Measuring the Economy

1. Measuring the Economy

2. Three Approaches • Output Approach: • Primary – agriculture • Secondary – manufacturing • Tertiary – services • Expenditure Approach: • Consumers • Businesses • Government • Foreign buyers • Income Approach: • Labor – wages, salaries, etc. • Land – rents • Capital – interest payments • Entrepreneurship – business profits

3. Three Approaches Aggregate expenditure on domestically produced final goods & services = $21,500 (EXPENDITURE APPROACH) Sum of factor payments = $21,500 (INCOME APPROACH) Sum of value added = $21,500 (OUTPUT APPROACH)

4. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP has to measure different products (“apples and oranges”)…it can only do that by calculating everything on the basis of its market value

5. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: domestic services, underground economy, etc.

6. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: owner occupied housing, domestic services, underground economy, etc. GDP tries to avoid double counting, so it excludes “intermediate goods” that are used to produce final goods, e.g. wheat for bread…exception is “unsold inventory” at end of year

7. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: owner occupied housing, domestic services, underground economy, etc. GDP tries to avoid double counting, so it excludes “intermediate goods” that are used to produce final goods, e.g. wheat for bread…exception is “unsold inventory” at end of year GDP includes both physical goods as well as services, even government services such as police and firefighters

8. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: owner occupied housing, domestic services, underground economy, etc. GDP tries to avoid double counting, so it excludes “intermediate goods” that are used to produce final goods, e.g. wheat for bread…exception is “unsold inventory” at end of year GDP only includes things produced in the current period; it excludes things that were produced earlier and resold, e.g. use cars, stock trading GDP includes both physical goods as well as services, even government services such as police and firefighters

9. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: owner occupied housing, domestic services, underground economy, etc. GDP tries to avoid double counting, so it excludes “intermediate goods” that are used to produce final goods, e.g. wheat for bread…exception is “unsold inventory” at end of year GDP looks at where goods are physically produced (or services performed)…so if a US citizen works in China, his/her production is counted as China’s GDP GDP only includes things produced in the current period; it excludes things that were produced earlier and resold, e.g. use cars, stock trading GDP includes both physical goods as well as services, even government services such as police and firefighters

10. GDP is the Market Value… Of All… Final… Goods and Services… Produced… Within a Country… In a Given Time Period GDP tries to be as comprehensive as possible, but can’t measure everything. Examples: owner occupied housing, domestic services, underground economy, etc. GDP tries to avoid double counting, so it excludes “intermediate goods” that are used to produce final goods, e.g. wheat for bread…exception is “unsold inventory” at end of year GDP is usually measured annually or quarterly…it’s a “flow” measure (vs. stock measure)…if measured quarterly, the number is usually “annualized” and “seasonally adjusted” GDP only includes things produced in the current period; it excludes things that were produced earlier and resold, e.g. use cars, stock trading GDP looks at where goods are physically produced (or services performed)…so if a US citizen works in China, his/her production is counted as China’s GDP GDP includes both physical goods as well as services, even government services such as police and firefighters

11. Government spending (+) Government borrowing (-) Taxes Transfers (+) G Private borrowing (+) Private savings (-) Cons. spending Wages, rent, interest, profits C Factor Markets Product Markets Firm costs for purchase of FoP Firm revenue Investment spending Corporate borrowing / stock issuance (+) I X Exports (+) Foreign borrowing / sale of stock IM Imports (-) Foreign lending / purchase of stock

12. Components of GDP (“Y”) • Consumer Spending (“C”) • Spending by households on goods and services; but excludes purchase of new housing • Investment or Business Spending (“I”) • Spending on capital equipment, inventories and buildings, includes household purchase of new housing • Government Purchases (“G”) • Spending on goods and services by all levels of government, includes wages of government workers but excludes transfer payments • Net Exports (“X” – “M” = “NX”) • Spending on domestic goods by foreigners (X) minus spending on foreign goods by domestic residents (M) • Therefore: Y = C + I + G + (X – M)

13. Limitations of GDP • Data inaccuracies • Unrecorded activities • Informal transactions, e.g., volunteer work, parenting, etc. • DIY work, e.g. subsistence farming, home repair, etc. • Underground economies • External costs/benefits • Resource depletion • Pollution (or pollution clean up) • Quality of life • Leisure time • Safety, quiet, stress, aesthetic aspects of life • Composition of output (“bads”) • Semi-automatic rifle vs. jar of baby food

14. Other NIPA Measures • Gross National Product (GNP) • Similar to GDP, but it treats income of nationals overseas as part of national income (and excludes local income of foreigners) • Net National Product (NNP) • Similar to GNP, but excludes capital depreciation (cost of wear and tear on capital stock and buildings) • Personal Income (PI) • Income that households receive • Disposable Income (DI) • Income that households have left after paying taxes • Key points: many measures, all different but derived from one another, generally tell the same story

15. Per Capital GDP GDP in US$B - 2010 GDP Per Capital in US$ - 2010 $5.90T $5.45T $4,428 $42,831

16. Real vs. Nominal GDP Sample Economy Nominal GDP Calculation = + x x = + x x = + x x Real GDP Calculation (2010 as base year) GDP Deflator = Nominal GDP / Real GDP

17. "Gross domestic product does not allow for the health of our children, thequality of their education, or the joy of their play. It does not include the beautyof our poetry or the strength of our marriages, the intelligence of our publicdebate or the integrity of our public officials. It measures neither our courage,nor our wisdom, nor our devotion to our country. It measures everything, inshort, except that which makes life worthwhile, and it can tell us everythingabout America except why we are proud that we are Americans.” … Robert Kennedy

18. “GDPdoes not measure the health of our children, but nations with larger GDP can afford better health care for their children. GDP does not measure the quality of their education, but nations with larger GDP can afford better educational systems. GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and to enjoy poetry. GDP does not take account of our intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable attributes are easier to foster when people are less concerned about being able to afford the material necessities of life. In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life.” … Greg Manikw (Harvard Economist)