Ch06 GDP and Measurement

Ch06 GDP and Measurement


>>Hello everyone, this is
Scott, and this week we’re going to be talking about GDP and how we measure it. So we’re going to go through what
GDP is, gross domestic product, and it’s a measurement of wealth. We’re going to talk about what
causes GDP and wealth to grow. We’re going to talk about how we split GDP
into both what’s called nominal and real GDP. We’re going to talk about cyclical and short
run changes in GDPs so we’re going to be talking about sort of the economic booms and the
recessions and how they go back and forth. We’re going to talk about the
various ways to calculate GDP. So you could look at GDP from various different
angles to try and estimate what GDP really is. And then we’re going to talk about
how GDP doesn’t capture everything and some of the weaknesses within GDP. So what is GDP? Now I’m not going to do this for a lot
of things but this definition here — we are going to break down almost
every single word on the coming slides. So GDP is the market value of all
final goods and services produced within a country within a given year. The way I like to think about
it is it’s how quickly can and economy make stuff of
value in a given time period? Its ability to produce well. So GDP per capita is just talking about how much
stuff there is divided by the number of people. So if you look at the GDP, and this is in
2010, the GDP of the US was about 15 trillion and the GDP of China was about $11 trillion. But China has a lot more people than the US. So if you take the GDP and divide it
by the population the average person, the average slice of the pie, the per capita
GDP in the US is substantially higher than it is in China and so what we’re
going to be looking at is GDP. We’re going to be talking about how well an
economy grows and we’re also going to be talking about the wealth of certain countries and what
we’re going to be doing there is we’re going to be talking about the per capita GDP. So why is this important? Well if we start looking at GDP over time, and
this is for India, 80% of their population lives on less than two dollars
a day, but in the last 20 or 30 years what we’re seeing is there’s
a real take off in that economy and more and more people are starting to live
at what we call Western standards of American and European standard of living. So we want to understand what is this
growth first and then over the course of this course we’re going to try and
understand what causes some countries to grow and other countries not to grow. So what is GDP? Again, GDP is the market value of all final
goods and services produced within a country. So what we’re trying to measure is how
much stuff is the country producing? But we don’t want to just count items, right? A hundred screws or bolts aren’t worth
the same as 100 computers or 100 houses. So what we need to do is we
need to standardize everything. So what we’re going to do is we’re going to say let each product be worth
what it sells for, its market value. We’re not going to judge the value and say that
one thing that’s worth $10 is more valuable than something else that’s worth $10. So a good book that sells for $10 or cigarettes
that sell for $10 are both equally valued. They are valued at the market price. In a real simplified example where
there are only cars and computers, what we’re going to do is we’re
going to take the number of cars that are produced times how much they sell for and say well that’s the market
value of those cars. Here’s the price of a computer
and the number of computers, here’s the market value of those computers. And we would just add up every single item
and say that’s how much GDP is for all goods and services that are produced
in a given period of time. You’ll notice that the definition
talks about final goods and services. Well, we want to talk about
intermediate goods and final goods. So if I buy — if I have a restaurant
and I buy a bunch of cheese and eggs and then I break them together and make
an omelette and I sell the omelette, well the output for the economy is the omelette which includes the intermediate
goods of cheese and eggs. We don’t want to count the sale of
the cheese, count the sale of the eggs and count the sale of the omelette. That would double count or
even triple count these goods. So what we’re going to look at is the
value of the final goods and services which includes all the inputs
or intermediate goods. GDP measures goods and services so it’s not just
goods that are cars and refrigerators and stoves and clothes, they’re also services like
going to the doctor or getting a haircut, getting an accountant or legal services. Those services are also value. They are things that occur in the market that
have market transaction so GDP measures goods and services and in fact if you look at for the
US economy the percentage of GDP that’s made up of services has been increasing steadily. We are now truly a service economy. GDP measures the amount of goods and
services produced so we are not talking about the accumulation of wealth. We’re talking about how quickly
it can produce goods. So used goods don’t count. If I have a bicycle and I sell you the
bicycle and it’s a market transaction, we’re not adding to the wealth of the
economy, we’re just transferring wealth which is the same reason why
financial assets like buying and selling bonds don’t count towards
GDP because that’s just a re-allocation. It doesn’t include production. So GDP is only production
of new goods and services. It’s the production market value
of goods and services produced within a country in a given period of time. Well, we’re talking about within a country,
that’s how we define gross domestic product. If we want to know all the goods and services
that Americans produce and if I’m living in Germany or England that’s
gross national product. Gross national product is the value of all
