Gross Domestic Product (GDP)

• Real GDP per capita is a basic measure of a country's standard of living
• Between 2000 and 2010, India's real GDP grew by 7% per year on average
• The growth in India between 2000 and 2010 led to a doubling of the standard of living between 2000 and 2010
• This chapter explains what GDP means, how it is measured, the difference between the level of GDP and the growth rate of GDP, the difference between nominal GDP and real GDP, how growth in per capita real GDP is a standard measure of economic progress, the use of GDP in business cycle measurement, and problems with GDP as a measure of output and welfare

Gross Domestic Product (GDP)

• GDP is the market value of all finished goods and services produced within a country in a year
• GDP per capita is GDP divided by population

What is GDP?

• An economy's total output includes millions of different goods and services
• Some goods are more valuable than others
• GDP uses market values to determine how much each good or service is worth and then sums the total
• Intermediate goods are sold to firms and then bundled or processed with other goods or services for sale at a later stage
• Finished goods are sold to final users and then consumed or held in personal inventories
• To avoid double counting, only finished goods are included in GDP
• Machinery and equipment used to produce other goods are included in GDP
• The output of an economy includes both goods and services
• Haircuts, medical care, and transportation are examples of services
• Most of GDP today are services
• In the United States, services account for nearly 80% of GDP
• GDP measures production
• Sales of old houses, used goods, and financial assets do not add to GDP
• U.S. GDP includes goods and services produced by labor and capital located in the United States, regardless of the nationality of the workers or property owners
• Gross national product (GNP) is similar to GDP, but measures what is produced by the labor and property supplied by U.S. permanent residents
• National wealth refers to the value of a nation's entire stock of assets
• GDP tells how much the nation produced in a year, not how much it has accumulated in its entire history
• The Bureau of Economic Analysis (BEA), a part of the Department of Commerce, calculates GDP

Gross National Product (GNP)

• GNP is the market value of all finished goods and services produced by a country's permanent residents, wherever they are located, within a year

Growth Rate

• The growth rate of GDP for 2018 is calculated as [(GDP 2018 - GDP2017) / GDP 2017] × 100
• Using actual numbers (in billions) for 2018, the growth rate of GDP = [($20,580 – $19,519) / $19,519] × 100 = 5.4%

Nominal vs. Real GDP

• Nominal GDP is calculated using prices at the time of sale
  • GDP in 2018 is calculated using 2018 prices
  • GDP in 2017 is calculated using 2017 prices
• This creates problems when comparing GDP over time
  • Increases in nominal GDP may be due to greater production or increased prices
• Increases in production, not increases in prices improve the standard of living
• To remove the effect of price changes, GDP is calculated in constant prices
• 2018 prices × 2018 quantities = $20.58 trillion (2018 nominal GDP)
• 2017 prices × 2017 quantities = $19.52 trillion (2017 nominal GDP)
• 2018 prices × 2017 quantities = $19.99 trillion (2017 real GDP in 2018 dollars)
• If prices in 2017 and 2018 were the same, GDP in 2017 would have been $19.99 trillion

Nominal Variables

• Nominal variables such as nominal GDP have not been adjusted for changes in price

Real Variables

• Real variables such as real GDP have been adjusted for changes in prices by using the same set of prices in all time periods
• 2018 prices × 2018 quantities = $20.6 trillion (2018 nominal GDP) and 2017 prices × 2017 quantities = $19.5 trillion (2017 nominal GDP), increase in nominal GDP = [(20.6 – 19.5) / 19.5] × 100 = 5.6%
• 2018 prices × 2018 quantities = $20.6 trillion (2018 real GDP) and 2018 prices × 2017 quantities = $19.9 trillion (2017 real GDP), increase in real GDP = [(20.6 – 19.9) / 19.9] × 100 = 3.5%

