10 24 2012 Issues involved in measuring GDP Market Value Finals goods approach o Avoid double counting Value added approach Non Market transactions o Household goods and services domestic production Goods and services produced inside the home for use inside the home If I clean my house and my friend cleans his house its not part of GDP but if we pay eachother to clean eachothers homes and report the income to the government it is part of GDP o Underground economies Working under the table or off the books Government doesn t know about these transactions so it is not part of GDP People do this to avoid paying income taxes etc o Illegal Markets GDP would rise if marijuana was legalized Non Productive transactions are excluded o Government transfer payments SS payments food stamps etc o Gifts Transfer of wealth from grandmother to you doesn t represent new wealth production o Sale Purchase of securities If you buy stock it s a transfer of assets but doesn t mean the company did anything Its not a productive transactions Secondhand goods are excluded o Don t want to double count Example is used cars Goods that are produced but not sold are included as inventory changes The production is part of investment spending as part of inventory spending and not consumption spending How much is 15 Trillion 15 000 000 000 000 Nominal GDP Real GDP Measures output using current prices Measures output usuing constant base year prices Example Economy produces 4 goods in 2 different years Year 1 Bread Beer Wine Cheese Q1 100 loaves 200 gallons 300 bottles 400 pounds P1 4 3 2 1 Q1 P1 400 600 600 400 Nominal GDP 2000 Cant add them up because they are all different units but we can add up the prices Year 2 Bread Beer Wine Cheese Q2 200 loaves 400 gallons 200 bottles 600 pounds P2 5 2 10 2 sum of Q2 P2 Q1 P1 1000 800 2000 1200 Nominal GDP 5000 Nominal GDP changed from 2000 to 5000 Percent change of nominal GDP changex X2 X1 X1 100 5000 2000 2000 100 150 increase Did output increase by 150 NOOOO Prices also increased Real GDP Assume Year 1 is a base year Real GDP year 1 Nominal GDP year 1 2000 since year 1 is a base year Real GDP year 2 Bread Beer Wine Cheese Q2 200 loaves 400 gallons 200 bottles 600 pounds P1 4 3 2 1 Q2 P1 800 1200 400 600 Real GDP2 3000 Change in Real GDP is 3000 2000 2000 100 50 Increase GDP Price deflator year t nominal GDP Real GDP Year 1 GDPPD Year 1 2000 2000 100 100 Year 2 GDPPD Year 2 5000 3000 100 167 changeGDPPD 167 100 100 100 67 Problems with using a simple base year approach Every 5 years the entire real GDP series would have to be revised when a new base year was chosen Puts too much weight on the goods and services whose prices increased the least Underestimating inflation in the economy Overestimate real GDP growth Since 1995 the BEA has calculated chain type real GDP 1 Find chain type growth rate g sqrt 1 5 1 0638 1 2632 times what it was in year 1 2 Find chain type real GDP2 LOOK IN TEXTBOOK Chain type GDPPD1 2000 2000 100 100 Chain type GDPPD2 5000 2526 1 197 98 Ways of Measuring GDP 10 24 2012 Simple circular flow model o Simplify economy as much as possible Only firms and households Goods and Services Firms Households Revenue Resources Income GDP can be measured as Value of final output Aggregate Expenditures Sources of income Uses of income Ways of measuring GDP Value of final output o GDP PiQi Aggregate Expenditures o GDP C I G X M Consumption investment government exports imports net export Source of Income o GDP w i R profits NFIA CCA SD Wages Interest Rent profits net factor income from abroad depreciation capital consumption allowance statistical discrepancy Use of Income o GDP C S T M Consumption spending Saving taxes imports National Income Product Accounts NIPA Simon Kuznets 1933 National Income methodology Expenditure Approach Gross Domestic Product GDP C I G X M Gross National Product GNP GNP GDP NFIA NFIA Net factor income from abroad NFIA receipts of factor income from rest of the world o Payments of factor income to the rest of the world The ford factory not built in USA does not contribute to the USA but the Toyota factory in the USA does contribute to GDP because its on US Soil GNP Excludes Toyota factory and includes the ford factory National Income Product Accounts NIPA Expenditure Approach GDP Equation 2 GNP GDP NFIA NNP Net National Product GNP CCA Income received by producers in the economy Personal Income Ni income received but not earned income earned but NI NNP SD not received dividends government transfer payments personal interest corporate profits social insurance contributions net interest income indirect business taxes Disposable personal income DPI DPI PI Personal Taxes Measuring GDP as expenditures measuring GDP as income For any firm in the economy their profits sales costs For any firm in the economy producing final goods and services gross profit as economy as whole gross sales gross costs Gross sales Gross Costs Gross Profit Gross sales Resource Costs Other Costs Profits C I G X M w i R Profits NFIA GDP as expendutes GDP as income NNP GNP CCA NNP w i R Profits SD NI NNP SD NI W i R Profits ALL EQUATIONS IN COURSE HANDOUTS Is GDP a good measure of the quality of life Defensive expenditures o Health Environment safety Will increase GDP but people are worse off o More people can share a certain amount of wealth in certain Value of life is ignored Population differences places o Per Capita GDP GDP Pop Distribution of income Cultural Differences Marital Status Wars and natural disaster Alternative measures of Economic Welfare Index of sustainable economic welfare o Dacy and Cobb 1989 o Now compiled by Friends of the Earth Adjustments to GDP o Income equality o Domestic Labor o Health and Education o Services from Consumer durables Washer Dryer Shovel Measure of economic welfare o Nordhals and Tobin 1972 o Adds value of leisure o Adds underground economy and illegal markets o Subtracts negative externalities Global Footprint o Measure of the amount of land used up in economic activity International Markets 10 24 2012 Price influenced by exchange rates Exchange Rate is value of one country s currency in terms of the others country s currency Quantity Transactions Balance of Payments accounts o A record of one country s trade in goods services income and financial assets with the rest of the world Exchange Rates Currency Foreign Exchange Markets o Large banks in major cities around the world where exchange of currency takes place