Chapter 6 (p. 196-229)

SEX, DRUGS, AND GDP IN EUROPE

The new GDP definition includes illegal drug deals, prostitution, and even sales of stolen goods. Normalizing the accounting standards across nations makes sense. But illegal activities are difficult to measure. In addition, if the illegal activities are a relatively stable portion of GDP, then there is really no bias when they are not included. In fact, the new estimates, in an attempt to provide a more complete measure, may actually introduce more error into GDP measurement due to the difficulty of estimating illegal trade. So why the change in definition? One possibility is that many European nations are dealing with high deficit- (and debt-) to-GDP ratios, and some of these new measurements (in a backhanded way) help lower these ratios. increasing GDP by simply redefining how it is measured automatically lowers deficit and debt ratios and helps nations that have higher government debt levels

Real GDP: Adjusting GDP for Price Changes

The raw GDP data, based on market values, is computed on the basis of the prices of goods and services current at the time GDP is calculated. Economists refer to these prices as the *current prices*

Underground Economy

The underground, or shadow, economy encompasses transactions that are not reported to the government and therefore are not taxed. These transactions are often settled in cash. many underground transactions are for legal goods and services, but these activities are not reported in order to avoid taxes. Legal activities that go unreported include tips for waiting tables and tending bar, lawn services, and even home renovations. How big is the underground economy? No one is exactly sure... it is roughly 15% of GDP and that in transitioning economies the percentage rises to between 21% and 30% of GDP. The United States is widely believed to have one of the smallest shadow economies in the world, with less than 10% of GDP unaccounted for in the official measurement. Why is the underground economy so small in the United States? The simple answer is that in the United States and in many other developed economies, most citizens can earn more by legitimately participating in the economy than by engaging in illegal activities. In short, a strong economy that generates jobs and opportunities for advancement helps to reduce the size of the underground economy. This means that participants in the economy rarely face demands for bribes or kickbacks from authorities or organized crime. This is not the case in many developing nations.

If a citizen of Mexico buys $50,000 worth of stock in Apple Inc. (a U.S. company), and pays a 10% trading fee to a U.S. stock broker, how much is added to U.S. GDP?

$5,000. Only the fee for the broker adds to GDP, since it is a service. The $50,000 stock purchase does not count toward production, since it is just a change of ownership.

What was the rate of growth of real GDP in Mexico in 2016?

% change in real GDP + % change in price level ≈ % change in nominal GDP % change in real GDP ≈ % change in nominal GDP - % change in price level For 2016, we have % change in real GDP ≈ 6.9 - 4.6 ≈ 2.3

How would you compute real GDP growth in Mexico in 2013?

% change in real GDP ≈ 3.1 - 1.8 ≈ 1.3

Computing nominal GDP is straightforward: we add the market values (actual prices) of all final goods and services.

To compute real GDP, we also need a measure of overall prices, known as a price level.

Many people think that recessions are more common today, and/or more severe, than they have been in the past. In fact, the opposite is true

U.S. recessions have gotten steadily rarer and shorter in the last 150 years

real GDP =

(nominal GDP/price level) x 100

Real GDP def

*GDP adjusted for changes in prices* any time we evaluate GDP figures across different time periods, we must use real GDP to account for inflation

GDP deflator def

*a measure of the price level used to calculate real GDP.* The price level in GDP data, the GDP deflator, includes the prices of the final goods and services counted in GDP GDP deflator "deflates" all the price inflation out of nominal GDP so that we can see real GDP.

a business cycle def

*a short-run fluctuation in economic activity* Even if an economy is expanding in the long run, it is normal for it to experience temporary downturns Economic activity increases during the expansion period of the business cycle, but declines during the contraction phase. The peaks and troughs divide the business cycle into 2 phases: *expansions and contractions.*

