Macroeconomic Performance and GDP Measurement

Macroeconomic Performance

• How national income and output are measured.
• How to compare income and output internationally.
• What GDP measures and its limitations.

Aim of the Lecture

• Explain how GDP is measured.
• Explain how GDP is compared internationally.
• Weigh the pros and cons of using GDP as a measure of wellbeing.

Measuring National Income and Output

• Three ways of measuring Gross Domestic Product (GDP):
  • The product method.
  • The income method.
  • The expenditure method.

The Circular Flow of National Income and Expenditure

• The circular flow includes:
  • Production.
  • Incomes.
  • Expenditure.

Measuring National Income and Output - Methods

• Product method: Sum the value of all goods and services produced in the country, industry by industry.
• Income method: Add up all household incomes, including wages, salaries, profits, rent, and interest.
• Expenditure method: Sum of private consumption (C), government spending (G), investment (I), and net export spending on goods and services (X-M).
• Thus, $GDP = C + G + I + X - M$

Value Added as Output

• Production occurs in stages: supply chain from raw materials to final product.
• Value-added measures each firm’s contribution to total output, i.e., the amount of market value produced by that firm.
• The sum of all values added in an economy is a measure of the economy’s total output, called Gross Value Added (GVA).

Example of Adding Value

• Firm A sells raw materials to firm B for £120.
• Firm B processes them and sells them to firm C for £160.
• Firm C uses them to produce a finished good, which it sells to a wholesaler for £300, who then sells it to a retailer for £350, which then adds a £25 mark-up.
• Assuming no VAT, and using a value-added approach, total value of production equals: £$120 + 40 + 140 + 50 + 25 = 375$

UK GVA (Product-Based Measure): 2022

UK GVA (by Category of Income): 2022

GDP vs GNI

• Gross National Income (GNI) is the total income received by a country from its residents and businesses, regardless of whether they are located in the country or abroad.
• GDP focuses on the value of domestic production.
• GNI differs from GDP due to net income from abroad.

Nominal GDP vs Real GDP

• Nominal GDP: GDP measured at current prices.
• Real GDP: GDP measured in constant prices.
• Real GDP accounts for inflation: measuring each year’s GDP in, say, 2018 prices, would reveal how much real GDP had changed from one year to another.
• It would eliminate increases in nominal GDP that were due to increases in prices.

International Comparisons

• GDP measures the size of an economy.
• GDP per capita or GDP per worker is more informative for comparing living standards and productivity.
• GDP per capita measures material living standards.
• GDP per worker (or per hour worked) measures labor productivity.

International Comparisons (cont’d)

• GDP in each country is measured in the local currency.
• To make international comparisons, we convert different countries’ nominal GDP into the same currency.
• The Purchasing-Power Parity (PPP) exchange rate equates the prices of a representative bundle of goods in two countries.
• Purchasing-power parity (PPP) exchange rate: An exchange rate corrected to take into account the purchasing power of a currency.
• Purchasing-power standard GDP: GDP measured at a country’s PPP exchange rate.

GDP per Head as a Percentage of the EU-15 Average: 2023

National Income and Living Standards

GDP excludes:

• Non-marketed items (‘do-it-yourself’ and home-based activities).
• The ‘underground’ or ‘shadow’ economy.

Production may be a poor indicator of welfare:

• Production does not equal consumption.
• Production has human costs.
• GDP ignores externalities (environmental side effects).
• Production of ‘bads’ included in GDP (crime, stress, and environmental damage).
• GDP ignores distribution of income.

Lecture Summary

1. National income or output can be measured by the product, expenditure, or income methods.
2. To compare living standards internationally, national income should be expressed per capita and at purchasing-power parity exchange rates.
3. GDP is not a complete measure of economic welfare.