Chapter 6: GDP and the Measurement of Progress

GDP Does Not Count the Health of Nations

Even though the value of health is not included in GDP, that doesn't mean that society doesn't value health. To understand the trade-offs, however, it is important that we put numbers on the value of health so that we can make appropriate comparisons and make wise choices.

Growth in real GDP per capita is usually the best reflection of changing living standards. Growth in real GDP typically gives the same broad idea of how economic conditions are changing as does growth in real GDP per capita, but there can be big differences for countries with rapidly growing populations.

For instance, between 1993 and 2003, Guatemala experienced real GDP growth of about 3.6% a year. That might sound good but over that same period population grew at 2.8% a year, so real GDP per capita in Guatemala grew at just 0.8% a year. In comparison, real GDP per capita in the United States typically grows by about 2.1% a year. Thus, not only is the United States richer than Guatemala, people in the United States are getting richer faster.

What is a finished good or service?

Some goods and services are sold to firms and then bundled or processed with other goods or services for sale at a later stage. These are called intermediate goods and services. We distinguish these from finished goods and services, which are sold to final users and then consumed or held in personal inventories.

Growth Rate Equation

To compute the growth rate of GDP from 2017 to 2018, for example, you need only two numbers: the GDP at the end of 2017 and the GDP at the end of 2018.

The Factor Income Approach:

Y = Employee Compensation + Rent + Interest + Profit

two common ways of splitting GDP:

1. National spending approach to GDP: Y=C+I+G+(Exports−Imports) 2. Factor income approach to GDP: Y=Employee Compensation+Rent+Interest+Profit

We do, however, count the production of machinery and equipment used to produce other goods as part of GDP.

A tractor, for example, may help to produce soybeans, but the tractor is not part of the finished product of soybeans. Thus, both tractor production and soybean production add to GDP, even though the computer chip does not.

The National Spending Approach: Y=C+I+G+(Exports−Imports)

Economists have found it useful, especially for the analysis of short-run economic fluctuations, to split GDP into consumption (C), investment (I), government purchases (G) and Exports minus Imports, which is often shortened to Net Exports (NX). To understand why this is equivalent to thinking of GDP as the market value of all finished goods and services produced within a country in a year, note that produced goods can be consumed, invested, or purchased by governments or foreigners. Finally, some consumed, invested, and government-purchased goods are imported. Imported goods are not part of U.S. GDP, so we subtract imports. Y=Nominal GDP (the market value all finished 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

GDP Does Not Count Bads: Environmental Costs

GDP adds up the market value of finished goods and services, but it does not subtract the value of bads. Pollution, for example, is a bad that is produced every year, but this bad is not counted in the GDP statistics. The statistics also do not count the destruction of water aquifers, the accumulation of carbon dioxide in the atmosphere, or the changing supplies of natural resources. Similarly, GDP statistics do not count the loss of animal or plant species as economic costs, unless those animals and plants had a direct commercial role in the economy. Other bads, for example, the bad of crime, are also not counted in GDP statistics. Since more pollution isn't counted as a bad, it's not surprising that less pollution is also not counted as a good. America has cleaner air and cleaner water than it did in 1960, but GDP statistics do not reflect this improvement.

GDP per capita

GDP divided by a country's population.

GDP Does Not Measure the Distribution of Income

GDP per capita is a rough measure of the standard of living in a country. But if GDP per capita grows by 10%, this does not necessarily mean that everyone's income grows by 10% or even that the average person's income grows by 10%.

GDP Does Not Count the Underground Economy

Illegal or underground-market transactions are omitted from GDP

If we want to compare GDP over time, we should always compare real GDP, that is, GDP calculated using the same prices in all years.

Interestingly, it doesn't matter much what prices we use to calculate real GDP, so long as we use the same prices in all years.

GDP Does Not Count Non Priced Production

Nonpriced production occurs when valuable goods and services are produced but no explicit monetary payment is made. If a son mows his parent's lawn, the service will not be included in GDP. If a lawn care firm provided the identical work, it would be included in GDP. The omission of nonpriced production introduces two biases into GDP statistics: biases over time and biases across nations.