NET EXPORTS (NX) def

*net exports (NX) = exports - imports* produces some goods and services that are exported to other countries, and it imports some goods and services produced elsewhere *only exports add to GDP because they are produced domestically* Imports are tracked, but they do not add to GDP, because our goal is to measure domestic production accurately. imports enter into GDP calculations twice: once positively and once negatively, and the net result is zero. *When spending on imports is larger than spending on exports, net exports are negative.* Net exports are typically negative for the United States. imports enter the GDP calculations as a negative value, they seem to reduce GDP. But imports are then used for one of the other GDP categories (C, I, or G), and so they enter positively there. Imports are accounted for without increasing or decreasing GDP. EX. we import $10 million worth of bananas from Guatemala. These bananas increase consumption by $10 million, but they also increase imports by $10 million, and so net exports falls by $10 million. The net result is that GDP is unaffected, as C rises by the same amount that NX falls. More imports coming in means more goods and services for people in that nation. All else equal, imports do not make us worse off.

INVESTMENT (I) def

*private spending on the tools, plant, and equipment used to produce future output.* ex. Investment is something as simple as the purchase of a shovel, a tractor, or a personal computer to help a small business produce goods and services for its customers. But investment also includes more complex endeavors, such as the construction of large factories. Investment also includes all purchases by businesses that add to their inventories. Investment spending makes up only about one-sixth of all GDP, but don't underestimate its importance. Most economists agree that investment spending leads to greater future GDP.

Macroeconomics

*study of the broader economy* - the economy of an entire nation or society what happens when: -- the national output of goods and services rises and falls [rather than just from a single firm or industry] -- overall national employment levels rise and fall [rather than employment at a single firm] -- overall price level goes up and down [rather than the price of just one product] looks at the *big picture created by all markets in the economy*—the markets for salmon, coffee, computers, cars, haircuts, and health care

Inflation def

*the growth in the overall level of prices in an economy* Prices of goods and services almost always rise through time because of inflation. Because GDP is calculated using market values (prices) of goods and services, inflation causes GDP to go up even if there is no change in the quantity of goods and services produced. Therefore, when we look at GDP data over time, we have to adjust it for the effects of inflation

Gross Domestic Product (GDP) def

*the market value of all final goods and services produced within a nation during a specific period of time, typically a year* the primary measure of a nation's output and income that economists use to measure overall production of goods and services in an economy the sum of all the output from coffee shops, doctor's offices, software firms, fast-food restaurants, and all the other firms that produce goods and services within a nation's borders The sale of output becomes income to the firms' owners and the resource suppliers. --This dual function of GDP is part of the reason we focus on GDP as a barometer of the economy. -- When GDP goes up, national output and income are both higher. -- When GDP falls, the economy is producing less than before, and total national income is falling.

To compute real GDP, we use the current prices of goods and services and then adjust them to prices from an agreed-upon common time period, or base period. We do this in two steps:

1. Divide nominal GDP by the price level. 2. Multiply the result by the price level (100) from the base period.

Leisure Time

Because GDP only counts market activity, it fails to capture how long workers labor to produce goods and services. The United States is near the middle of the pack, with an average workweek of 36 hours. This means that comparisons of GDP across countries are problematic because they do not account for the extra time available to workers in countries with substantially fewer hours worked.

nominal GDP def

The GDP calculated from current prices rises much faster than real GDP The difference between these percentages reflects price level growth, or inflation.

GDP Equation

GDP = C + I + G + NX OR GDP = C + I + G + (exports - imports) - consumption is by far the largest component of GDP - followed by investment and then by government purchases - the value of net exports is negative. (This negative value occurs because the United States imports more goods than it exports.)

*Within a Country*

GDP includes only goods and services produced domestically, or within a nation's physical borders. The output of foreign-owned firms that is produced inside the United States is included in U.S. GDP, but the output of U.S. firms that is produced overseas is included in the GDP of the overseas nation.

