GDP and Unemployment

How do Economists Measure the State of the Economy?

gross domestic product - GPD

Gross Domestic Product (GDP)

• The market value of final goods and services produced in a country during a given period

• Economists aggregate the quantities of many different goods and services into a single number by adding up the market values of the different goods and services that the economy produces

Why is Measuring GDP Criticised?

its doesn’t accurately reflect factors such as distribution of income and the effect or economic growth on the environment

Measuring Output

Market Value

• provide a convenient way to aggregate the many different good and services produced in a modern economy

• however, not all economically valuable goods and services are bought and sold in markets

Government Goods and Services in GDP Measurement

• Not Sold in Markets → No market-determined prices

• Provide Societal Benefits (e.g., infrastructure, parks, street lighting, basic research, communications)

• Challenges in Valuation 

• Quantities Are Known, But Prices Are Not 

  • Resource allocation is determined by budgets and policy, not market forces

  • No direct exchange of money between buyers and sellers

• GDP Measurement Issues

• Valued at Cost 

  • Government production is measured by its cost, not by its market value

Government Goods and Services Potential Overstatement of GDP

• Waste and inefficiency (e.g., lack of competition, corruption, political factors)

• Public spending may not accurately reflect its economic value

Government Goods and Services in GDP Resource Misallocation Risks

• If public projects are inefficient or politically motivated, resources may be wasted

• Deadweight Loss: Costs of production may exceed societal benefits

Government Goods and Services in GDP Social Welfare Considerations

• Market prices may not reflect the true social value of these goods

• Public goods often lead to market failure if left to private markets

Government Goods and Services in GDP Impact on Economic Output

• Stimulates demand and economic activity

• Injects money into the economy

• Increases production capacities

Final Goods and Services

Consumed by the ultimate user

• End products of production

• Included in GDP

Capital/Intermediate Goods and Services

a long lived good, which is itself produced and used to produce other goods and services

not directly consumed by households

not included in GDP to avoid double counting

Capital/Intermediate Goods Examples

• Buildings & Infrastructure – Houses, apartments, motels 

• Equipment & Machinery – Restaurant stoves, tools in cooking schools 

• Vehicles for Business Use – Delivery trucks, taxis 

Is Money a Capital Good?

no - it facilitates transactions but doesn’t produce goods or services itself

Value Added

the market value of the product minus the cost of inputs purchased from other firms

• you count value added in the year it is produced

What does Domestic mean in GDP?

the activity is measured within a country's borders

(nationality of owners or company is not relevant)

4 Categories of Users of Final Goods and Services

• Households

• Firms 

• Governments 

• Foreign sector

Economists assume that all final goods and services that are produced in a country in a given year will be purchased and used by members of one or more of the four groups

Expenditure Method for Measuring GDP

GDP can be measured with equal accuracy by either of two methods: 

• Adding up the market value of all the final goods and services that are produced domestically

• Adding up the total amount spent by each of the four groups on final goods and services and subtracting spending on imported goods and services

Consumption Expenditure

spending by households for goods and services

Consumer Durables

long-lived consumer goods

e.g. cars, furniture, appliances

Consumer Non-Durable Goods

shorter-lived goods

e.g. clothing, food ,bedding

Services

largest component of consumer spending

e.g. education, taxis, haircuts

Investment

Spending by firms on final goods and services

Aimed at increasing the production capacity of the economy

Business Fixed Investment

purchases of new capital goods

e.g. plant, property, equipment

Residential Investment

construction of new homes and apartment buildings

Inventory Investment

the change in unsold goods to the company’s inventory

these goods are produced but not yet sold

can be positive or negative

Financial Investment

• purchases of stocks, bonds, and other financial assets

• generally transfers ownership of a portion of the firm's existing capital stock

• doesn’t correspond to any increase in physical capital or production capacity, in most cases

  • new stock issues can be an exception

Economic Investment

the increase in the capital goods used to produce other goods 

• value is based on the purchase price of the capital goods, not on stock value

Government Purchases

Final goods and services bought by federal, state, and local governments

e.g. Fighter jets, Teaching, Office Supplies

Excludes transfer payments (redistribution) and interest paid on government debt

Transfer Payments

made by government, but the government receives no current goods or services

e.g. social security, food stamps

no purchases of final goods and services involved - no added production - spending by recipients is included in GDP

Net Exports Calculation

exports - imports

Exports

goods and services produced domestically and sold abroad

reduce the amount available to the domestic economy

Imports

purchases in the US of goods and services produced abroad

can be consumption, investment or government spending

increase the amount available to the domestic economy

GDP Expenditures Equation

Y = C + I + G + NX

• Y - GDP or output 

• C - Consumption Expenditure 

• I - Investment 

• G - Government Purchases 

• NX - Net Exports

Income Approach to GDP

when a good is sold, its proceeds are distributed to workers or business owners

GDP Equation

labour income + capital income

Labour Income

wages, salaries, benefits, and incomes of the self-employed

About ⅔ of GDP

Capital Income

pays for physical capital and intangibles

• Profits for business owners

• Rent for land 

• Interest for bond holders – Measured before taxes

• Royalties

3 Faces of GDP

Circular Flow Diagram

Adjusting for Price Changes

• Compare GDP for different years to see how much output has changed 

• To see how much output has grown, use only the changes in quantities

  • Hold prices constant

Why does GDP Change over Time?

