GDP and Its Discontents

Suggested Supplementary Reading

• Ebook: Peter Kennedy Macroeconomic Essentials: Understanding Economics in the News

Quantity Aggregates• To understand the macroeconomy, we need to measure

it.

Chief measure of economy is the level of production• We need to combine the many goods produced or

consumed in an economy into one measure.

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=?

Gross Domestic Product (GDP)

• GDP is the sum of the value of new, final goods produced within the domestic borders of an economy.

All goods sold in an economy share a common unit of measure: the price at which they are sold.

Final goods are goods sold to their end-users

Sum up the value of goods

GDP does not include:

• Intermediate goods which are sold from one firm to another for immediate transformation into other goods.

• financial transactions like buying stocks.

• purchases of used goods which have been sold before.

• goods produced overseas by domestic firms.

Three Methods for Calculating GDP

1. Production Method - The value added created in all the sectors of the economy.

2. Expenditure Method - The sum of the domestic spending on final goods (less domestic demand satisfied by imports).

3. Income Method – The Wage, Rent, Interest and Profit Income generated by the domestic economy.

Production Method

• At the plant level, Value added = Sales + Change in inventories

- materials, intermediate inputs and energy costs.

• Value added at the firm level is directly taxed in the EU (VAT)

• GDP is the sum of VA across establishments.

• The value of a final good is equal to the value added at each stage of production.

Hong Kong Census and Statistics

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1980 2008

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Sh

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DP

Hong Kong Industries

Expenditure MethodC

+Consumption Consumer durables, non-

durables, services

I

+Investment Structures (incl. Residential),

Equipment, and Inventory

G

+Government Consumption

Government Spending on Goods, Services, and Salaries.

X

-EXports Goods & Services Shipped

Abroad

IM IMports Goods & Services from Abroad

= GDP A + NX = (C + I + G) + (X – IM)

Japanese ExpenditureFiscal Year 2003(Billion Yen)

Items

Actual final consumption of households [C] 332,970.6 66.43% Government actual final consumption [G] 38,578.9 7.70% Gross domestic fixed capital formation [I] 120,238.8 23.99% Of which intangible fixed assets 10,810.2 2.16% Changes in inventories 270.0 0.05% Exports of goods and services [X] 60,375.7 12.04% (less) Imports of goods and services (51,180.5) 10.21%

Gross domestic expenditure 501,253.5 100.00%

(cf) Incomes from the rest of the world 12,787.4 (less) Income� � to the rest of the world 4,001.1 Gross national income 510,039.8

Expenditure Categories in Hong Kong: 2008

Hong Kong Census and Statistics

Hong Kong Expenditure

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

Perso

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Income Method

• Survey domestic residents and calculate their wage income, interest income, rental income plus the income of proprietors of small firms plus the profits & depreciation of the corporate sector. – Subtract net international income flows.

• Not calculated for HK on an annual basis.

Income Method, Japan 2003

(1) Generation of Income AccountCalendar Year(Billion Yen)

Items 2003

Compensation of employees ,payable 265,484.8 53.70% (1) Wages and salaries 223,445.0 45.20% (2) Employers' social contributions 42,039.8 8.50%Taxes on production (less) Subsidies 36,562.4 7.40%Proprieters Income 19,884.5 4.02%Corporate Profits and Interest Payments 71,160.3 14.39%Depreciation 101,301.0 20.49% (regrouped) Value added ,gross/gross domestic product 494,393.0 100.00%

High Concept

Income =

Expenditure =

Value Added

High Concept

• Value of a final good expenditure is equal to value added at each stage of production. (Expenditure = Value Added)

• Value Added would be paid to workers, creditors, or kept as profits. (Income = Value Added)

GNP vs. GDP

GNP GDP

Gross National Product Gross Domestic Product

= income earned by domestic residents

= income created within national borders.

Compare Macau and the Philippines GDP or GNP

• Macau produces a lot of profits paid to overseas owners of casinos.

• Philippines workers earn a lot of income overseas.

• Which is larger Philippines’ GDP or Philippines GNP?

• Does Macau have greater GDP or GNP?

Comparing GDP levels across time

• GDP measures the value of the goods produced by an economy by using the market price of each good to assign it a value.

• Problem: Prices of goods in terms of money are changing overtime making comparisons in overall value difficult. – Bias: Money prices are growing over time as money

supply grows.

• Solution: Choose a Base Year’s prices as a fixed yardstick of value for different goods.

Real GDP: Yt

• GDP aka Nominal GDP aka Current Dollar GDP is the weighted sum of the number of goods produced using their current prices as the weight.

