Real vs Nominal GDP Example

Consider the simple pizza and calzone economy

• The nominal GDP for each of the years is just the quantities times the prices for each of the products at that year:
  • 2013: $10 \cdot \text{\textdollar} 10 + 15 \cdot \text{\textdollar} 5 = \text{\textdollar} 175$
  • 2017: $20 \cdot \text{\textdollar}12 + 30 \cdot \text{\textdollar}6 = \text{\textdollar}420$
• The real GDP for each of the years with 2013 as a base year uses prices at the base year for the quantities of each good at that year:
  • 2013: $10 \cdot \text{\textdollar}10 + 15 \cdot \text{\textdollar}5 = \text{\textdollar}175$
  • 2017: $20 \cdot \text{\textdollar}10 + 30 \cdot \text{\textdollar}5 = \text{\textdollar}350$

Market Value

• Good or service not bought or sold in the market doesn’t count toward GDP, e.g. unpaid work of a homemaker doesn’t contribute to GDP, but paid housekeeping or childcard services are part of GDP
  • As women’s labor force participation grew between 1960 and 1999, GDP increase for two reasons
    • Women entering workforce now have an output measured by GDP, this is a real addition to the GDP
    • Those women who previously provided unpain childcare services that are now getting paid for the same services do not represent a true net additional to goods and services produced (since they were providing the same service regardless of whether they were getting paid). However, the GDP only accounted for these services when the women entered the workforce, and so the GDP’s measured increase simply fixes a measurement issues.
    • Point here is that the GDP increase over this time period is likely an overstatement of the actual net increase in goods and services because it did not account for the unpaid labor of women before entering the workforce.
• Some non-market goods are included in GDP:
  • Wages in kind (e.g. health benefits)
  • Agricultural output for self-consumption (added only for farmers, just assume they’re eating their own output); for non-farmers, no point in measuring this due to its minimal addition and high measurement cost
  • Imputed rent from a home owner occupying their own house; counting opportunity cost of renting your house
  • Services (e.g. checking accounts) provided by financial intermediaries (banks) are given imputed values for difference in interest rates i.e. difference between the rate at which they loan out your money vs the interest rates they pay you for having your money in their account
  • Govt goods and services not sold in market but still included because they have value, increase output, and have known quantities
• Some goods excluded from GDP:
  • Non-production transactions
    • Public transfer payments (e.g social security, unemployment benefits); money given to citizen without them having produced a good or service
    • Private transfer payments, like gifts
  • Capital gains and losses, making money from change in price on same good or service (e.g. buying house at $x, selling at $y)
  • Unpaid volunteer work for charities
  • Illegal market activities
  • Financial market transactions
    • Financial securities represent ownership (stock) or loans (bonds); not real production but rather means of financing production
    • Interest by government or consumers

Final vs Intermediate Goods

• Final goods consumed by ultimate user
  • Included in GDP
• Intermediate goods are used up in production of final goods
  • Not included in GDP to avoid double counting; final good price assumed to account for all intermediate goods used
  • Example: barber charges $10 for a haircut and barber’s assistant is paid $2/hr for sweeping up hair. Haircut’s contribution to GDP is still $10, the $2/hr rate is not factored in because it’s intermediate, not a direct contribution to the final good.

Capital Goods vs Consumption Goods

• Capital good: good that helps to increase future production
  • Different from financial capital, which refers to the funds companies use to grow
  • All company spending is on capital goods
  • Examples include houses, apartments, stoves in restaurants (but not homes), delivery vehicles
  • Not considered to be final goods as they’re used for production of final goods, but not intermediate goods because not immediately used up during production of the final goods
  • So…they are classified as final goods and added to the GDP as investment
• Consumption good: goods purchased for consumption, and not used later for production of other consumption goods
  • All household spending is consumption except for the purchase of the house itself, which is always a capital good

Government spending

• All govt spending is valued arbitrarily and is added as a cost
• All govt spending is considered to be on final goods for simplicity

Value Added Method

• Value added for firm is market value - cost of inputs purchased from other firms

• Helps resolve issues with production of intermediate and final goods in separate time periods

• GDP counts value added in the year it is produced. For example, consider the follow cost table:

