Gross Domestic Product (GDP)

Essentials of National Output

• Gross Domestic Product (GDP) measures the total national economic output over a specific period.
• GDP can be expressed as:
• Current dollars, which reflect actual dollar amounts.
• Constant dollars, which are adjusted for inflation.
• GDP is not a perfect indicator of economic well-being.
• It does not account for population size.
• It does not account for leisure time.
• It does not reflect the quality of goods and services.
• It does not factor in environmental damage.
• GDP can be measured using both the expenditure approach and the income approach.

Gross Domestic Product

• The GDP quantifies the national output, considering millions of different goods and services.
• A common denominator is using the monetary value, making the price the measure of value.
• The monetary value of all goods and services produced within an economy during a specific period, usually a year, calculates GDP.

Considerations When Calculating GDP

• Measurement might seem straightforward but has important pitfalls:
• Avoid double counting by only including the value of final goods and services.
• Final goods are for the ultimate consumer.
• Intermediate goods are inputs for final goods.
• Do not include the value of intermediate goods.
• Nonmarketed final goods and services must be factored in at cost (e.g., public services).
• Omit certain final outputs for practical reasons (e.g., homemaker services).
• Exclude purely financial transactions, as they don't reflect new production.
• This includes government and private transfer payments.
• The sale and purchase of securities are also excluded.
• Exclude sales of secondhand goods in GDP calculations
• The value of the good is already accounted for in the year it was produced.

Test your understanding (True or False?)

• False - Private transfer payments are excluded from GDP.
• False - Selling stock isn't included in GDP, so amounts from selling stick are excluded also
• False - Purchases of used cars are not included.
• True - New cars bought are a final good if they are used for the buyers personal purposes
• False - Services like health care are included in GDP

Exercises

• A poker game does not increase or decrease GDP, this is a non-productive transfer of wealth
• The following are included in calculating GDP
  • Payment by the government to a naval officer
  • Wages paid by the University of Michigan to a professor
  • They are productive and involve some sort of payment relating to the economy, as interest on a government bond isn't productive, and neither is paying for a secondhand car

Adjusting GDP for Price Changes

• GDP relies on current prices, changes in price impact GDP
• Rising prices leads to a higher GDP figure.
• Economists adjust to eliminate price changes for an accurate comparison.
• Value is expressed relative to a base year.
• Expressed in current dollars and impacted by price changes.
• Expressed in constant dollars, eliminating the impact of price levels.
• GDP adjusted for price changes is called real GDP.
• Real GDP is compared to GDP expressed in current dollars to understand economic activity.

Price Indexes

• Measure the degree prices have changed
• Calculated by dividing the current value by the constant value
• Deflating uses the price index to convert current dollar values into constant dollar values.
• Firms use deflating to compare output across multiple periods
• Price indexes are often expressed as percentage changes or are multiplied by 100
• This allows for a measure versus an average.

Test your understanding (True or False?)

• True - GDP in constant dollars is specifically adjusted for price level
• True - A price index of 130 means the price level is 30% higher than in the base period

Exercise: Puritania Table

• The completed table cannot be generated without knowing the answer

Using Value-Added to Calculate GDP

• GDP includes values of final goods, not solely the final producers, but all industries.
• Automobile manufacturing value consists of steel, tires, glass, and other components.
• This understanding of calculation is important as it explains how GDP calculates
• Value-added is the monetary value a firm adds to a product
• The total value added must be equal in final product
• GDP can be calculated by adding value across industrial groups

Test your understanding (True or False?)

• True - if firm sales are $180m and it purchases $60m, then the firm value added id $100m
• False - Flour in all produced US states cannot be intermediate, it is used personally also

Exercise: Value added

• This procedure is considered wrong as it omits the intermediate sales.

Limitations of GDP

• GDP should not be considered an ideal measure of economic well-being
• Five limitations to bear in mind
• Population, or lack of insights to wealth/person. GDP should be considered relative to the capita for correct insights
• Leisure, or the quality-of-life improvements of leisure time, not accounted for in GDP
• Quality of goods, or accurate reflection in quality increases. Improvement is not reflected in GDP
• The social desirability of composition/distribution is not reflected. There are no insights on which output is preferred
• Social costs, or environmental damage, are not deducted from GDP

Test your understanding

• False - Other factors impact citizens more than the GDP of other nations e.g. taxes, healthcare, population etc
• True - 80-hour work weeks would artificially raise gross domestic product.

Exercise: Paper Mill

• Pollution is not reflected in the GDP figure
• Should not be reflected, as this is harmful to society.

The Expenditures Approach to GDP

• Calculate by adding the spending of all goods/services
• Four categories of spending
• Personal consumption expenditures, or household durable/nondurable/services. This can account for 2/3 of the total amount
• Gross private domestic investments, or investment spending by US firms. This accounts for equipment, construction, and inventory. Increases of investment are positive to real GDP, and declines must be subtracted
• Government purchases, or the expenditure of all levels of US governments (federal, state, local). Transfer payments such as social security are not included
• Net exports, or the amount spent from other countries minus the US.

Important points

• If capital is positive, the nations production will grow, negative will shrink
• Net exports can be negative

Test your understanding

True or False?

• False: these count as private domestic investments, or production and not spending.
• True: they can either be positive if exports are more than imports, or negative if the reverse is true
• True: consumption includes all listed expenses
• False: a home sale would not be included, but the agent fee would count

Income for output

Here, use the previous expenditure methods to create income and determine how gross domestic product can be calculated

GDP will calculate using all methods and not the direct sum