goods and services produced by US residents. Here we’re just focused more on location. Same thing, we’re just defining one measure
and we’re going to track it over time. Twenty or thirty years ago the more
popular measure was gross national product, now it’s shifted to gross domestic product
and now we’re talking about within a year because this is a production cycle. How much stuff can be produced? So think of this as like an annual income. Just like we can measure the miles per hour
you’re driving without you actually driving for an hour — if you’re on the
highway and you’re going 60 mph, we’re looking at it in terms of a rate. GDP is just a rate as well. You don’t have to drive for an hour
to understand how fast you’re going. We don’t have to produce for an
entire year to understand GDP. We’re just looking at it in terms of a rate. So it’s important for us to
think about what’s not in GDP. Well, used goods are not in GDP at all. Why? Because they weren’t produced. Purely financial transactions
are just transfers of wealth. That’s not in GDP. Non-market transactions — so if I choose to
stay home with my kids there’s no market price, there’s no market value for that but
yet if I hire someone to watch my kids that is a market price and
that is included in GDP. Illegal activities. So if I sell drugs or if my teen acts
as a babysitter and doesn’t report that, there’s no market transaction
there that is documented and those activities are not included in GDP. Leisure. So if we went from working 50 hours
a week to 40 to 30 that isn’t included in GDP. So it only measures market transaction. Leisure is a non-market transaction again. It doesn’t include bads. So when I drive and I pollute as I’m
driving that’s not reflected in GDP. Again only the output is included in GDP. And any measure that talks about
the distribution of wealth. So we talk about how much stuff is
being produced within our country but we don’t say where that’s going with GDP. There are other measures that we can look
at to talk about the distribution of wealth but for now GDP is just a measure of output. So one of them that we talked about was leisure
and how much we’re working and if you look at the US, the US is working a
lot more than other countries and that could help explain why we have more GDP than some other countries
because we’re working more. Nowhere is that actually
reflected in the GDP measure. GDP isn’t reflected in per person
assuming that they work 40 hours a week or 30 hours a week or whatever that is. So GDP does not count non-market transactions
and this causes some huge biases over time. If you think about women’s working role in the
US, women were not as likely to participate in the labor force, in the formal
labor force, until about 1950. Once they started participating and they
started participating very heavily then GDP has increased and that’s just because
we now have more people working in the formal labor market even though those
roles that were traditionally more women’s roles in the 1950s have now become marketplace. So childrearing, while there are lots of
women and men who now raise their own kids, it’s also now more common to hire someone
to watch your kids and that does two things. Now that childrearing is a market transaction
which counts towards GDP and now whoever used to stay home is now working
which also increases GDP. The other thing that we have is
a bias across different nations. So as taxes go up and up and up in certain
countries, it’s far more common for people to just make trades under the table
and not report it to the government. When that happens GDP gets understated because there is no record of
that transaction occurring. So how can we count GDP? And there are actually three different
ways we can count GDP and the one we choose to use depends on what we’re
trying to study and investigate. So we could talk about aggregate production,
aggregate spending and aggregate income. We’ll talk about those three in turn but one
thing I want you to realize is that all three of these are looking at output
from different lenses. One is just looking at how much stuff is
being produced, another is looking at well when that stuff is being produced
someone is buying it so we can look at how people are spending and buying
those goods and another one is income. When I spend money on something that’s income
from somewhere else so we could look at all of the income that’s occurring
within the economy and we’re just slicing the same
production three different ways to try and estimate what’s really
happening in the economy. Now theoretically the first way
of calculating GDP is the easiest. So GDP is just a measure of production. So it could just be measured how much stuff
is coming off the factory production line, that’s for the goods, and how much stuff is
being produced in offices, that’s the services, and adding up the market value and saying
this is how much stuff is being produced in an economy at any given time. This next one is one we’re going to use over
and over and over again and what we’re going to be doing is we’re going to be looking
at aggregate spending and what we’re going to do is we’re going to say well
how much are the different sectors of the economy buying of
that goods and services? So we’re going to be looking at what the
consumers purchased, what the firms purchased, what the government purchased and what people
outside of the economy, the export or import or net exports, what they purchase. So I know what you’re thinking
and this always confused me too — what happens if something
is produced on December 31 and we’re looking at a calendar year? Well, people haven’t bought it yet. Well there’s some trickery that we can do
to try and get these numbers to work out. We could just sell it to ourselves as inventory,
but let’s go through this on the next page and I’ll help explain why we
would use this approach for some of the analysis we’re going