*Including Only Final Goods and Services*

GDP is the summation of spending on goods and services. However, not all spending is included (intermediate goods = excluded, final goods = included.) ex. The sale of the cell phone is included as part of GDP, but the value of the intermediate goods is not. What happens if we count the value added during each intermediate step in making a cell phone? If we counted the value of each intermediate step, we would arrive at a total of $328, which would overstate the phone's value in the economy because it sells for only $199... double counting

3. MEASURING BUSINESS CYCLES

GDP is used to determine whether an economy is expanding or contracting in the short run

Quality of the Environment

GDP measures the final amount of goods and services produced in a given period, but it does not distinguish how those goods and services are produced In particular, it does not account for negative environmental side effects that sometimes occur in production. Citizens in both countries enjoy the same standard of living, but their well-being is not the same. The lax environmental standards in the second economy lead to air and water pollution as well as health problems for its citizens. Since there is more to quality of life than the goods and services we buy, using GDP to infer that both places are equally desirable is unsound.

From a Particular Time Period

GDP only counts goods and services produced during a given time period. Goods or services produced in earlier years do not count in the current year's GDP. when a new car is produced, it adds to GDP in the year it is sold a used car that is resold does not count in current GDP, because it was already counted in GDP for the year when it was first produced sales of financial assets such as stocks and bonds do not count toward GDP. After all, these kinds of sales, do not create anything new; they simply transfer ownership from one person to another. In this way, they are like used goods. However, brokerage fees do count as payment for the brokerage service, and they are included in GDP.

per capita GDP

GDP per person (divide the country's total GDP by its population) When we want to gauge living standards for an average person, we compute per capita GDP

1. MEASURING LIVING STANDARDS

If both output and income are higher, this indicates that living standards are also higher. While not perfect, GDP offers us a way of estimating living standards across both time and place...it is not the best indicator of living standards for a typical person... ex. in 2016, China produced more than twice as much GDP as Japan, yet China's population was about 10 times the population of Japan. If we divide each nation's GDP by its population, we find that in Japan there was near $39,000 GDP (or income) for every person, and in China only about $8,000 per person.

EX. If corn production is 12 billion bushels and these bushels sell for $5 each, the contribution of corn to GDP is $60 billion. If car production is 8 million vehicles and cars sell for $30,000 each, the contribution of cars to GDP is $240 billion.

If these were the only goods produced in a given year, GDP would be $60 billion + $240 billion = $300 billion.

nominal GDP, which is from raw GDP data, includes information on both the price level and real GDP

When either of these factors changes, nominal GDP is affected. In fact, the growth rate of nominal GDP is approximately equal to the sum of the growth rates of these two factors: growth of nominal GDP ≈ growth of real GDP + growth of price level rewritten: % change in nominal GDP ≈ % change in real GDP + % change in price level

1. WEALTHIER INDIVIDUALS REPORT GREATER LIFE SATISFACTION THAN POORER PEOPLE IN THE SAME COUNTRY.

Why do percentage changes matter in this study? Basic economics assumes a diminishing utility of income, which means that increases in life satisfaction (utility) per dollar should decline as income increases. This study demonstrates that percentage changes do matter: the data indicate that a doubling of income leads to about a 0.35 unit increase on the life satisfaction ladder.

recession def

a short-term economic downturn that typically lasts about six to eighteen months income levels fall and many individuals lose their jobs or cannot find work during recessions

Gross national product (GNP) def

an alternative measure of national output, is the output produced by workers and resources owned by residents of the nation. ex. shoes produced by Nike in Thailand would count as part of U.S. GNP, since the owners of Nike are citizens (and residents) of the United States. Many nations prefer GDP to GNP because much of their domestic output is produced by foreign-owned firms (like Nike shoes produced in Thailand). For these nations, GDP is larger than GNP. These countries prefer GDP because it measures the production that takes place within their borders. Thus, GDP has become the standard measure of international output.

Over the past several decades, the US economy has evolved from

an economy that primarily manufactured goods to one that... provides services (like retail, healthcare, financial, and food services)

price level

an index of the average prices of goods and services throughout the economy It goes up when prices generally rise, and it falls when prices across the economy fall.

2. WEALTHIER NATIONS REPORT GREATER LIFE SATISFACTION THAN POORER NATIONS.

clear positive relationship between life satisfaction and income around the globe there really is a lot of variation in happiness, even at a given income level. Money may not be able to buy happiness, but there is significant evidence that more income presents more opportunities to "pursue happiness."

