measuring a nation’s output
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Measuring a nation’s output. Having a number that summarizes the level of economic activity is clearly convenient Alternative would be to see how much of each type of good is available But then it is hard to compare One year output is 2 apples, 2 bananas Next year 3.5 apples, 1 banana - PowerPoint PPT PresentationTRANSCRIPT
Measuring a nation’s outputMeasuring a nation’s output Having a number that summarizes the Having a number that summarizes the
level of economic activity is clearly level of economic activity is clearly convenientconvenient
Alternative would be to see how much of Alternative would be to see how much of each type of good is availableeach type of good is available
But then it is hard to compareBut then it is hard to compare– One year output is 2 apples, 2 bananasOne year output is 2 apples, 2 bananas– Next year 3.5 apples, 1 bananaNext year 3.5 apples, 1 banana– Did output go up or down? Not clear!!Did output go up or down? Not clear!!
How would you measure How would you measure a nation’s output?a nation’s output?
Gross domestic productGross domestic product
Most frequently used measure of an Most frequently used measure of an economy’s outputeconomy’s output
Definition:Definition: GDP is the GDP is the market valuemarket value of the of the finalfinal goods and services goods and services produced in a country during a produced in a country during a given given periodperiod
Computing GDP (Example)Computing GDP (Example)
The GDP produced in a typical night in The GDP produced in a typical night in SoBeSoBe
100 people go to a nightclub (cover 100 people go to a nightclub (cover is $20 each)is $20 each)
100 go to the new world orchestra 100 go to the new world orchestra ($40 dlls per ticket)($40 dlls per ticket)
300 rolls of sushi are prepared ($15 300 rolls of sushi are prepared ($15 per roll)per roll)
50 gallons of orange juice are 50 gallons of orange juice are consumed ($5 per gallon)consumed ($5 per gallon)
Computing GDP (Example)Computing GDP (Example)
A typical night at southbeachA typical night at southbeach 100 nightclub (times $20)100 nightclub (times $20) 100 orchestra (times $40)100 orchestra (times $40) 300 rolls of sushi (times $15)300 rolls of sushi (times $15) 50 gallons of OJ (times $5)50 gallons of OJ (times $5)
$2000$2000
+$4000+$4000
+$4500+$4500
+$ 250+$ 250
GDP=$10750GDP=$10750
Remark: GDP is a sum of quantities weighted by price
Important remarksImportant remarks
When computing GDP more When computing GDP more expensive items receive a higher expensive items receive a higher weight than cheaper onesweight than cheaper ones
Is that reasonable?Is that reasonable?– Idea behind it: Amount people are Idea behind it: Amount people are
willing to pay is an indication of the willing to pay is an indication of the benefit they receivebenefit they receive
Important remarks (2)Important remarks (2) Only Only final goodsfinal goods are counted in GDP are counted in GDP
We did not include (to name a few)We did not include (to name a few)– The DJ wages paid by the nightclubThe DJ wages paid by the nightclub– The wages of the musicians of the The wages of the musicians of the
orchestraorchestra– The ingredients needed for sushi: Fish, The ingredients needed for sushi: Fish,
rice, wasabirice, wasabi– Oranges purchased to prepare OJOranges purchased to prepare OJ
A A final goodfinal good is the end product of a is the end product of a process and it is the good or service process and it is the good or service that consumers actually usethat consumers actually use
The goods or services produced on The goods or services produced on the way towards making the final the way towards making the final product are called product are called intermediateintermediate
DefinitionsDefinitions: Final vs intermediate goods: Final vs intermediate goods
If we computed GDP by adding If we computed GDP by adding market value of final + intermediate market value of final + intermediate goods we would be double counting goods we would be double counting – Oranges (intermediate good) are Oranges (intermediate good) are
purchased to produce juice (final good) purchased to produce juice (final good) and the final good price includes the and the final good price includes the cost of the necessary inputs to produce cost of the necessary inputs to produce itit
Why GDP includes only final Why GDP includes only final goods?goods?
Computing GDP is rather Computing GDP is rather complicated and costly!complicated and costly!
A list of each final good produced A list of each final good produced during the year is required (together during the year is required (together with prices).with prices).
It is mathematically simple, but the It is mathematically simple, but the amount of information required is amount of information required is hugehuge
Is there any alternative way?Is there any alternative way?
The expenditure method for The expenditure method for measuring GDPmeasuring GDP
Any good or service that is produced Any good or service that is produced will also be purchased and used by will also be purchased and used by some economic agentsome economic agent
The 4 economic agents considered in The 4 economic agents considered in national accounts are:national accounts are:– HouseholdsHouseholds– FirmsFirms– GovernmentGovernment– Foreign sectorForeign sector
Expenditure method (contd)Expenditure method (contd)
Note: Amounts that purchasers Note: Amounts that purchasers spend on various goods and services spend on various goods and services is equal to the market value of those is equal to the market value of those goodsgoods
GDP can be measured with equal GDP can be measured with equal accuracy by either of two methods:accuracy by either of two methods:
Adding up the market value of all goods and Adding up the market value of all goods and services that are domestically producedservices that are domestically produced
Adding up the total amount spent by each of Adding up the total amount spent by each of the four groups on final goods and services, and the four groups on final goods and services, and subtracting spending on imported goods & subtracting spending on imported goods & servicesservices
(output) (output) GDP=C+I+G+X-MGDP=C+I+G+X-M (total expenditure) (total expenditure)
What economists mean by investmentWhat economists mean by investment
Investment is spending by firms on Investment is spending by firms on newnew factories, office buildings, machinery, and factories, office buildings, machinery, and inventories and spending by households inventories and spending by households on on newnew houses. Improvements on existing houses. Improvements on existing structures are also included.structures are also included.
