GDP(english)

CLASS NOTES: MEASURING PRODUCTION, INCOME,
AND SPENDING
Introduction:
1.Look at any newspaper – it is full of statistics regarding the well being of the overall
economy. Why?
2.The overall economy affects all of us. Think about the job market or buying a home
3.Macroeconomics: The study of economy-wide phenomena, including inflation,
unemployment, and economic growth.
4.Microeconomics will be very useful in studying the economy as a whole, because the
economy as a whole is just a collection of many individuals.
Purpose of today: Discuss the data that economists and policymakers use to monitor the overall economy.
Key: economists and policymakers need more than just a vague sense of how things are going, we need concrete data to help understand our economy and analyze potential economic policies.
Link to past: Markets looked at how prices and outputs are determined by rational economic agents interacting with each other. Are there macroeconomic equivalents for prices and output?
Motivational perspective: If we are going to analyze policies and determine the current and future states of the economy, we better figure out what an ideal measure is, and how close we can get to the ideal in reality.
Punchline: The “performance” of the overall economy is simi lar to the health of an individual – there is no one single measure. Rather, we have a collection of variables (statistics) which are all inter-related. Our trick is to identify each variable and then see how they are all related. Then we can figure out the most effective treatments (first rule of medicine: do no harm…)
The Economy’s Income and Expenditure:
GDP: tries to measure the total income that everyone in the economy is earning.
Key: GDP is going to measure two things at once. In other words, there are two things that turn out to be identical, and GDP is the measure of these things.
1.Total income of everyone
2.Total expenditure on the economy’s output of goods and services
For the economy as a whole, total income must equal total expenditure.
Why? Every transaction involves a buyer and a seller. The buyer pays $100 (an expenditure of $100), and the seller receives the $100. In the end, all of the $100 ends up as income for people.
Question: How do we measure “total income” or “total expenditures?” That is:
How do we measure GDP?
GDP (Gross Domestic Product): The market value of all final goods and services produced within a country in a given period of time.
This is how they are going to calculate GDP.
Think back to the papers…this is very important stuff!
Let’s break this definition down:
“GDP is the market value…”
GDP adds together many different kinds of products: computer purchase, haircut, car, wine, ect..
How can it add apples and oranges? It uses market prices.
Market prices measure the amount people are willing to pay for different goods –they reflect the value of those goods.
In other words, GDP cares a great deal about how much value we place on goods, not just how many goods are consumed.
“…Of all…”
Tries to be comprehensive, but it does exclude:
1.items produced and sold illicitly.
2.Items produced and consumed at home (a home garden)
“…Final…”
example: International paper makes paper, which Hallmark uses to make a greeting card.
The paper is an intermediate good, and is not counted towards GDP, only the greeting card is.
“…Goods and services…”
includes both tangible goods (computer, apples, ect.) and intangible services (haircuts, housecleaning, doctors visits, ect.)
“…Produced…”
Includes items only that are produced in the current year. A used car sale is not a part of GDP.
“…Within a country…”
The key is geographic confines.
A Canadian working temporarily in the U.S. – his production adds to U.S. GDP. An American who owns a factory in Haiti does NOT contribute to U.S. GDP
Note that this is the big difference between GDP and GNP.
“…In a given period of time…”
Usually either quarterly or annually.
Quarterly GDP is “adjusted seasonally”
The Components of GDP:
Idea: GDP is measuring total expenditures – but we can spend our income on lots of different types of goods.
Economists, in trying to understand the economy, care about what types of spending make up big or small shares of total GDP, and how these shares change over time (and what causes these changes).
GDP = Y = total income = total expenditures
Y = C + I + G + NX This is an identity: it must be true by definition.
C = consumption (I buy a bottle of wine)
I = investment (GM builds a new car factory)
G = Navy buys a new submarine
NX = net exports (exports – imports) British Airways buying a new plane from Boeing.
Real versus nominal GDP:
There is a problem when we start to compare GDP over time:
Suppose GDP increases this year – what could drive this?
1.The economy is producing a larger output of goods and services.
2.Goods and services are being sold at a higher price.
Key: it is crucial to be able to separate out these two effects.
Goal: measure the total quantity of goods and services the economy is producing that is not affected by changes in the prices of those goods and services.
Intuition: Compare a house built 10 years ago to the exact same house built today. It should contribute the same to GDP in each year, yet because prices rise over time, the house adds more to GDP toda y than it did 10 years ago. We want to correct for this “price affect.”
Real GDP: answer the question: “what would be the value of the goods and services produced this year if we valued these goods and services at the prices that prevailed in some specific year in the past?
= Real GDP show how the economy’s overall production of goods and services changes over time. It takes into account prices and adjusts for them.
An Intuitive Illustration:
The goal of GDP is, loosely, to gauge the economic well-being of society. To see the importance of using REAL GDP rather than NOMINAL GDP, consider the following scenario:
Suppose in year 1, a country produced 2 bottles of wine priced at $10 each. GDP in year one would therefore be $20. Now, suppose for some reason prices rose to $20 each, but quantity remained the same (2 bottles). What would GDP be? Well, at current prices, the market value of the final goods produced in the year is now $40, suggesting that our living standards have doubled! Would you feel twice as well off because your income doubled while at the same time prices doubled? Ofcourse not.
This is a serious error that must be corrected. This correction is at the heart of why we calculate REAL GDP: REAL GDP keeps prices constant at some base year. In the example above, if we kept prices constant at the levels in year 1 ($10), then REAL GDP in year two would remain at $20.
The main point, then is:
Construction of Real GDP:
Let’s look at a numerical example:
Prices and Quantities
Year P peaches Q peaches P pears Q pears_____ 2001 $1 100 $2 50
2002 2 150 3 100
2003 3 200 4 150
Year Calculating Nominal GDP
2001: 1x100 + 2x50 = $200
2002: 2x150 + 3x100 = $600
2003: 3x200 + 4x150 = $1,200
Year Calculating Real GDP (base year 2001)
2001: 1x100+ 2x50 = 200
2002: 1x150 + 2x100 = 350
2003: 1x200 + 2x150 = 500
Year Calculating the GDP Deflator
2001: (200/200)x100 = 100
2002: (600/350)x100 = 171
2003: (1200/500)x100 = 240
Main points:
1.Real GDP: what is the value of GDP using constant prices in a given (base) year?
2.GDP deflator: a measure of the price level calculated as the ration of nominal
GDP to real GDP times 100
3.GDP deflator = Nominal GDP/Real GDP x 100
Interpretation of GDP deflator: = 171: the price level increased by 71 percent from the year 2001 to 2002.
Note: Next time we will look at another measure of how prices change over time – the consumer price index (CPI).。