to do in this course. So as I said, the national spending
approach is memorize this formula, it’s going to come up over
and over and over again. Why is output, it’s the national GDP. It’s made up of what consumers buy,
investors buy, what government buys, and net exports which is exports minus imports
and what we want to think about is well when we have these cycles of
booms and busts, what’s happening? Is it that one part of the
economy is more responsive when things are going good or going poorly? And the answer turns out to be yes,
yes, this investment thing is the one that varies dramatically and
it’s the one that’s swinging around wildly in good times and bad times. So we want to talk about the
national spending approach. So just real quickly, C is
consumption, it’s what you or I buy. It’s goods and services, its foods,
its cars, it’s all that good stuff. I is what the firm is spending on tools and
plants but notice it also includes new homes and the reason why is I is going to be
closely tied to investments that happen across periods and it’s tied to interest rates. So as interest rates go up people
are less likely to buy homes. As interest rates fall people
are more likely to buy homes. So because it’s very impacted by the interest
rates what we’re going to do is we’re going to put new home spending in investment. G is government spending. So if government spending is on
their final goods and services, so if they are buying military or tanks or
schools or roads, that’s government spending. It does not include transfer payments. We’ll talk about transfer payments but transfer
payments are like I’m putting money in, they take it and they give it to someone else. That’s just a re-allocation. That is not a final good and service. And then net exports. This is the amount of stuff that
we produce that’s sold elsewhere but then we are also spending money
that wasn’t produced here so we have to subtract off the imports because we’re trying
to see what’s produced within our country. The amount of money that we’re spending on
imports shouldn’t count towards our production, it should count towards someone else’s. So we need to subtract off imports. Just to give you an idea of how GDP sizes
up, almost two-thirds of it is consumption so that’s consumers are buying
stuff, eating it, using it. We have about 16% in investment
and about 18% in government goods and currently we’re running a trade deficit
so we’re exporting or we’re importing more than we’re exporting and
the sum of this would equal about $17 trillion which
is the GDP in about 2013. So conceptually the third way you can
measure GDP is rather than looking at someone’s spending, there’s
someone on the other side of that transaction where
they’re getting income. So we could add up everyone’s income and
we think about wages which is the income for workers or rents which is the income
for landlords, interest which is the owners of the capital or profit and we
could add up all those and figure out how much money is being spent or how
much money is being brought in because on every transaction whatever’s
being spent is income somewhere else. Now we know that there’s some discrepancies
there because there’s sales tax and other stuff but theoretically we could account
for that so that’s the third method. I’ll give you an example of how
that works on the next slide. So if you think about buying a new car and
I said well let’s pretend it’s worth 25,000, that’s what the buyer pays for it, and there’s
a wholesale value and a cost of production, that $25,000 could get split out in a certain
way so some of it goes to the salesperson, some of it goes to the dealership, some
of it goes to the wages for the workers who put it together, some of it went to
the suppliers for the medical or the metal and the technology and some of it goes
profit to GM and some of it goes to dividends to the stockholders, we can break
that $25,000 out back to its sources and calculate the spending based on who
receives the money just as easily — or not just as easily but as
another way to calculate GDP. So we have these three different
various methods. They’re all trying to do the same thing but why
would we use one compared to something else? And what it’s going to come
down to is we’re going to start to investigate how these different
goods tie out so if we’re going to talk about business fluctuations and we’re going
to try and understand why are there booms and busts, we can focus on
the national spending approach and say consumption is normally pretty smooth and we can say government spending has some
ripples but it’s normally countercyclical and doesn’t explain it but investment
spending explains almost all of the business fluctuations. So depending on what we’re trying to
analyze it sometimes makes more sense to put on different lenses and try and understand the
phenomenon that were trying to investigate. Of course the main phenomenon that we’re
trying to understand is what causes growth and growth is a really good thing so what we
need to understand is how do we measure growth? And the way we measure growth is we look at
what GDP is in one year compared to what it was in the previous year to say how much did
it change by and then create a percentage so we divide it by the base
year, the previous year, and multiply by 100 to get the growth rate. So for 2013 we could look at here’s
the GDP in 2013, here it was in 2012. So the difference between those
two tells us how much it changed. Divide it by the base year and then multiply
by 100 to get a percent and we would know that GDP went up by about 3.5 or 3.4% in 2013. It gives us a way to measure growth. So so far when we’ve talked about growth or GDP, what we’ve done is we’ve said
multiply the output by the prices and it will tell us what the value is for what
we’ve produced in one year compared to the next. So in 2014 if a country only produced pizza,