Durable consumption goods def

consumed over a long period subject to significant cyclical fluctuations that correspond to the health of the economy Because durable goods are generally designed to last for many years, consumers tend to purchase more of these goods when the economy is strong...when the economy is weak, they put off purchases of durables and make what they already have last longer

Nondurable consumption goods def

consumed over a short period don't last very long, so consumers often purchase them regardless of economic conditions.

The BEA breaks GDP into 4 major categories:

consumption (C) investment (I) government purchases (G) net exports (NX)

2. MEASURING ECONOMIC GROWTH

economic growth = changes in living standards over time When economies grow, living standards rise, and this outcome is evident in GDP data. ex. change in real per capita GDP in the United States from 1970 to 2018... The overall positive slope = U.S. living standards rose over the course of 50 years, even though growth was not positive every year. The data show that income for the average person in 2018 was more than double what it was in 1970 (even after adjusting for inflation).

price level growth rate = % change in price level

ex. 110-108/108 x 100 = 1.9% This means that throughout the U.S. economy in 2018, inflation was 1.9%.

Final goods def

goods that are sold to final users

Intermediate goods def

goods that firms repackage or bundle with other goods for sale at a later stage

GDP and Happiness

greater wealth does make it easier to afford conveniences, experiences, and even health and well-being that contribute to life satisfaction or happiness. Per capita GDP is positively correlated with many human welfare outcomes that nearly everybody finds desirable: higher life expectancy, higher levels of education, and reduced infant mortality. This probably doesn't surprise you; income allows people to buy better health care, medicines, and education, among other purchases. consistently positive relationship between self-reported life satisfaction and income

Economic growth def

measured as the percentage change in real per capita GDP this measure starts with GDP data but then adjusts for both population growth and inflation

Growth Rates

nominal GDP growth in 2018 = GDP2018-GDP2017/GDP2017 x 100 Growth rates are calculated as percentage changes in a variable.

Economic expansion

occurs *from the bottom of a trough to the next peak*, when economic activity is *increasing* --jobs are relatively easy to find and average income levels climb

Services def

outputs that provide benefits without producing a tangible product service output now accounts for about two-thirds of all U.S. output.

the Great Recession def

recession that began in December 2007 and lasted until June 2009 dubbed the Great Recession because of its length and depth -- was felt across almost all of the globe. In the United States, it lasted nineteen months, and real GDP fell by more than 8% in the last three months of 2008. In addition, the recovery from the Great Recession was very slow.

Looking at GDP as Different Types of Expenditures

the different categories of goods and services included in GDP *The Bureau of Economic Analysis (BEA)* is the U.S. government agency that *tallies GDP data* in a process called *national income accounting*

CONSUMPTION (C) def

the purchase of final goods and services by households, with the exception of new housing Most people spend a large majority of their income on consumption goods and services. Consumption goods include everything from groceries to automobiles. 2 categories: durable and nondurable (This distinction is important when the economy swings back and forth between good times and bad times.)

Microeconomics

the study of what people buy, what jobs they take, and how they distribute their income between purchases and savings examine the decisions of firms and how they compete with other firms ex. study the markets for particular goods like salmon... study the behavior of people who consume salmon and firms that sell salmon—demanders and suppliers Then you bring them together to see how the equilibrium price depends on the behavior of both demanders and suppliers.

Three Uses of GDP Data

to measure... 1. living standards 2. economic growth 3. business cycles to determine whether an economy is experiencing recession or expansion

Why Do Economists Continue to Rely on GDP Data?

In addition to the production of goods and services, there are many other measurements that economists might use to determine a country's standard of living: life expectancy, educational levels, access to health care, crime rates, and so on. One problem with including these additional factors in GDP is that they are difficult to measure and rank. Moreover, the combined statistic that we would generate would be even more challenging to understand. Therefore, we limit GDP to measuring economic production, knowing that it is not a perfect measure of well-being. In addition, GDP is actually correlated with many of the variables we care about, like a cleaner environment, better access to high-quality health care, more education, more leisure time, and lower crime rates.