• Real GDP aka Constant Dollar GDP aka GDP adjusted for inflation is the weighted sum of the number of goods produces using the Base Year prices as yardsticks.

Real GDP: Yt

• GDP aka Nominal GDP aka Current Dollar GDP is the weighted sum of the number of goods produced using their current prices as the weight.

• Real GDP aka Constant Dollar GDP aka GDP adjusted for inflation is the weighted sum of the number of goods produces using the Base Year prices as yardsticks.

USA

0.0

2000.0

4000.0

6000.0

8000.0

10000.0

12000.0

14000.0

16000.0

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Bill

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US

$

Nominal GDP Real GDP

Real GDP vs. Nominal GDPSt. Louis Federal Reserve

Hong Kong

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1961 1966 1971 1976 1981 1986 1991 1996 2001

Mill. H

K$

Nominal GDP Real GDP

GDP vs. GNP: Hong Kong

Solved ProblemReal GDP: 2005 (2004 Base Year)

2005 2004

P Q P Q

Kitkat 8 150 6 135

M&Ms 10 150 4 135

Nominal GDP

Real GDP

USA

0.0

2000.0

4000.0

6000.0

8000.0

10000.0

12000.0

14000.0

16000.0

1970

1972

1974

1976

1978

1980

1982

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1988

1990

1992

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1996

1998

2000

2002

2004

2006

Bill

ion

US

$

Nominal GDP Real GDP

Real GDP vs. Nominal GDPSt. Louis Federal Reserve

Hong Kong

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

1961 1966 1971 1976 1981 1986 1991 1996 2001

Mill. H

K$

Nominal GDP Real GDP

GDP vs. GNP: Hong Kong

Comparing GDP across Countries

• When you compare income in two different countries, each country’s GDP per capita is measured in local currency. You need to measure both with common yardstick to compare.

• Typically, the common yardstick will be US$. GDP can be converted to US$ by Exchange Rate Method (divide national GDP by the exchange rate) or PPP Method (divide national GDP by PPP).

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 developing countries).– PPP conversion measures how much the goods

purchased by the average person would cost in the US. Better measure of living standards.

World Bank Conversion Factors

Price Indices: Pt

• Two most commonly used price indices are GDP Deflator and Consumer Price Index (CPI)

• The GDP deflator is the ratio of nominal GDP to Real GDP (multiplied by 100).

100

100

Nominal GDPP GDPDeflator

Real GDP

GDPP

Y

Consumer Price Index

• The CPI is the price of a representative market basket of goods relative to the price of that same basket during a benchmark/base year (multiplied by 100).

100t

Cost of Market Basket in year tCPI

Cost of Market Basket in Base year

International Comparisons Project

• Researchers at U. of Pennsylvania periodically choose a representative world market basket and go to different countries to collect prices of that market basket of good.

• For a country, we calculate PPP = Purchasing Power Parity as the price of the market basket relative to price of the market basket in US.

• For any country, the exchange rate, St, is the number of domestic dollars per US$.

Penn World Tables

Depreciation

• Part of the Investment that is being done will only go to replacing depreciated capital.

• When Hurricane Katrina hits, repair of infrastructure counts as GDP even though that only replaces what is lost.

• Net DP• Conceivably, since only consumer spending

generates benefit to household welfare, maybe consumption itself is a better measure.

National Resource Depletion

• Selling of mineral extraction and other non-renewable resources increases income but this also runs down wealth.

• Example: Nauru and Phosphates

https://www.cia.gov/library/publications/the-world-factbook/geos/nr.html

Environmental Quality

• Clean air and water are important for welfare but not measurable as a market good (ie. GDP is a market good).

• Possible Solution: Estimate of environmental quality.

Inputed Services of Non-Market Capital

• Welfare generated by renting housing included in GDP, but what if you own your own home?

• Statistical agencies include imputed value of homes by checking rental rates but not cars, TV’s etc.

• Is rental market parallel to purchase market?

Housework

• If you pay someone to do housework or watch your kids, then it will be counted in GDP. If you do it yourself, it will not be.

• Big shift from household production to market production of housing services in recent years (helpers, daycare, kindergarten, tutors, etc.)

• This shift would increase GDP without more goods being produced.

Income Distribution

• GDP per Capita is a measure of the income for the average person

• But if one person has $1,000,000 and another person has 0, the average is $500,000.

• This is a quite different economy than one in which two people both have $500,000.

Health/Crime

• Life expectancy and infant mortality are key indicators of living standard.