• Prices change AND

• Quantity of output changes

Nominal GDP

• a measure of GDP in which the quantities produced are valued at current-year prices

• measures the current money value of production

Real GDP

• a measure of GDP in which the quantities produced are valued at the prices in a base year, rather than at current prices

• measures the actual physical volume of production

What Normally happens to Real and Nominal GDP?

usually they increase each year

Why is Real GDP rising and Nominal GDP falling rare?

historically prices fall faster than the increase in output

What happens if Nominal GDP goes up while Real GDP does down?

fewer goods and services produced

prices increase faster than output decreased

Why would Nominal GDP be Smaller than Real GDP?

the prices in the current year are less than the base year

usually true for years before the base year

GDP and Economic Well-Being

GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain many of the inputs into a worthwhile life

What does Real GDP Omit?

• illegal transactions

• volunteer work

• household production

• leisure

Will Maximising GDP Maximise Wellbeing?

not necessarily, its a case-by-case issue

What would the Loss from Reduced Leisure Offset?

the gain from producing and consuming a greater quantity of goods and services

Underground Economy

all unreported transactions, legal and illegal

some underground activity is illegal 

• a service of value is provided

• drug dealers, bookies, fences, prostitution, etc

estimates suggest the underground economy is large regardless of national income level

Casual Labour is Paid in?

cash - failure to report this reduces taxes

Environmental Quality

Clean-up activities are included in GDP

• Gets environment back to its starting point, not better

• The deterioration in the quality of air and water would more than offset the gains from greater production

Resource Depletion

No adjustment is made for the decline in resource availability when mining or other harvesting is done

What Other Intangibles does GDP not Value?

• Crime rates

• Traffic congestion

• Civic organizations

• Open space

• Sense of community

Poverty and Economic Inequality

• GDP does not capture the effects of income inequality

• US uses an absolute standard of poverty

• Inequality matters and it is increasing in the US

• GDP cannot differentiate between an unequal and an egalitarian society if they have similar economic sizes

• As rising inequality is resulting in a rise in societal discontentment and increased polarization, policymakers will need to account for these issues when assessing development

GDP Limitations

• tells us about aggregate consumption, but it does not tell us about personal well-being

• tells us about production, but not about the pollution that comes with it, or the depletion of natural resources it requires

• tells us about government expenditure and private investments, but not about the quality of life they generate

• as global annual GDP peaked, our ecological footprint did so too, leading to an ecological deficit

• forests were cut to make way for agriculture and industry, oceans were depleted of their fish stocks, and fossil fuels were burned and polluted the air, leading to climate change

• in the short-term that lead to growth, in the long-term it damaged our health, wealth and well-being

GDP as a Welfare Measure

GDP omits and undervalues some goods and services

GDP per capita is positively associated with several measures of well-being

• Material standard of living: more goods and services

• Health and life expectancy

• Education

What do Countries with High Real GDP per Head of Population tend to have?

• higher life expectancy

• lower infant mortality

• better nutrition and healthcare

Unemployment

The working age population fall into:

What Happens when the Unemployment Rate is Low?

jobs are secure and relatively easy to find

Employed

a person who works full/part time, or is on vacation or sick leave from a regular job

Unemployed

a person who isn’t employed but is actively seeking employment

Out of the Labour Force

a person who isn’t employed or actively seeking employment

Labour Force

the total number of people employed and unemployed in the economy

Unemployment Rate

the percentage of the labour force classified as unemployed

Participation Rate

the percentage of the working population in the labour force

calculated by dividing the labour force by the working age population

Types of Unemployment

1. frictional unemployment

2. structural unemployment

3. seasonal / cyclical unemployment

add up to total unemployment rate

Frictional Unemployment

• short-term

• associated with the process of matching workers with jobs

• the process of matching workers with jobs

Structural Unemployment

• long-term and chronic

• exists even when the economy is producing at the normal rate

• several factors contribute:

  • A lack of skills

  • Language barriers

  • Discrimination

• economic changes sometimes create a long-term mismatch between the skills that some workers have and the available jobs

What Substantial Economic Losses does Long-Term Unemployment Cause to Society?

loss of income for workers and loss of output for firms

Seasonal/Cyclical Unemployment

• extra unemployment

• occurs during the periods of recession

• occurs when the economy experiences a decline in the demand for the goods and services it produces

Economic Costs of Unemployment

Lost wages and production

Decreased taxes and increased transfers

Psychological Costs of Unemployment

Individual self-esteem

Family stress of decreased income and increased uncertainty

Social Costs of Unemployment

Potential increases in crimes and social problems

Social resources spent to address these

Long-Term Unemployed

have been out of work for 6 months or longer

Short-Term Unemployed Outcomes

• find a permanent job after searching a few weeks

  • economic costs are low

• leave the labour force

• short-term/temporary job that leads to unemployment again

  • these chronically unemployed have costs similar to the long-term unemployed

Unemployment Spell

the period during which an individual is continuously unemployed

Duration of Unemployment

the length of the unemployment spell

Discouraged Workers

would like to have a job but they have not looked for work in the past four weeks because they believe they are no jobs available

counted as out of the labour force

could be counted as unemployed but they are not

Involuntary Part-Time Workers

people who like to work full time but can’t find a full time job

counted as employed