Buying stocks only changes ownership and Buying stocks only changes ownership and does not add to GDP (this type of financial does not add to GDP (this type of financial expenditure is not investment in expenditure is not investment in economics)economics)
The need for computing “real” GDPThe need for computing “real” GDP
Economists like making time Economists like making time comparisons of aggregate data to comparisons of aggregate data to see “how the economy is see “how the economy is performing”performing”
Near elections a president would like Near elections a president would like saying that the economy grew during saying that the economy grew during her/his term her/his term
Measured by GDP Mexico and Angola grow Measured by GDP Mexico and Angola grow
much faster than the USmuch faster than the US
GDP, annual growth (% rate)
0
5
10
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40
year
1989
1990
1991
1992
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1995
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1998
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0
100
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300
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Mexico USA Angola
What is going on then?What is going on then?Consider the following hypothetical Consider the following hypothetical
economyeconomy Year: 2002Year: 2002
Goods producedGoods produced 10 Microsoft office 2000 10 Microsoft office 2000
($100 each)($100 each) 2 Pentium 4 ($2000 2 Pentium 4 ($2000
each)each)GDP = GDP =
10*100+2*2000=$500010*100+2*2000=$5000
Year: 2003Year: 2003
Goods producedGoods produced 10 Microsoft office 2000 10 Microsoft office 2000
($200 each)($200 each) 2 Pentium 4 ($4000 each)2 Pentium 4 ($4000 each)GDP = GDP =
10*200+2*4000=$10,00010*200+2*4000=$10,000
The quantities of goods and services produced are thesame, yet, GDP doubled. Why?
We need to exclude the effects of We need to exclude the effects of price changes!!!!!price changes!!!!!
How to do it?How to do it?– Standard approach is to use a common Standard approach is to use a common
set of prices to value quantities set of prices to value quantities produced in different yearsproduced in different years
– One picks a particular year, called One picks a particular year, called base base yearyear, and uses the prices for that year to , and uses the prices for that year to calculate the market value of output for calculate the market value of output for all other yearsall other years
Compute Real GDP for our exampleCompute Real GDP for our example Step 1. Set the base yearStep 1. Set the base year
Year: 2002Year: 2002
Goods producedGoods produced 10 Microsoft office 2000 10 Microsoft office 2000
($100 each)($100 each) 2 Pentium 4 ($2000 2 Pentium 4 ($2000
each)each) Real GDP =Real GDP =
Year: 2003Year: 2003
Goods producedGoods produced 10 Microsoft office 2000 10 Microsoft office 2000
($200 each)($200 each) 2 Pentium 4 ($4000 each)2 Pentium 4 ($4000 each)Real GDP =Real GDP =
One problem with real One problem with real GDP: New goods biasGDP: New goods bias
How to make cross-country income How to make cross-country income comparisons?comparisons?
• Each country reports GDP in terms of their local currency
• How can we compare incomes across countries?
Illustrative ExampleIllustrative Example
Suppose all countries produce, each year, one good: a big-mac
If GDP measures the quantity of goods and services produced by each given country, any sensible measure of GDP in this example should say all countries have the same GDP
GDP in dollars is extremely different GDP in dollars is extremely different across countries!!!across countries!!!
Country Big mac price (local currency, april 2003)
In US dollars
US 2.71 2.71
China Yuan 9.90 1.20
Mexico Peso 23.00 2.18
Argentina Peso 4.10 1.43
Switzerland S Franc 6.30 4.59
Source: The economist’s big mac index
What is going on?, How to construct What is going on?, How to construct comparable GDP figures?comparable GDP figures?
• A dollar has very different purchasing power across countries
• In other words, relative prices vary a lot across the world
• When making cross country comparisons use PPP adjusted measures
• Method (in simple terms): Use one country’s prices to compute the GDP of all other countries
REAL GDP growth in Angola, REAL GDP growth in Angola, Mexico and the USMexico and the US
Real GDP, annual growth (% rate)
-8
-6
-4
-2
0
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4
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year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
0
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Mexico USA Angola
Measuring Economic Growth
The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next.
Growth year 2004: (GDP2004-GDP2003)/GDP2003 - 1
GDP vs Welfare
Real GDP is not a perfect measure of economic welfare because:
1. Quality improvements tend to be neglected in calculating real GDP so the inflation rate is overstated and real GDP understated.
2. Real GDP does not include household production, that is, productive activities done in and around the house by members of the household.
GDP vs Welfare
3. Real GDP, as measured, omits the underground economy, which is illegal economic activity or legal economic activity that goes unreported for tax avoidance reasons.
4. Health and life expectancy are not directly included in real GDP.
5. Leisure time, a valuable component of an individual’s welfare, is not included in real GDP.
6. Environmental damage is not deducted from real GDP.
7. Political freedom and social justice are not included in real GDP.