GDP Deflator

• The GDP deflator is a price index that can be used to measure inflation
• GDP deflator = Nominal GDP / Real GDP × 100
• If 2016 nominal GDP is $18.57 trillion and 2016 real GDP (in 2009 dollars) = $16.66 trillion, GDP deflator is calculated as 18.57 trillion / 16.66 trillion × 100 = 111.46
• The 2016 prices were 11.46% higher (111.46 – 100) than 2009 prices using the GDP deflator

Real GDP Growth Per Capita

• Growth in real GDP per capita is the best reflection of changing living standards
• Growth in real GDP does not account for changes in population
• Large differences can arise for countries with rapidly growing populations

Cyclical and Short-Run Changes in GDP

• GDP is used to compare economic output across countries and over long periods
• GDP is also used to measure short-run fluctuations in an economy
• According to the National Bureau of Economic Research (NBER), a recession is a considerable decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales

Recession

• A recession is a significant, widespread decline in real GDP and employment

Business Fluctuations (or Business Cycles)

• Business fluctuations are short-run movements in real GDP around its long-term trend

The Many Ways of Splitting GDP

• Economists split the production of goods and services in many ways:
  • National spending approach: adding up components of spending with the formula Y = C + I + G + (Exports – Imports)
  • Factor income approach: adding up income generated by producing goods and services with the formula Y = Employee Compensation + Rent + Interest + Profit

National Spending Approach

• National spending approach formula used: Y = C + I + G + NX
  • Y: Nominal GDP. The market value of all finished goods and services
  • C: Consumption. Private spending on finished goods and services
  • I: Investment. Private spending on tools, plant, and equipment used to produce future output
  • G: Government purchases. Spending by all levels of government on finished goods and services, excluding transfers
  • NX: Net exports. The value of exports minus the value of imports
• On average between 1950–2021: Consumption: 63.4%, Government: 20.6%, Investment: 17.3%, Net exports: -1.4%
• In 2021: Consumption (68.0%) and Government (17.6%) and Investment (17.8%) and Net exports (-3.5%)

Factor Income Approach

• The factor income approach formula calculates GDP by adding up all the incomes received: Y = Employee compensation + Rent + Interest + Profit
• Money spent by a consumer is received by workers, landlords, owners of capital, and businesses
• When the factor income approach is used adjustments may me needed for things like sales taxes

Problems with GDP

• GDP does not account for illegal or underground-market transactions
• Underground transactions are significant in countries with higher levels of corruption and taxes
• The portion of the informal sector in Latin America is estimated at 41% of the officially measured GDP
• In the United States or Western Europe, the underground economy is likely 10% to 20% of GDP
• GDP does not count non-priced production when valuable goods and services are produced, but no monetary payment is made, like doing housework, reading free blogs, or volunteering
• This introduces two biases into GDP statistics because as more women in the United States entered the workforce, housework shifted from unpaid to paid
• Women's participation in the workforce varies across countries, underestimating the proportion of work included in GDP
• GDP adds up the value of finished goods and services but does not subtract the value of "bads", such as pollution, changing supplies of natural resources, the loss of animal or plant species, or crime
• "Green accounting” attempts to cover the environment more explicitly
• Environmental amenities are difficult to value
• GDP does not count the health of nations
• To allocate resources, we must put numbers on the value of health
• Between 2007 and 2014, life expectancy increased in the United States by about a year
• Economists have estimated that people value an additional year of life at about $150,000
• An extra year of life valued at $150,000 for 300 million people is worth $45 trillion

Takeaway

• GDP is an estimate of the economic output of a nation over a year
• GDP can be summed up in different ways
• The national spending identity splits GDP according to different classes of income spending: Y = C + I + G + NX
• The factor income approach splits GDP into different classes of income receiving: Y = Employee compensation + Interest + Rent + Profit
• GDP per capita is a rough estimate of the standard of living in a nation
• Real GDP is corrected for inflation by using the same set of prices in every year
• GDP does not include goods in the underground economy, the value of goods that are difficult to price, the value of bads, the health of nations or the distribution of income