  Company	Revenue	Cost of inputs	Value added
  ABC Grain	$0.50	$0.00	$0.50
  General Flour	$1.20	$0.50	$0.70
  Hot’n’Fresh	$2.00	$1.20	$0.80
  Total			$2.00

  Here we are assuming the grain and flour were produced in late 2017, while the final bread was made in 2018. So in 2017, ABC Grain adds $0.50 of value by producing and selling grain to General Flour. General Flour then produce $1.20 of flour, adding a net value of $0.70. Both of these values are added to 2017 so a total of $1.20. Hot’n’fresh then uses this flour to produce $2.00 of bread in 2018, so the net value of $0.80 is added to 2018.

GDP vs GNP

• Gross national product (GNP): total factor income earned by citizens of a country
• Four factors of production:
  • Land: is paid rents
  • Labor: is paid wages/salaries
  • Capital: is paid interest
  • Entrepreneurship: is paid profits
• Factor incomes is income derived from selling the services of the factors of production
• This includes factor incomes from Americans abroad, and excludes factor incomes earned by foreigners

Expenditure Method

• Four groups that buy final goods: households, firms, governments, and foreign buyers
• Total expenditure = total market value of goods and services = $C + I + G + (X-M)$ = GDP, where $C$ = consumption, $I$ = investment, $G$ = gov expenditures, $X$ = exports, $M$ = imports
• Change in inventory = end year inventory - beginning year inventory

Economic Investment vs Financial Investment

• Financial investments are not added to GDP
  • Includes purchases of stocks, bonds, and other financial assets
  • Gerenally transfer ownership of existing capital stock
• Economic investments are added to GDP
  • Production of capital goods used to produce other goods

Chain Weighting

• Real GDP uses chain weights approach, geometric average

  $$\frac{\text{2009 Real GDP}}{\text{2007 Real GDP}} = \sqrt{\text{Ratio of real GDPs w 2007 prices}} \cdot \sqrt{\text{Ratio of real GDPs w 2008 prices}}$$

Nominal GDP vs Real GDP

• Typically real and nominal GDP increase each year
• Nominal GDP can rise while real GDP goes down in recessions as prices of goods increase faster than output decreases
• Nominal GDP can be smaller than real GDP if base year prices are greater than current prices

Real GDP and Economic Well-Being

Is real GDP a good measure of economic well-being? Things worth considering:

• GDP ignores:
  • Leisure (produces no goods for market)
  • Nonmarket Economic Activities
  • Underground economy
  • Environmental quality
  • Resource depletion
  • Intangible measuring quality of life: people value low crime, traffic congestion, sense of community, open space, etc; thus, it understates the true nature of reality, as increasing these quality of life are not factored in
  • Economic inequality
• GDP accounts well for:
  • Material standard of living i.e. more goods and services
  • Health and life expectancy
  • Eduation
• GDP and meaning of life:
  • Life satisfaction index asks people to rate how they feel about their lives 0-10
  • Broad conclusions: richer is better, but money matters less as you get richer; i.e. you reach a threshold after which your happiness is no longer impact by mone

U1 - U6 Rates

• U1 = Percentage of labor force unemployed 15 weeks or longer
• U2 = Percentage of labor force who lost jobs or completed temporary work
• U3 = Percentage of labor force who did not work in the last week but have looked for work in the last four weeks (this is the officially reported unemployment rate)
• U4 = Take U3 and add “discouraged workers” to the numerator and denominator. U4 = (Unemployed + Discouraged) / (Labor Force + Discouraged)
• U5 = (Unemployed + All Marginally Attached) / (Labor Force + All Marginally Attached)
• U6 = Total unemployed (from U3), plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force. U6 = (Unemployed + Marginally Attached + Involuntary Part-Time workers) / (Labor Force + Marginally Attached).

Workers

• Marginally attached workers: people not working nor seeking work because they believe they won’t get the result and are discouraged, as well as any other reason
  • Counted as out of the labor force, not unemployed since they haven’t looked for work in past four weeks
• Involuntary part-time workers: people who want full-time but can’t find it (considered underemployed, but counted as employed)

Cost of unemployment

• Economic: lost wages and production
• Mental: individual self-esteem, family stress
• Social: potential increase in crime, drug abuse