GDP: Calculation and Nominal GDP

• Gross Domestic Product (GDP) is a measure of aggregate output in the national income.

GDP Calculation Approaches

• GDP is the value of final goods and services produced in the economy during a specific period.
• It includes final goods sold domestically and abroad, along with intermediate goods sold abroad.
• To prevent double counting between countries, intermediate goods bought from abroad are excluded from the GDP calculation.
• GDP is the sum of value added in the economy during a specific period.
• Value added by a firm is the value of its production minus the value of intermediate goods used.
• GDP can be calculated as the sum of incomes in the economy during a specific period.
• GDP equals wages + profit + rent + taxes.

Nominal GDP

• This is the sum of quantities of final goods produced multiplied by their current prices.
• Nominal GDP increases due to increased production and rising prices.
• Changes in nominal GDP reflect both changes in quantities and prices.
• It is also referred to as GDP in current prices or GDP in current euros.

Real GDP

• Computed by multiplying the quantities of final goods by constant prices.
• Real GDP isolates changes in quantities by eliminating the effect of increasing prices.
• It is also called GDP in terms of goods, GDP in constant euros, GDP adjusted for inflation, GDP in chained (base year) euros, or GDP in (base year) euros.
• Changes in Real GDP reflect changes in quantities only.

GDP Growth

• The rate of growth of real GDP.
• Expansions represent positive GDP growth.
• Recessions represent represent negative GDP growth.
• Growth Rate of GDP is calculated by g = (GDPt - GDPt-1)/GDPt-1 = GDP / GDPt-1
• A positive growth rate indicates growth, while a negative rate suggests a potential recession.

GDP per Capita

• Calculated by GDP / total population.

Problems with GDP

• Does not account for the underground economy.
• Overlooks measures of happiness, equality, health, living standard, leisure, housework, and income inequality.
• Does not acknowledge negative externalities of GDP growth like environmental damage.
• Green GDP measures GDP while considering environmental consequences.
• The Human Development Index reflects living standards.

Unemployment

• Employment (N) is the number of people who have a job.
• Unemployment (U) is the number of people who do not have a job but are actively looking for one.
• The labor force (L) is the sum of employment and unemployment (L = N + U).
• Unemployment rate (u) is the ratio of the unemployed to the labor force (u = U/L).
• People not in the labor force are not employed, not seeking employment, not eligible, or unable to work.
• Discouraged workers are those who have stopped seeking employment.
• The participation rate is the percentage of the working-age population in the workforce, calculated as Labour Force / Total Population of Working Age (18-64).

Data Collection

• Unemployment data is collected via censuses and surveys.
• Most countries use large household surveys to compute the unemployment rate.
• The EU employs the Labour Force Survey, conducting interviews with a representative sample of individuals.
• An individual is classified as employed if they have done at least one hour of paid work in the week before the interview.
• The USA uses the Current Population Survey, interviewing 60,000 households monthly.
• A person is employed if they have a job at the time of the interview and unemployed if they do not have a job and have been looking for one in the last four weeks.

Importance of Unemployment

• High unemployment leads to financial and psychological suffering for the unemployed.
• It also signifies that the economy is not using resources efficiently.
• High unemployment results in decreased tax revenue, wages, and consumption, leading to social uncertainty.
• Low unemployment can cause labor shortages and inflationary pressures, reducing productivity.

Inflation Rate

• Inflation is a sustained rise in the general level of prices.
• The inflation rate measures the rate at which the price level increases.
• Deflation is a sustained decline in the price level, resulting in a negative inflation rate.

GDP deflator

• Compares the price of all currently produced domestic final goods & services to the price of the same goods & services in the base year.
• Pt = Nominal GDPt / Real GDPt = $Yt/Yt
• In the base year, Real GDP and Nominal GDP are equal, and the price level equals 1.
• Rate of Inflation is calculated by t = (Pt - Pt-1)/Pt-1, which provides the rate at which the general level of prices increases.

Consumer Price Index

• The GDP deflator provides the average price of output, while consumers focus on the average price of consumption.
• The GDP deflator and CPI do not have to be the same number, as the goods produced in an economy and the goods consumed in an economy will likely be different.
• The CPI is an index number, hence only the rate of change is meaningful.
• The Inflation rate is calculated by t = (CPIt - CPIt-1) / CPIt-1
• In the EU, CPI is measured by the Harmonised Index of Consumption Prices (HICP).
• HICP measures average changes in prices paid by consumers for a specific and updated basket of goods & services
• Each country calculates HICP, which is then aggregated into EU HICP based on consumption expenditure share in the Euro Area
• The basket is updated annually.

Problems with CPI

• Determining the composition of the basket can be challenging.
• Consumer consumption habits change yearly.
• New goods and quality improvements can occur within the year.

GDP vs CPI

• GDP considers all final goods & services produced domestically in an economy.
• CPI considers only goods & services consumed domestically.

Consequences of Inflation

• Reduced Purchasing Power: As prices rise, the value of money decreases, meaning consumers can buy less with the same amount of money.
• Uncertainty & Reduced Investment: Businesses and consumers may hesitate to spend or invest due to unpredictable costs
• Income Redistribution: Fixed-income earners and savers lose, while borrowers benefit as debts become easier to repay.
• Taxation can become distorted if tax brackets are not adjusted for inflation, increasing people’s nominal income while real income remains the same or even decreases.
• Higher Interest Rates: borrowing becomes more expensive, the return on savings increases, and Central Banks often raise interest rates to control inflation
• Cost-Push Inflation: rising wages as a result of reduced purchasing power demand, increased production costs, creating a cycle of continuous price increases.
• Erosion of Savings: money held in savings loses value unless interest rates keep up with inflation.
• Wage-Price Spiral: workers demand higher wages to keep up with rising costs, which can further fuel inflation.