GDP Flashcards
What does GDP means?
- “Gross” means “total”.
- “Domestic” means some “geographical boundary”, typically a country’s borders.
- “Product” means “output”.
GDP measures…
The total market value of all final G&S newly produced in a specified country or region during a specified period (e.g. a year or a quarter).
Generally speaking, GDP is a measure of the size of an economy and its composition.
Why are GDP statistics important?
Business and financial companies need to know how big an economy is now and in the near future (i.e., how fast it is growing or contracting) in order to work out:
- how much sale they can make in that economy
- and therefore how much they need to produce and invest.
Why does it matter to be large?
Larger countries have bigger influence in their region and beyond because they:
- Provide a larger market for other countries’ exports
- Afford to make more investment overseas
- Afford to promote its culture and value overseas – soft power (e.g., Confucius Institute, British Council, Alliance Francaise, Goethe Institute)
- Afford larger contributions to international organizations (e.g., IMF, World Bank) and thus have a bigger say in their policies and decisions or even to challenge them
- Afford larger military expenses.
GDP includes:
Newly produced final, market G&S
GDP excludes:
- Intermediate G&S
-
Financial assets
- These are claims on somethings; they are not G&S. E.g., shares are claims on company ownership; bonds are claims on financial payments.
- Informal sector
-
Domestic work
- (services provided by owner-occupied dwellings are included though)
-
Illegal activities (Shadow Economy)
- (practices vary by countries)
GDP Geographical boundaries:
Where – within a specified country (e.g., Australia) or region (e.g., Euro Zone)
- Australia’s GDP excludes production by Australian firms operating overseas
- Exclude imports
GDP time boundaries:
When – during a specified period, e.g., year 2014 or 2014Q3
- 2014 GDP excludes second-hand goods made before 2014
- But include the services of selling second- hand goods produced during 2014
How to Measure GDP?
- Production method
- Income method
- Expenditure method (dépenses)
The three methods are equivalent in principal because:
- The expenditure on a final product is equal to the product’s market value
- A person’s expenditure on a final product is the income of some other persons
- A person’s income is equal to his/her value- add to the final product.
In reality they could be different because of data limitation and measurement errors.
Production method =
Adding up the value added of all domestic producers
Income method =
Adding up the income generated from all domestic production
Expenditure method =
Adding up the expenditures on all domestically produced final G&S
Expenditure approach to GDP (formula):
Y = C + I + G + (X – M)
Y = C + I + G + NX
- Y = GDP
- C = (private) consumption
- I = (private) investment
- G = government purchases
- X = exports
- M = imports
- NX = net exports = exports – imports
Consumption and Investment:
- Consumption: any newly produced G&S purchased by households.
-
Investment: new fixed capital (e.g., machine or factory) + new inventory + new residential houses.
- A new inventory can be considered an investment because it will generate a future return equal to itself (minus any depreciation).
Government Purchases
Include:
- Consumption and investment (e.g., spending on road construction).
Excludes:
-
Transfer payments (TP) like unemployment benefits or pension.
- This is because TP is not consumption as the government does not receive any G&S as a result of making a TP.
Nominal vs Real GDP:
- Nominal GDP is measured in current prices (e.g., nominal GDP in 2012 is measured in 2012 prices).
- Real GDP is measured in constant prices.
Change in the market value of output over time can be due to change in output quantity, change in the price (i.e., inflation), or both.
If we want to measure how a country’s output quantity change over time, we need to keep the prices constant when measuring GDP.
Real GDP notes:
- Conceptually it involves fixing the prices at a pre-specified base year, e.g., 1996, so the real GDP in 2012 is measured in 1996 prices.
- Because the prices are fixed at the base year, changes in real GDP over time are entirely due to changes in output volume.
Real GDP growth is output volume growth, not output value growth.
- Unless stated otherwise, GDP always refers to “real GDP” (same for GDP per capita etc.).
GDP deflator =
- GDP deflator is a price index (not a price), so it has no unit (so don’t attach a “$” or “%” sign to it).
- It is a measure of the average prices of G&S produced in the domestic economy in a given year relative to the base year.
- There are many other price indexes (e.g., CPI)
Price vs Price Index
- The price of a product is its dollar value, e.g., an average house costs about A$450,000 in Brisbane in 2014.