Nonmarket Goods

Many goods and services are produced but not sold in a market. These are then not counted in GDP data even though they create value for society. For instance, work done at home, such as an individual caring for their children, washing their dishes, mowing their lawn, or washing their car, are services produced but not counted in GDP. When the nonmarket segment of an economy is large, the result can be a dramatic undercounting of the annual output being produced. In less-developed societies where many households live off the land and produce goods for their own consumption, GDP—the measure of market activity—is a less reliable measure of economic output.

Employment

Micro: The job status and decisions of an individual or firm Macro: The job status of a national population, particularly the number of people who are unemployed

Prices

Micro: The price of a single good Macro: The combined prices of all goods in an economy

Output

Micro: The production of a single worker, firm, or industry Macro: The production of an entire economy

Income

Micro: income of a person or the revenue of a firm Macro: income of an entire nation or a national economy

Production Equals Income

Nation's output and income are essentially the same thing Nations and individuals that produce large amounts of highly valued output are relatively wealthy

GOVERNMENT SPENDING (G) def

National, state, and local governments purchase many goods and services. These purchases are included in GDP as government spending *spending by all levels of government on final goods and services.* ex. every government employee receives a salary, which is considered part of GDP. Similarly, governments spend money purchasing buildings, equipment, and supplies from private-sector firms. Governments also spend on public works projects, including national defense, highway construction, schools, and post offices. *Transfer payments the government makes to households, such as welfare payments, social security, and unemployment insurance, do not count as GDP, since they are not direct purchases of new goods and services.

*Counting Market Values*

Nations produce a wide variety of goods and services that are measured in various units. Looking only at quantities, one might conclude that because the nation produced about 1,500 bushels of corn for every car, corn production is much more important to the U.S. economy. But of course this conclusion is wrong; a bushel of corn is not worth nearly as much as a car. To add corn and cars and the other goods and services in GDP, *economists use market values. That is, we include not only the quantity data but also the price of the good or service.* Market values allow us to add together many types of goods. At the same time, market values rely on prices, which can rise when inflation occurs. GDP will rise even though the production level stays the same. This is why we compute real GDP by adjusting for inflation

*Including Goods and Services*

Physical goods are easy to visualize, but less than half of U.S. GDP comes from goods; the majority comes from services. Most economists are not concerned about this move toward a service-dominated economy, but others lament this shift. These others remember that manufacturing industries were a source of prosperity for the U.S. economy and then assume they are still necessary for future growth. This is not a partisan issue; politicians from both major parties take this stand. However, this argument does not allow for the nature of modern economic growth. The fact that innovations in manufacturing spurred past growth does not mean that future growth should not occur through services.

What exactly does Amazon do that's economically so significant?

Provides a service: - helps people buy goods produced by others This intangible service is an important contributor to our US economy Provides income to many people

Economic contraction

After a certain period, the economy enters a recession, or an economic contraction *the period extending from the peak downward to the next trough* During this phase, economic activity is *declining* --more people lose their jobs and income levels often fall GDP declined during these recessionary periods, but NOT in a consistent, predictable pattern

What Are Some Shortcomings of GDP Data?

1. Nonmarket Goods 2. Underground Economy 3. Quality of the Environment 4. Leisure Time 5. GDP and Happiness

World's Largest Economies by GDP, 2016

1. US (per cap 57k) 2. China (per cap 8k) 3. Japan 4. Germany (per cap 42k) 5. UK 6. France 7. India 8. Italy 9. Brazil 10. Canada (per cap 42k) 11. Russia

There are at least two reasons why people today overestimate the occurrence of recession.

1. our most recent recession, the Great Recession that lasted from 2007 to 2009, was lengthy and deep. 2. bad news tends to attract media attention

How Is GDP Computed?

Counting Market Values Including Goods and Services Including Only Final Goods and Services Within a Country From a Particular Time Period Looking at GDP as Different Types of Expenditures

What Does GDP Tell Us about the Economy?

Economists measure the total output of an economy as a gauge of its overall health. Economy producing more and more valuable output = is a healthy economy If output falls for a certain period = there's something wrong in the economy.