beer and cigars and they had a value of $9600 and then the next year they produced $9900,
we’d say oh look there’s economic growth. But if you look really carefully there
something else that’s going on here. Well, the price has changed. In all of these the prices went
up and if you look at the output, well we’re producing less pizza than before,
we’re producing less beer and less cigars. So if we’re producing less of everything but
just prices went up we wouldn’t really want to call that growth because
our people aren’t actually able to consume more stuff, there’s
actually less stuff. So when we are calculating GDP and we are using
the same year prices, so this is 2014 and 2014 and 2015 and 2015, we call it nominal. So we’re just looking at the total value
of the output if we were to sell everything and put all the money in a cash register. But now what we’re going to want to do is
we’re going to want to say is this really grow? Is this better off? And one way we’re going to do that
is we’re going to hold prices steady. We’re going to say let’s let the prices stay the
same and then we’re going to compare the value of the output as it changes
over time and see what happens. So this is exactly what we said. We’re going to look at how the output changes
but we’re going to keep prices exactly the same and if we keep prices the same we’re going
to see that the value of the nominal output in 2014 was 9600 but the value of the output
in 2015 based on 2014 dollars was less. Well why? That’s saying in real terms we’re
now producing less stuff than we did before. This isn’t real growth. What we had was nominal growth
caused by inflation. This is our people, the real purchasing power, the real amount of stuff
they can consume went down. So nominal variables are just variables
that have not been adjusted for price. Real variables are ones that
have been adjusted for price. So think about it, if I was president of the
United States and my economy had the ability to produce exactly the same
amount that it produced last year, well my people aren’t getting
any better or any worse off. The real output is exactly the same. But if I double my money supply then I would
expect the prices of everything to double and my nominal GDP would be twice as much. But economists don’t really
care about nominal output. We care about the real standard of living. So we care about real variables. We care about how much stuff
people have to consume. So as a result we often look at real
variables and ignore nominal variables. So what does growth rate look like for the US? Well, check it out. The amount of real gross domestic product
has been increasing since after World War II. We’re producing more and more. Yes there are these little blips
that we’re going to be talking about, why they go up, why they go down. Those wiggles are the booms and the busts of
the business cycle and we’re going to be trying to explain what causes that and what causes
some countries to grow faster than others. So just like I talked about before this
highlights some of those recessionary periods. A recession is when growth slows
down or we don’t have growth at all. So if you look at that even though there’s
been steady growth there have been 11 periods since 1947 where we have a recession and
you’ll notice they’re not evenly spaced out, they’re not even periods of time. The recessions don’t last
for an even period of time. They’re unpredictable. So if you were to ask me, Scott when
is the next recession going to happen? I’m going to give you a blank look
and say your guess is as good as mine. No one can predict when these
things are going to happen. If we could predict it we
could probably prevent it or make billions of dollars in the stock market. So this graph instead of having
that trend of constantly going up, what we’re doing is we’re changing and saying
from year over year what is the growth rate? And on average the growth rate has
been a little bit more than 3%. So some years we have a lot of growth and some years we don’t have
much growth or negative growth. So this kind of shows the bouncing around from
year after year about when things are doing well and when we’re in a recession, when things
are doing well and when we’re in a recession. So this is just another way to see the
business cycle de-trended it’s called, to see what’s happening over time. So we’re going to want to be
talking about some terminology. So expansionary period is
when GDP is increasing. Recessionary is when GDP is decreasing. We want to talk about the peak which is when
you’re at the high point of the business cycle and the trough when you’re at the
low point of the business cycle. This business cycle, at least these definitions, will help us make sure we’re talking
about the same thing over time. Just so you know growth doesn’t
necessarily occur everywhere. There’s some places where economies
seem to grow very well and some places where economies don’t seem to grow at all and
we want to try and understand what that is and you’ll notice that there are
dramatic differences on this graph as to how much GDP has actually grown on
average per year over the last 50 years or more. So GDP per capita growth rate is
our best measure of how the standard of living is changing for a person. Just so you get an idea of what’s going on. If I have 100 people and my GDP doubles and my population doesn’t double then each
person is going to get twice as much stuff. But if I have a GDP that doubles but my population triples even though I have
more stuff it’s getting divided by more people. So this real GDP growth per person is
our best way to see how the standard of living is changing in a
particular place at a particular time. GDP deflator is a measure that we use to
take inflation out of the picture over time and it’s just nominal GDP divided by real
GDP and it gives us an idea of how much of that change in GDP is caused by price levels.

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