7.

Measuring GDP
3

Foreign Sector/ Rest of the World

The Big Picture

Consumption (C)

Imports (M)

Exports (X)

GDP=C+I+G+(X-M)
Aggregate Expenditures

Lending for

Investments (I)
Govt borrowing Govt Expenditures (G)

Savings

Financial Sector

Firms Government

7. MEASURING GDP
Households

Transfers
Disposable Income = Wages-taxes+transfers

Taxes

GDP
Aggregate Income

Macro Recitation 04 - Torsten Jochem - 2009/02/17-19

Based on chart in our textbook, p.146

Content
2 4

7. Measuring GDP
The Big Picture
GDP = Gross Domestic Product Every economic action has 2 sides to it: spending and receiving income. We can therefore explain the flows in the economy either via an expenditure or an income approach.
Expenditure Approach: Computing the GDP by adding up all spending on all final goods and services produced in one country in one year. Income Approach: Computing the GDP by adding up all earnings from resources used to produce output (e.g. labor wage, ) in one country in one year.

7. Measuring GDP
The Big Picture: The Flows of the Economy The Expenditure Approach The Income Approach Limitations of National Income Accounting Accounting for Price Changes
The CPI Nominal and Chained dollars GDP GNI

7. Measuring GDP
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7. Measuring GDP
The Expenditure Approach
GDP: Y = C + I + G + (X-M) Government Expenditures (G) (~10-20% of GDP)
Govt consumption (wages, coffee, paper, ) and govt investment (public goods, e.g. schools, infrastructure,)

The Big Picture

GDP = All final goods & services sold to final/end consumers at selling/market prices!
Hence, when Starbucks buys coffee or has a plumber come, these are intermediate goods & services and not counted into the GDP. Otherwise, there is double counting!

Exports(X) - Imports (M) = Net Exports (NX)

Of goods and services (invisibles); usually -2 to -6% of GDP

Note:
GDP does not include transfer payments from the govt (unemployment insurance, social security,) since they are no spending on any final good or service.

7. Measuring GDP
6 8

7. Measuring GDP
The Income Approach
GDP is computed by aggregating the incomes earned by input suppliers in production
Example: a Hersheys chocolate bar creates
incomes for the workers (labor); suppliers of milk, sugar, electricity,(resources), profits to the owner (capital, entrepreneurship, technology)

The Expenditure Approach

Consumption (C) (~60-70% of GDP)
All household purchases of final goods and services, except new housing; durable goods (last at least for 3 years) and non-durable goods. Selling private used stuff to other household is not counted (again, double-counting), since no new value was created.

Investment (I) (~15-20% of GDP)

Spending on current production not used for current consumption All new capital goods; new residential housing (=private investment); net additions to inventories; not bonds and stocks (this is just ownership of existing capital)

The price of the Hershey chocolate bar equals the sum of those incomes.

To avoid double-counting, only the value-added by each firm is computed.

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7. Measuring GDP
Limitations of National Accounting
(1) GDP values sold (new) products and services
(1.1) Do-it-yourself work, household work, child care, etc. are not included.
Societies more self-sufficient households have lower GDPs.

The Income Approach

The value-added at all stages sums to the market value of the final good. The value-added of all final goods adds up to the GDP based on the incomes approach. Aggregate spending = GDP (Y) = Aggregate Income
(assumed, that all profits by companies are paid out to the owners as income) Thats why we call GDP (Y) national output but also national income.

(1.2) Off-the-book production is missing in the GDP. Informal economies as a percentage of the economy are much much larger in developing economies. (1.3) Pure financial and barter exchanges not included (1.4) Sale of used goods not included (1.5) Govt and private transfer payments not included.
Social Security, unemployment benefits, Subsidies,

7. Measuring GDP
10

Foreign Sector/ Rest of the World

12

7. Measuring GDP
(2) GDP as a proxy of societies utility
If one thinks of GDP (=income/output) as a proxy for the utility created by society, then it misses out on leisure time (b/c its not sold in the market) and the quality of products, both which create utility.
e.g. a computer for $1000 today can do much more than a computer for $1,000 five years ago.

The Big Picture

Consumption (C)

Imports (M)

Exports (X)

C+I+G+(X-M)
Lending for

Investments (I)
Govt borrowing Govt Expenditures (G)

Expenditure Part of Cycle

Savings

Financial Sector

Government Transfers Taxes GDP Aggregate Income

Income Part of Cycle

(3) GDP & Prices

GDP is valued at current market/selling prices, hence with inflation it changes over time and is not comparable. Solution: real GDP (see later slides)

Disposable Income (DI)= Wages-taxes+transfers

Households
Based on chart in our textbook, p.146

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7. Measuring GDP
Accounting for Price Changes
GDP measured in current dollars is called Nominal GDP.
The issue: $1 in 1960 bought much more than $1 in 2008; market prices in 1960 not comparable to 2008. Example:
1979-1980: GDP increase of 9%, but inflation of 9%, too. So no real GDP increase!! GDP becomes inflated from inflation. We need to take out the hot air/deflate GDP back to its real value.

(4) Externalities: GDP does not include all costs.

GDP does not account for negative externality costs from investments: e.g. more factories increase GDP, but GDP does not capture long-term costs of more polluted air ( China) GDP when seen as a proxy for utility created by a society does not account for worse labor stand conditions (sweat shop conditions, child labor, etc.) which is lowering utility.

(5) GDP & Distribution

GDP does not say anything of who owns aggregate income (use GINI-Coefficient for that).

Taking inflation out of, we call it Real GDP.

7. Measuring GDP
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7. Measuring GDP
Calculation of Real GDP
Formula:
Real GDP = (Nominal GDP/Price index) x 100

(6) GDP vs. GNP (=Gross National Product)

GNP = domestic production vs. production by nationals worldwide

(7) NDP, NNP (=Net National Product)

NDP = GDP Depreciation (of investment goods) Say, we use up oil in our production this is not investment, but included in the final sales price. Say we invest $100K into a new truck that can do 300K till its dead. In the 1st year we drive 150K miles. So the truck is 50% used up. We shouldnt account for it at the end of the year with $100K as a new investment, but only with $50K since the rest has been used up (just as the oil) during production. (Likewise NNP = GNP Depreciation (of investment goods))

Example:
Base year = 2000 (thus price index in 2000 was 100) Nominal GDP for 2008 = $13,840 billion Price index for 2008 = 124

2008 Real GDP1 =

($13,840 billion / 124) x 100 =$11,161 billion
1

(with base year 2000)

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7. Measuring GDP

The Consumer Price Index (CPI)

Every year, a basket of the same basic households goods & services is evaluated at its current market prices; the price change of the basket gives us the inflation rate. Example:
1. Jan 2008: basket costs $735; 1. Jan 2009: same basket $765
765/735 = 1.04 4% inflation in 2008.

Any Questions?

Issues with the method:

Finding the exact same goods is hard, since electronics, cars, go out of sale and are replaced with better ones. Consumers shift their basket away from goods that become too expensive; hence, CPI may overstate true rising living costs. (Prices differ by sellers, regions, seasons, )

7. Measuring GDP
18

Calculation of CPI
Example: Say our base year is 2000 and the basket costs in 2000 $600.
Current year 2000 2001 2008 Basket price in current year $600 $650 $760 Basket price in base year $600 $600 $600 Price Index 100 108 126

760/600 = 1.26 * 100 = 126