5.3 National Income Accounting: Some Further Issues Flashcards
What is the difference between nominal and real GDP?
GDP valued at current prices is called nominal GDP. GDP valued at base-period prices is called real GDP.
What different information does real and nominal GDP tell us?
Nominal GDP tells us about the money value of output; real GDP tells us about the quantity of physical output.
What is the GDP deflator?
GDP deflator
An index number derived by dividing nominal GDP by real GDP. Its change measures the average change in price of all the items in the GDP.
What is the GDP deflator formula?
Why is the GDP deflator the most comprehensi e avaliable index of the price level?
The GDP deflator is the most comprehensive available index of the price level because it includes all the goods and services that are produced by the entire economy. It uses the current year’s basket of production to compare the current year’s prices with those prevailing in the base period. (Because it uses the current basket of goods and services, it does not run into the CPI’s problem of sometimes being based on an out-of-date basket.)
What is the difference between movements in the CPI and movements in the GDP deflator?
Movements in the CPI measure the change in the average price of consumer goods, whereas movements in the GDP deflator reflect the change in the average price of goods produced in Canada.
Changes in the GDP deflator and Consumer Price Index (CPI) similarly reflect overall inflationary trends. Changes in relative prices, however, may lead the two price indices to move in different ways.
What are the common Omissions from GDP?
-Illegal Activities
-The Underground Economy
-Home Production, Volunteering, and Leisure
-Free Products in the Digital World
-Economic “Bads”
Examples of illegal activity that are not included in the GDP
Many forms of illegal gambling, prostitution, and drug trade are in this category.
How do some illegal activities get included in national income measures?
Note that some illegal activities do get included in national income measures, although they are generally misclassified by industry. The income is included because people sometimes report their illegally earned income as part of their earnings from legal activities.
What is “the underground economy” and what is an example?
A significant omission from GDP is the so-called underground economy. The transactions that occur in the underground economy are perfectly legal in themselves; the only illegality involved is that such transactions are not reported for tax purposes. Because such transactions go unreported, they are omitted from GDP. One example of this is the carpenter who repairs a leak in your roof and takes payment in cash (and does not report it as income) in an effort to avoid taxation.
What is the estimate of the value of income earned in the underground economy?
Estimates of the value of income earned in the underground economy run from 2 percent to 15 percent of GDP
Why is leasure not counted in GDP? Why does this not nessesarly reflect a bad outcome to economoic growth?
Another extremely important non-market activity is leisure. If a lawyer chooses to reduce their time at work from 2400 hours to 2200 hours per year, measured national income will fall by the lawyer’s wage rate times 200 hours. Yet the value to the lawyer of the 200 hours of new leisure enjoyed outside of the marketplace presumably exceeds the lost wages (otherwise they would not have chosen to reduce their work effort by 200 hours), so total economic well-being has increased even though measured GDP has fallen.
Why are free products the digital world not counted? Does this reflect poorly on the economy?
Another example of activity that generates benefits that are not captured in GDP is the use of free products such as Internet search engines, social media platforms, online maps, and a whole range of other Internet-related services. The use of these products does not appear in GDP because there is no “purchase” involved, yet users clearly receive benefits.
Examples of Economic “bads”
When a coal-burning electric power plant sends sulphur dioxide into the atmosphere, leading to acid rain and environmental damage, the value of the electricity sold is included as part of GDP, but the value of the damage done by the acid rain is not deducted. Similarly, the gasoline that we use in our cars is part of national income when it is produced, but the environmental damage caused by the greenhouse gases that come from burning that gasoline is not deducted. To the extent that economic growth brings with it increases in pollution, congestion, and other disamenities of modern living, measurements of national income will overstate the improvement in living standards.
The current approach to measuring GDP continues to be used for three reasons.
- First, as we have just said, correcting the major omissions in the measure would be difficult if not impossible.
-Second, even though the level of measured GDP in any given year may be inaccurate, the change in GDP from one year to the next is a good indication of the changes in economic activity (as long as the omissions are themselves not changing a lot from one year to the next).
-The third reason is that policymakers need to measure the amount of market output in the economy in order to design policies to control inflation and set tax rates.
How can we use the GDP deflator to find the percentage change in prices between given years?
How can we use real GDP to find out the difference in quantities between given years?
