Introduction to Economic Growth Flashcards
Definition of GDP
“The value of all goods and services produced by the economy in a given period (yearly, quarterly, etc..)”
- Usually referred to annually
- GDP (aggregate output) is a measure of all goods and services (outputs) provided in an economy within a period of interest
- UK 2016 GDP = £2T
Nominal GDP
- Evaluated at current market prices
- Measures values using current prices
- Changes down to changes in prices and changes in quantity of output produced
Real GDP
- Real GDP is an inflation-adjusted measure
- Measures these values using the prices of a base year
- Changes down to quantities only (because this can truly show an increase or decrease in output)
Real GDP vs Nominal GDP
- Nominal differs from real GDP because nominal includes changes in prices due to inflation or a rise in the overall price level
- Nominal GDP often appears higher than real GDP higher than real GDP (inflation typically positive)
- Real GDP provides a more accurate measure of economic growth (focuses only on volume)
GDP at market exchange rates
- Measures these values using local prices and compares across countries using market exchange rates
- Differences in prices and quantities of output produced
GDP at purchasing power parity (PPP)
- Measures these values using the prices of a base country (if the countries GDP doesn’t change from market exchange rate to PPP, that country is the base)
- Changes down to quantities only (volume)
E.g. Chinese output measured at US prices shows that China has a greater output than US
“PPP defines the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country”
GDP at market exchange rates vs GDP PPP:
- PPP GDP is likely to be larger for a poor country than its market exchange rate GDP —> poorer countries have lower local prices (can buy more goods at lower prices)
- Market exchange rates tend to be volatile (i.e. currency may be depreciating but economy booming)
- Exchange rate measures local prices so rich countries GDP will always be exaggerated because things tend to be more expensive in rich countries (value of rich country goods overestimated)
- GDP based on market exchange rates tend to over-estimate the cost of living in poorer developing countries (mainly focuses on traded goods)
- Since PPP often uses a rich-country prices, measured consumption will exceed nominal (current local prices) consumption
- With PPP, two currencies are in equilibrium when a basket of goods is priced the same in both countries - provides a better sense of cost of living (removes inflation) - shows us only volume of output, how much can be bought for the same money
Substitution bias
- Consumers will tend to consume relative more of the goods that are cheaper and less of those that are expensive
- Using poor country prices would lead to large rich country PPP GDP, and smaller poor country PPP GDP, relative to rich country price (Overestimate rich country’s GDP and understate the poor country’s GDP) thus using rich country prices seems better for a more balanced measurement and comparison
- On average, consumers substitute towards the goods which are cheaper and substitute away from goods that are more expensive, hence, we observe this phenomenon of the substitution effect
Two choices for price on GDP Measurement
1) Rich country prices: Give small weighting to goods that rich countries produce a lot of and poor countries produce little of
2) Poor country prices: Give large weight to goods that the rich countries produce a lot of, and poor countries produce little of
We prefer to use rich countries prices as this seems better for a more balanced measurement and comparison
GDP per capita
- Per capita GDP is a measure of the total output of a country that takes gross domestic product (GDP) and divides it by the number of people in the country
Problems with GDP per capita
- Figures take no account of distribution of wealth
- do not include black market activity
- not conclude value of non-traded output
- must be adapted for changes in inflation
- converted into common currency, not natural currency
- conversion of the currency drastically effects the outcome (must be ppp)
- International comparisons can be difficult due to differences in accounting procedures and the accuracy of GDP statistics around the world
Also: GDP isn’t consumption GDP doesn’t include league Doesn’t include domestic goods More to happiness than consumption Decreasing marginal utility of consumption
- Does not include non-material aspects of standards of living: Environmental indicatiors Social indicators Education indicators Health indicators Political freedoms
Is Growth Sustainable?
Problem 1: running out of resources
- Possible solutions: Substitution, efficiency, recycling
- Role of markets and of public policy
- Prices rise as people worry that resources are depleting
- Isn’t an issue as profits act as an incentive for substitutes
Problem 2: Environmental degradation and climate change
- Substitution, efficiency and recycling still key
- Externalities: public policy key (prohibiting, taxation, fines)
Historically, “Environmental Kuznetsk Curve” for pollution at the local/national level
- For global externalities it will be hard e.g. price does not increase as pollution does
Pros of Growth
Pros:
- Lower unemployment/reduced poverty/reduced crime/higher incomes
- Moderates inflation’s as there is more productivity and a rise in demand, lower prices for firms and higher profits
- Multiplier effects on national income, greater consumptions and investment cause multiplier effects
- Higher tax revenues, improved public services, better welfare
- Shows increase in exports, lower current account balance
- Higher real wages and wealth as more in work
- Higher consumption
Cons of Growth
- Externalities: pollution/congestion/excessive lifestyles/debt
- Inequality: unequal wealth distribution
- Requirement of longer working hours
- Current account deficit
- Requires energy/raw materials, cost-push inflation if supply runs out (over-exploitation of finite resources)
More Pro-Growth Arguments
- Quantity of life
- Historic periods of low or no growth income associated with racism/facism in politics
- Low growth in rich world may regard growth/development and living standards in poor countries
- More leisure already an individual option