Defining when a recession begins and ends is not always obvious, in part because economic data are often revised over time.

The estimate of quarterly GDP, for example, is not ready for release until almost a month after the quarter is over. After that, additional rounds of updated estimates are published in the following two months. The government often makes significant changes in GDP estimates between the original estimate and the final estimate.

The GDP deflator

a price index that can be used to measure inflation he GDP deflator, however, is very easy to calculate once we know nominal and real GDP for a given year. The GDP deflator is simply the ratio of nominal to real GDP (multiplied by 100).

Net exports

exports minus imports to find domestically produced goods we add exports to national spending on domestically produced goods

GDP is also used to measure

fluctuations in an economy, namely the ups and downs in economic growth that occur within the space of a few years

GDP uses market values to determine

how much each good or service is worth and then sums the total.

If pressed to choose a single indicator of current economic performance,

most economists would probably choose real GDP growth

Consumption

private spending on finished goods and services Most consumption spending is made by households, such as spending on cars and chickens. Consumption spending, however, also includes spending on health care whether the spending comes from your pocket, an insurance company, or the government (as with Medicaid and Medicare). Note that while economists think of education as an investment in "human capital," the Bureau of Economic Analysis includes education as consumption spending alongside purchases of automobiles, smartphones, and televisions.

National wealth

refers to the value of a nation's entire stock of assets.

Recessions

significant, widespread declines in real GDP and employment—are of special concern to policymakers and the public. 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.

government purchases

spending by all levels of government on finished goods and services not including transfers Government purchases include spending on tanks, airplanes, office equipment, and roads, as well as spending on wages for government employees (in this case the government is implicitly thought of as the purchaser of services such as military services). This category includes both government consumption items (like toner cartridges for printers) and government investment items (like roads and levees), and is thus also called government consumption and investment purchases. A large part of what government does is transfer money from one citizen to another citizen; about 21% of the spending of the federal government, for example, is for Social Security payments.

Gross national product (GNP)

the market value of all finished goods and services produced by a country's residents, wherever located, in a year

Gross domestic product (GDP)

the market value of all finished goods and services produced within a country in a year sales of used goods, such as a used car, are not included in GDP. Similarly, sales of old houses and sales of financial securities like stocks and bonds are not included in the calculation of GDP. The sale of an old house does not add to GDP because the house was not produced in the year in which it sold. Sales of newly built houses, however, are counted in GDP. Stocks and bonds are claims to financial assets—they are not themselves produced goods or services—so sales of stocks and bonds and other financial assets are not counted in GDP. Even though the sales of old houses, used goods, and financial assets do not add to GDP, the services of real estate agents, used-car salespeople, and brokers do add to GDP because the services provided by these agents are produced in the year in which they are sold Although we typically think of GDP on a yearly basis, it is also calculated every quarter of the year. The calculations are done by the Bureau of Economic Analysis (BEA), which is part of the Department of Commerce and based in Washington, D.C. If you want to see whether you understand what the bureau is up to, try testing yourself with the questions at right.

Investment

the purchase of new capital goods; private spending on tools, plant, and equipment used to produce future output Most investment spending is made by businesses but an important exception is that new home production is counted as investment. It's important to remember that "investment" is spending on tools, plant, and equipment (capital). When a farmer buys a tractor, that is investment. If your university builds new classrooms and labs, that is investment. Buying IBM stock, however, is not investment, as this is a mere change in ownership of some capital goods from one person to another. To make sure that everything adds up, investment also includes changes in inventories.

business fluctuations or business cycles.

the short-run movements in real GDP around its long-term trend

real variable

variables such as real GDP, that have been adjusted for changes in prices by using the same set of prices in all time periods

Nominal GDP

variables, such as nominal GDP, that have not been adjusted for changes in prices calculated using prices at the time of sale Thus, GDP in 2018 is calculated using 2018 prices and GDP in 2017 is calculated using 2017 prices. What this means is that when we compare GDP in two different years we are seeing both the change in output and the change in prices. What we would like to know is whether the increase in GDP between 2017 and 2018 was due mostly to greater production—more cars and more chickens—or mostly due to increases in prices between 2017 and 2018. 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.