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GDP II: Real GDP, Growth Rates, and Unemployment

Real GDP vs. Nominal GDP

  • Nominal GDP: Represents the total value of goods and services produced within an economy, measured at current market prices. It is not adjusted for inflation.

  • Price Level: An index that measures the average prices of all goods and services throughout an economy in a given period.

  • GDP Deflator: This is a specific measure of the price level used to adjust nominal GDP to calculate real GDP. It reflects the prices of all domestically produced goods and services.

  • Base Year: A specific year chosen as a benchmark for normalizing prices. Real GDP values are expressed in the constant dollars of this base year, effectively removing the impact of inflation.

    • Real GDP effectively measures the quantity of goods and services produced, valued at base year prices.

    • The current base year for the GDP deflator in the provided context is 2015.

  • Formula for Real GDP:

    • To express real GDP in base year values (where the base year's price level is typically indexed at 100):
      real\ GDPt = \frac{nominal\ GDPt}{price\ level_t} \times 100

    • To express real GDP in the values of a specific target year \tau (where \text{price level}t is the GDP deflator for year t and \text{price level}\tau is the GDP deflator for the year you want to normalize to):
      real\ GDPt = \frac{nominal\ GDPt}{price\ levelt} \times price\ level\tau

  • Example: Real GDP of the United Kingdom (Base Year 2015):

    • January 2023:

      • Nominal GDP: £647,110 M

      • GDP Deflator: 124.76

      • Real GDP in 2015 £: \frac{£647,110 M}{124.76} \times 100 \approx £518,699.98 M

      • Real GDP in 2023 £: \frac{£647,110 M}{124.76} \times 124.76 = £647,110 M (This is equivalent to its nominal GDP, as it's priced in its current year's prices).

    • January 2018:

      • Nominal GDP: £531,867 M

      • GDP Deflator: 104.75

      • Real GDP in 2015 £: \frac{£531,867 M}{104.75} \times 100 \approx £507,749.97 M

      • Real GDP in 2023 £: \frac{£531,867 M}{104.75} \times 124.76 \approx £633,522.01 M

    • January 2013:

      • Nominal GDP: £438,017 M

      • GDP Deflator: 98.49

      • Real GDP in 2015 £: \frac{£438,017 M}{98.49} \times 100 \approx £444,630.93 M

      • Real GDP in 2023 £: \frac{£438,017 M}{98.49} \times 124.76 \approx £555,145.45 M

  • Real GDP vs. Nominal GDP (Graphical Illustration): A FRED chart for the United Kingdom demonstrates the divergence between Nominal GDP and Real GDP over time. Nominal GDP (measured in current prices) typically shows a steeper upward trend due to inflation, while Real GDP (adjusted to a 2015 base year) represents the actual volume of economic output, providing a clearer picture of economic growth without price effects. The real GDP is calculated as (Gross Domestic Product / GDP Deflator) * 100.

GDP Growth Rates

  • Importance: The growth rate of GDP is a key indicator of economic expansion or contraction.

  • Definition: A growth rate is a percentage change over a specified period.

  • General Growth Rate Formula (for a time series X between X1 and X2):
    growth\ rate\ between\ X1\ and\ X2 = \frac{X2 - X1}{X_1} \times 100

  • Nominal GDP Growth Rate (for a one-year time span, e.g., in 2024):
    nominal\ GDP\ growth\ rate\ in\ 2024 = \frac{nominal\ GDP{2024} - nominal\ GDP{2023}}{nominal\ GDP_{2023}} \times 100

  • Two Ways to Compute Real GDP Growth Rates:

    1. Directly: Calculate real GDP for each period and then apply the general growth rate formula.
      Real\ GDP\ Growth\ in\ 2024 = \frac{real\ GDP{2024} - real\ GDP{2023}}{real\ GDP_{2023}} \times 100

