GDP and Its Discontents

Suggested Supplementary Reading

Ebook: Peter Kennedy Macroeconomic
Essentials: Understanding Economics in
the News

Quantity Aggregates
To understand the macroeconomy, we need to measure it.

Chief measure of economy is the level of production

We need to combine the many goods produced or
consumed in an economy into one measure.

+
+

=?

All goods sold in an economy

share a common unit of
measure: the price at which
they are sold.

Sum up
the value
of goods

Gross Domestic Product (GDP)

GDP is the sum of the value of new, final
goods produced within the domestic borders
of an economy.
Final goods are goods
sold to their end-users

GDP does not include:

Intermediate goods which are sold from
one firm to another for immediate
transformation into other goods.
financial transactions like buying
stocks.
purchases of used goods which have
been sold before.
goods produced overseas by domestic
firms.

Three Methods for Calculating GDP

1. Production Method - The value added
created in all the sectors of the economy.
2. Expenditure Method - The sum of the
domestic spending on final goods (less
domestic demand satisfied by imports).
3. Income Method The Wage, Rent,
Interest and Profit Income generated by
the domestic economy.

Production Method
At the plant level, Value added =
Sales + Change in inventories
- materials, intermediate inputs and energy costs.

Value added at the firm level is directly taxed

in the EU (VAT)
GDP is the sum of VA across establishments.
The value of a final good is equal to the value
added at each stage of production.

Hong Kong Census and Statistics

Expenditure Method
C
+

Consumption

Consumer durables, nondurables, services

I
+

Investment

Structures (incl. Residential),

Equipment, and Inventory

G Government Government Spending on

+ Consumption Goods, Services, and Salaries.
X
-

EXports

Goods & Services Shipped

Abroad

IM IMports

Goods & Services from Abroad

A + NX = (C + I + G) + (X IM)

GDP

Japanese Expenditure

Expenditure Categories in Hong Kong:

2008

Hong Kong Census and Statistics

Income Method
Survey domestic residents and calculate
their wage income, interest income, rental
income plus the income of proprietors of
small firms plus the profits & depreciation
of the corporate sector.
Subtract net international income flows.

Not calculated for HK on an annual basis.

Income Method, Japan 2003

High Concept
Income =
Expenditure =
Value Added

High Concept
Value of a final good expenditure is equal
to value added at each stage of
production. (Expenditure = Value Added)
Value Added would be paid to workers,
creditors, or kept as profits. (Income =
Value Added)

GNP vs. GDP

GNP
Gross National Product

GDP
Gross Domestic Product

= income earned by
domestic residents

= income created within

national borders.

Compare Macau and the

Philippines GDP or GNP
Macau produces a lot of profits paid to
overseas owners of casinos.
Philippines workers earn a lot of income
overseas.
Which is larger Philippines GDP or
Philippines GNP?
Does Macau have greater GDP or GNP?

Comparing GDP levels across time

GDP measures the value of the goods produced
by an economy by using the market price of
each good to assign it a value.
Problem: Prices of goods in terms of money are
changing overtime making comparisons in
overall value difficult.
Bias: Money prices are growing over time as money
supply grows.

Solution: Choose a Base Years prices as a fixed

yardstick of value for different goods.

Real GDP: Yt
GDP aka Nominal GDP aka Current Dollar
GDP is the weighted sum of the number of
goods produced using their current prices
as the weight.
Real GDP aka Constant Dollar GDP aka
GDP adjusted for inflation is the weighted
sum of the number of goods produces
using the Base Year prices as yardsticks.

Real GDP: Yt
GDP aka Nominal GDP aka Current Dollar
GDP is the weighted sum of the number of
goods produced using their current prices
as the weight.
Real GDP aka Constant Dollar GDP aka
GDP adjusted for inflation is the weighted
sum of the number of goods produces
using the Base Year prices as yardsticks.

Real GDP vs. Nominal GDP

St. Louis Federal Reserve

GDP vs. GNP: Hong Kong

Solved Problem
Real GDP: 2005 (2004 Base Year)
2005
P
Kitkat
M&Ms
Nominal GDP
Real GDP

2004
P

150

135

10

150

135

Real GDP vs. Nominal GDP

St. Louis Federal Reserve

GDP vs. GNP: Hong Kong

Comparing GDP across

Countries
When you compare income in two different
countries, each countrys GDP per capita is
measured in local currency. You need to
measure both with common yardstick to
compare.
Typically, the common yardstick will be
US$. GDP can be converted to US$ by
Exchange Rate Method (divide national
GDP by the exchange rate) or PPP Method
(divide national GDP by PPP).

PPP vs. Exchange Rate

Conversion
Exchange rates are easily available so
exchange rate is a quick and dirty comparison.
Measures how many US dollars someone could buy
with average income.

However, money goes farther in some countries

as many types of goods are relatively cheap
(especially developing countries).
PPP conversion measures how much the goods
purchased by the average person would cost in the
US. Better measure of living standards.
World Bank Conversion Factors

Price Indices: Pt
Two most commonly used price indices
are GDP Deflator and Consumer Price
Index (CPI)
The GDP deflator is the ratio of nominal
GDP to Real GDP (multiplied by 100).

Nominal GDP
P GDP Deflator
100
Real GDP
GDP
P
100
Y

Consumer Price Index

The CPI is the price of a representative
market basket of goods relative to the price of
that same basket during a benchmark/base
year (multiplied by 100).

Cost of Market Basket in year t

CPI t
100
Cost of Market Basket in Base year

International Comparisons Project

Researchers at U. of Pennsylvania periodically
choose a representative world market basket
and go to different countries to collect prices of
that market basket of good.
For a country, we calculate PPP = Purchasing
Power Parity as the price of the market basket
relative to price of the market basket in US.
For any country, the exchange rate, St, is the
number of domestic dollars per US$.
Penn World Tables

Depreciation
Part of the Investment that is being done will
only go to replacing depreciated capital.
When Hurricane Katrina hits, repair of
infrastructure counts as GDP even though that
only replaces what is lost.
Net DP
Conceivably, since only consumer spending
generates benefit to household welfare, maybe
consumption itself is a better measure.

National Resource Depletion

Selling of mineral extraction and other
non-renewable resources increases
income but this also runs down wealth.
Example: Nauru and Phosphates
https://www.cia.gov/library/publications/theworld-factbook/geos/nr.html

Environmental Quality
Clean air and water are important for
welfare but not measurable as a market
good (ie. GDP is a market good).
Possible Solution: Estimate of
environmental quality.

Inputed Services of Non-Market

Capital
Welfare generated by renting housing
included in GDP, but what if you own your
own home?
Statistical agencies include imputed value
of homes by checking rental rates but not
cars, TVs etc.
Is rental market parallel to purchase
market?

Housework
If you pay someone to do housework or
watch your kids, then it will be counted in
GDP. If you do it yourself, it will not be.
Big shift from household production to
market production of housing services in
recent years (helpers, daycare,
kindergarten, tutors, etc.)
This shift would increase GDP without
more goods being produced.

Income Distribution
GDP per Capita is a measure of the
income for the average person
But if one person has $1,000,000 and
another person has 0, the average is
$500,000.
This is a quite different economy than one
in which two people both have $500,000.

Health/Crime
Life expectancy and infant mortality are
key indicators of living standard.