GDP Concepts

Chapter 24

Gross Domestic Product

All final goods and services produced during

the year by factors of production located

within the country.

Intermediate Goods

vs.

Final Goods

Intermediate Goods Examples:

•A waterpump installed in the factory to help build a new car.•Flour that is used by a baker in baking bread for sale.•Electricity used to light the lawyer’s office.•Bandages used by a physician in his office.•Lumber used by a contractor to build a house.•Paper rolls used by a newspaper company.

Final Goods Examples:

•Flour purchased by a housewife to bake bread.•Gas you buy for your car.•The new car you bought.•A new home.•The services that the lawyer bills you for.•The lightbulbs you buy for your apartment.•Dinner out.

The Circular Flow: The Concept.

Dollars flow one direction, goods and services flow the other.

You pay the barber, the barber pays the grocer, the grocer pays the repair shop and so on.

In each of these cases, notice that goods and services flowed the other way: the repair shop fixed the grocer’s car, the grocer provider food to the barber, the barber cut your hair...

See the original drawing in Ruffin&Gregory Ch 24.

One Way to Measure GDP: As the sum of all final expenditures.

GDP = C + I + G + X - M

Where C is Consumption expenditures on new product, (no matter where it was originally produced).I is Investment expenditures, both Fixed Investment (which is expenditure on plant and equipment) and Inventory Investment (e.g. the Pontiac dealer fails to see a Pontiac by year’s end we consider him to have “bought it.”G is Government expenditures.X is Exports and M is imports.

Study questions re circular flow:

1. Are there any other possible categories that we have missed of things that people produce for people to buy?(That is, besides C, I, G, and X-M).

2. We aim to measure everything that wasproduced during the year, but what if it wasnever purchased during the year?

Government Expenditures are a little different from the other kinds: Some things are not counted atall, and other things are never “purchased” directly byanyone.

Transfers are not counted: Why not? When I am taxed to collect money for a Social Security payment, it just transfers money from one pocket to another--no new goods and services are created.

Only government purchases of goods and services are counted. Example? Police, army, roads...

Another way to measure GDP:(That is, another way as opposed to counting the marketvalue of the produced goods).GDP is also the sum of people’s incomes.E.g. salaries and wages + rent payments + interest payments + corporate profits + proprietor’s incomes + a few other categories like this. In other words, GDP is equivalently the sum of all expenditures on newly produced goods and services or the sum of all incomes.Thus gross domestic product is identical with gross domestic income. We say: GDPGDI.

Real GDPNominal means measured in todays (“current”) prices.

Real means measured in some reference (base year) year prices so as to take out the effect of inflation.

They are calculated so that

(Nominal GDP)/(Inflation measure) = Real GDP

Notes: The inflation measure is sometimes called the “GDP deflator.” Can you see why? The inflationmeasure is calibrated so that in the base year it equals 1.0.E.g. if inflation is 10% by the next year, the inflation measurebecomes 1.1 and so on.

Since 1950, continual inflation has meant that nominal GDP grew at a faster rate than real GDP.

Recall why it is that the two curves cross exactly inthe base year, the year on which the inflation measureis based.

Purchasing Power Parity

Finding the right way to compare

different countries in terms of output.

PPP: The value of peoples’ incomesin terms of its purchasing power; thisputs income per capita data closerto an equal basis.

Remember that GDP measures a people’s incomenot anything else.

Some things of importance that GDP is often mistakenfor but for which GDP is not intended to measure:

1. A nation’s true well-being--it cannot measure this.2. A nation’s material well-being--it is a weak measure.3. A nation’s true wealth--difficult to express let alone quantify.4. A nation’s material wealth--income, which GDPmeasures is not the same thing as wealth.5. More troublesome to economists, GDP is even asomewhat flawed measure of a nation’s income.

Why GDP sometimes misrepresents a nation’s income:

1. Some goods are never accounted: e.g. housewife services; volunteer services.2. The value of leisure time.3. External costs of production, such as air and waterpollution are never deducted from the calculations.

Why GDP doesn’t measure a nation’s materialwealth:

1. Wealth and income are different concepts.2. Wealth measures the things of value you havesaved and stored up over many periods; income measures the flow of money to you this period.3. An important part of a nation’s material wealth are those assets we all “own” together, like our parksour defense system, our natural resources, and our‘purple mountain majesties above the fruited plain...”

Why GDP is not a measure of a nation’s true wealth:

1. Consider what we Americans often mention as part ofour “true national wealth:” The Declaration of Independence declares that we believe...”that all men are created equal endowed by their creator with certain inalienable rights and among these are life, liberty and the pursuit of happiness.” 2. Consider what our writers and commentators often mention as among our “national treasures:” Mahalia Jackson, Babe Ruth, Richard Feynman, F. Scott Fitzgerald, Ernest Hemmingway, Jonas Salk, John Glenn.....

Why GDP is sometimes not a very good measure of our material well-being:

1. Sometimes our material wealth is significantly different from our income as an indicator: e.g the idea is like were you to become unemployed but had a large savings account to draw on, we wouldn’t worry as much for you as if you had had no savings.2. Sometimes our nation’s GDP may go way up because everyone is working hard to counteract some disaster as war, epidemics, or natural disasters: e.g. are we really rich if half of our high GDP is going to materials to fight an ugly war with the Germans?

Why GDP doesn’t measure a people’s true well-being:

1. Economists have never intended for it to be mistaken in this way.2. As always, it is up to each of us as individuals to understand that there is more to life than income.3. In any case, GDP is a large aggregate and isn’t likely to predict for an individual.4. Non-marketed goods, services, relationships and experiences are very often mentioned by individuals to be or to be among the “most important things” to them.

Consider some examples from popular culture:

“When you’ve got your health, you’ve got just about everything.” A old TV commercial.

“Love is all there is, it makes the world go ‘round...” B. Dylan

“All you need is love...” The Beatles

“I have a dream when one day all God’s children...will walk hand in hand..” M.L.King

“You are my sunshine, my only sunshine.” Trad.

So what good is GDP?1. It is a pretty good measure of national income,and undoubtedly the best we have so far.2. Much of the nonmaterial, tremendously importantthings in our lives are difficult if not impossible forpolicy makers to do anything about--it may not evenbe any of their business to try to interfere.3. Many of the nonmaterial things tend to average out over time: e.g. some people are always at death’sdoor, some are getting married and it’s always differentpeople but for the nation it tends to average out.4. Gross indicators of the nation’s well-being dostrongly respond to GDP: e.g. divorces, heart disease,crime...