    2. Indirectly (Approximation): This method approximates real GDP growth by subtracting the price level growth rate from the nominal GDP growth rate.
      Real\ GDP\ Growth\ Rate \approx Nominal\ GDP\ Growth\ Rate - Price\ Level\ Growth\ Rate

  • Example: US GDP Growth Rate in 2024:

    • US GDP Data:

      • 2024: Nominal GDP = \$29.179 T, GDP Deflator = 125.241

      • 2023: Nominal GDP = \$27.721 T, GDP Deflator = 122.266

    • Calculations:

      • Nominal GDP Growth Rate:
        Nominal\ Growth = \frac{\$29.179\ T - \$27.721\ T}{\$27.721\ T} \times 100 = \frac{\$1.458\ T}{\$27.721\ T} \times 100 \approx 5.26\%

      • Real GDP Growth Rate (Directly):

        • Real GDP 2024 (in base year values): \frac{\$29.179\ T}{125.241} \times 100 \approx \$23.298\ T

        • Real GDP 2023 (in base year values): \frac{\$27.721\ T}{122.266} \times 100 \approx \$22.673\ T

        • Real Growth Rate: \frac{\$23.298\ T - \$22.673\ T}{\$22.673\ T} \times 100 = \frac{\$0.625\ T}{\$22.673\ T} \times 100 \approx 2.76\%

      • Real GDP Growth Rate (Indirectly):

        • Price Level Growth Rate: \frac{125.241 - 122.266}{122.266} \times 100 = \frac{2.975}{122.266} \times 100 \approx 2.43\%

        • Real GDP Growth Rate \approx 5.26\% - 2.43\% \approx 2.83\% (This shows a small difference from the direct method due to the approximation).

  • US GDP Growth (Graphical Representation): A FRED chart illustrates the percentage change in Gross Domestic Product and Real Gross Domestic Product over time for the US. Shaded areas on the graph typically denote US recessions, highlighting periods where economic growth significantly slows or becomes negative.

Shortcomings of GDP

GDP is a valuable economic indicator, but it does not provide a complete measure of a nation's well-being or progress:

  • Does not count non-market goods and services or the underground economy:

    • Non-market goods and services: These are goods and services produced but not exchanged in a formal market, meaning no monetary transaction is recorded. Examples include:

      • Goods or services you produce for yourself (e.g., cooking at home, caring for one's own children, personal home repairs).

      • Homeownership: The imputed rent for owner-occupied housing is an exception, as it's an estimate of the value of shelter services homeowners provide themselves and is included in GDP.

    • Underground economy: Encompasses economic transactions that are not reported to the government, often to avoid taxes or regulations, or because the activities are illegal. GDP cannot accurately account for these unrecorded transactions.

  • Does not account for the quality of the environment:

    • GDP measures economic output but does not reflect the environmental impact or the quality of natural resources like air and water.

    • A higher GDP might even result from activities that cause environmental degradation (e.g., increased industrial production leading to pollution).

    • Many people consider a clean environment a crucial aspect of their standard of living, which GDP fails to capture.

  • Does not measure leisure time:

    • GDP focuses on how much is produced, not on the labor input or associated leisure time required for that production.

    • Two countries could have similar GDP per capita, but one might achieve it through much longer working hours, implying a lower quality of life due to less leisure.

    • Example: 2023 Average Hours Worked vs. GDP per Capita:

      • Korea: 1872 hours, \$54,033 GDP per Capita

      • United States: 1799 hours, \$81,695 GDP per Capita

      • Australia: 1651 hours, \$69,115 GDP per Capita

      • Japan: 1611 hours, \$50,207 GDP per Capita

      • United Kingdom: 1524 hours, \$58,906 GDP per Capita

      • Germany: 1343 hours, \$69,338 GDP per Capita

      • This data shows that countries like Germany achieve relatively high GDP per capita with significantly fewer working hours compared to, for example, the United States, suggesting more leisure time for their citizens.

