 2005 GDP per Capita $3,000 20000 15000 $2,000 10000 $1,000 5000 $0 Low income Lower middle income Middle income Exchange Rate PPP Upper middle income 0 High income: OECD High income: nonOECD Exchange Rate PPP Is China the Biggest Economy in the World? • Discuss Subramanian Link