- A price index is a measure of the price level in a given year (or quarter etc.) relative to the base year, e.g., a house price index in 2014 shows the house price in 2014 relative to the base year (e.g., 2009).
- The price index in the base year is always set to 100.
So if the house price index in 2014 is 108, then it means that Brisbane’s house prices on average are 8% higher in 2014 than in 2009. But the index itself does not tell us what the cost is in dollar terms.
PPP-based GDP or GDP (PPP)
In cross-country comparison of GDP, figures based on Purchasing Power Parity (PPP) valuation are often used.
It adjusts for differences in the cost-of- living across countries.
A hair-cut costs more in the US than in China even when both prices are expressed in the same currency.
- Conceptually, GDP (PPP) is calculated using the prices of the reference country to estimate a country’s output value.
- Typically, the US is chosen as the reference country.
- (In practice, the calculation involves the estimation of PPP-based exchange rates which is a very complicated process.)
Is GDP (PPP) a better measure?
Theoretically, GDP (PPP) is a superior measure to GDP.
- However, calculating GDP (PPP) requires data on relative living costs across countries.
- The World Bank’s 2011 International Comparison Program (ICP) needs to consider over 1,000 products across 199 countries.
- Finding reliable prices data is challenging, especially for developing countries.
- Some people consider GDP (PPP) to be less transparent and more burdened by data errors than GDP.
- So it is safer to use both measures for cross-country comparison.
Summary of Different GDP Measures:
- Nominal GDP = GDP (current price)
-
Real GDP = GDP (constant price)
- useful for comparing a country’s own outputs over different time periods
-
Nominal GDP (PPP) = GDP (PPP, current price)
- useful for comparing outputs across countries for a single period
-
Real GDP (PPP) = GDP (PPP, constant price)
- useful for comparing outputs across countries over time.
GDP per capita:
- Because GDP is equal to total output of the whole nation, GDP per capita is often seen as a proxy for average output per person even though part of the population like children and retirees do not produce.
Being big is not not the same as being rich!
- Switzerland is small in terms of GDP but rich in terms of GDP per capita
- India is large in terms of GDP but poor in terms of GDP per capita.
- GDP per capita is only an average income measure, it does not consider income distribution within a country.
- There are many rich people in Indians as well as many poor people in Switzerland!
GDP per capita & Wellbeing:
- GDP per capita is commonly used as a measure of wellbeing or standard of living because people with higher incomes can afford more and better quality G&S.
- Producing more junk food will increase GDP and thus GDP per capita, but does it increase our wellbeing when the health consequence is taken into account?
- Also, how about inequality, pollution, leisure, crime etc.?
Note about Happiness/Income
- The graph shows that overall there is a positive relationship between happiness (and life satisfaction) and income.
- But it also shows a very diverse degree of happiness among the developing countries with similar (low) incomes.
- Also, a lot of developed countries have similar level of happiness despite a diverse level of incomes.
- So the graph indicates that there are more than income to being happy.
- This is the idea behind Bhutan’s Gross National Happiness measure.
Gross National Happiness:
Bhutan is among the least developed countries in terms of GDP per capita.
- In 1972, it proposed to measure development in terms of Gross National Happiness (GNH) instead of GDP.
- GNH covers sustainable development, cultural integrity, ecosystem conservation, and good governance.
World Happiness Report:
- The United Nations has adopted Bhutan’s holistic approach to development.
- Since 2012, it has published the World Happiness Report, ranking countries based on real GDP per capita, social support, healthy life expectancy, freedom to make life choices, generosity, and perceptions of corruption.
Australian Example: MAP
- Australia Bureau of Statistics has developed “Measures of Australia’s Progress” (MAP) to gauge whether life in Australia is getting better over time and how so.
- It uses a large number of indicators to measure progress in 4 broad areas:
- Economy
- Society
- Environment
- Governance
Material Standard of Living:
Even if one focuses entirely on the material standard of living, there are alternative and arguably better measures than GDP per capita, such as Net Domestic Product (NDP) per capita and Gross National Income (GNI) per capita.
Conclusion:
- GDP is a useful but limited measure of economic size.
- Using GDP per capita to measure well-being is even more problematic.
- A lot of alternative measures have been developed.
- These measures are highly correlated, but in some cases, they can yield very different results.
- But GDP and GDP per capita remain popular partly due to their simplicity.