  • Does not directly measure happiness:

    • While economic wealth and higher living standards can contribute to overall life satisfaction, GDP is not a direct measure of subjective happiness or well-being.

    • Stevenson and Wolfers (2013) findings: Found a positive correlation between wealth and life satisfaction:

      1. Within a country, wealthier individuals report greater life satisfaction than poorer people.

      2. Across countries, wealthier nations generally report greater life satisfaction than poorer nations.

  • GDP and Life Satisfaction (Graphical Illustration): A scatter plot titled 'GDP and Life Satisfaction' (using a \text{0-10} scale for satisfaction and log scale for GDP per capita at PPP) suggests a general positive relationship: as GDP per capita increases, average life satisfaction tends to rise, though other factors clearly play a role and there is variation among countries.

Why We Still Use GDP

Despite its limitations, GDP remains a primary indicator for several compelling reasons:

  • It is a clearly defined positive statistic that quantifies the total economic output.

  • It can be (mostly) objectively measured across countries, allowing for consistent international comparisons of economic activity.

  • It has a positive correlation with life satisfaction and other indicators of human welfare, suggesting it captures a significant aspect of living standards.

Unemployment

  • Labor Force: Comprises all individuals who are either currently employed or actively seeking work and are part of the work-eligible population. The labor force represents the total available workforce in an economy.

  • Unemployment: Occurs when a worker who is not currently employed is actively searching for a job but has been unsuccessful in finding one.

    • Individuals can be unemployed voluntarily (e.g., quitting to find a better job) or involuntarily (e.g., laid off).

  • Unemployment Rate: The percentage of the labor force that is unemployed.

  • US Unemployment Rates (Graphical Representation): A FRED chart shows the historical US unemployment rate. Recessions (shaded areas) are consistently associated with significant spikes in unemployment, demonstrating the direct relationship between economic downturns and job losses.

  • US Labor Force Participation Rate (Graphical Representation): A FRED chart tracks the percentage of the work-eligible population that is in the labor force. This rate showed a long-term increase, especially from the 1960s to 2000 due to demographic changes and increased female labor force participation, followed by a decline in recent decades due to factors like an aging population and increased school enrollment.

  • Population Categories for Unemployment:

    • Work-eligible population: Defined as civilians aged 16 and over who are not institutionalized (e.g., inpatients, prisoners, or active military personnel).

    • Labor force: Individuals within the work-eligible population who are either employed or actively seeking employment.

    • Key groups not in the labor force: Individuals within the work-eligible population who are neither employed nor actively searching for work. These include:

      • Full-time students

      • Retirees

      • Homemakers

      • Discouraged workers (those who have stopped looking for jobs due to belief that no jobs are available).

    • Unemployed: Workers who are members of the labor force, are not currently employed, and are actively searching for a job without success.

  • Formulas for Unemployment and Labor Force Participation Rates:

    • Unemployment Rate (u):
      u = \frac{number\ unemployed}{labor\ force} \times 100

    • Labor Force Participation Rate (LFPR):
      LFPR = \frac{labor\ force}{work - eligible\ population} \times 100

  • Example: Unemployment Rate & LFPR for United States and New Zealand:

    • Given Data:

      • United States:

        • Work-Eligible Population: 268,722 Thousands

        • Labor Force: 167,951 Thousands

        • Unemployed: 6,886 Thousands

      • New Zealand:

        • Work-Eligible Population: 4,240 Thousands

        • Labor Force: 3,019 Thousands

        • Unemployed: 145 Thousands

    • Calculations:

      • United States:

        • Unemployment Rate: \frac{6,886}{167,951} \times 100 \approx 4.10\%

        • Labor Force Participation Rate: \frac{167,951}{268,722} \times 100 \approx 62.49\%

      • New Zealand:

        • Unemployment Rate: \frac{145}{3,019} \times 100 \approx 4.80\%

        • Labor Force Participation Rate: \frac{3,019}{4,240} \times 100 \approx 71.20\%