Gross Domestic Product: Part II Notes

Gross Domestic Product: Part II

GDP Math

  • Calculating GDP involves addition, multiplication, and division.

  • Example using a hypothetical small country producing Apple Pie, T-shirts, and Gasoline:

    Year

    Apple Pie (P)

    Apple Pie (Q)

    T-shirts (P)

    T-shirts (Q)

    Gasoline (P)

    Gasoline (Q)

    2015

    $4.00

    10

    $6.00

    20

    $2.50

    100

    2016

    $4.50

    12

    $6.10

    22

    $2.75

    110

    2017

    $5.25

    16

    $6.80

    25

    $2.90

    125

    2018

    $5.50

    17

    $7.20

    29

    $3.00

    135

    • 2017 is the base year.

Nominal GDP

  • Nominal GDP uses the prices and quantities of a given year.

  • Example Calculation for 2015:
    (4∗10)+(6∗20)+(2.50∗100)=40+120+250=410(4 * 10) + (6 * 20) + (2.50 * 100) = 40 + 120 + 250 = 410

Real GDP

  • Real GDP accounts for price changes by using the base year prices.

  • Base year prices are fixed over time.

  • Example Calculation for 2015 (using 2017 as the base year):
    (5.25∗10)+(6.80∗20)+(2.90∗100)=52.5+136+290=478.50(5.25 * 10) + (6.80 * 20) + (2.90 * 100) = 52.5 + 136 + 290 = 478.50

  • The difference between nominal and real GDP arises because real GDP adjusts for inflation.

GDP Deflator

  • The GDP deflator measures the change in the price level over time.

  • It is an index.

  • The base year is always 100 because the nominal and real GDP are the same in the base year.

  • Prices generally increase over time, so the GDP deflator is typically less than 100 before the base year and greater than 100 after the base year.

  • Formula:
    GDPDeflator=(NominalGDP/RealGDP)∗100GDP Deflator = (Nominal GDP / Real GDP) * 100

Using the GDP Deflator

  • Real GDP removes the price effect, so comparing changes in real GDP over time shows the actual change in the quantity of goods and services.

  • Comparing changes in the GDP deflator over time reflects changes in the price level.

  • The rate of change can vary from year to year and provides useful information.

Growth Rates

  • Growth rates are expressed as a percentage change.

  • Formula:
    %Δ=((X<em>1−X</em>0)/X0)∗100\% \Delta = ((X<em>1 - X</em>0) / X_0) * 100

    • Where X can be real GDP, nominal GDP, or the GDP deflator.

  • Growth rates allow for quick comparisons between different countries or time periods.

  • Examples of comparisons:

    • Change in real GDP from 2011 to 2021 for France vs. Germany.

    • Change in the price level from 2001-2011 and 2011-2021 for Japan.

Calculating Real GDP

  • To calculate real GDP:
    RealGDP=(NominalGDP/GDPDeflator)∗100Real GDP = (Nominal GDP / GDP Deflator) * 100

  • Example:

    • Nominal GDP in 2021 = $23,500 billion

    • GDP Deflator in 2021 (base year 2000) = 125

    • Real GDP in 2021 = (23500/125)∗100=18,800(23500 / 125) * 100 = 18,800 billion (in 2000 dollars)

  • This allows comparison of real output changes without the skewing effect of inflation.

GDP Deflator Example

  • Using FRED (Federal Reserve Economic Data) data:

    • 2001, Q1: GDP Deflator = 73.822

    • 2020, Q4: GDP Deflator = 106.244

  • Calculating the percentage change in the price level from 2001 to 2020:
    ((106.244−73.822)/73.822)∗100=43.92%((106.244 - 73.822) / 73.822) * 100 = 43.92 \%

Relationship Between Growth Rates

  • When growth rates are relatively small:
    %ΔNominal≈%ΔReal+%ΔPrices\% \Delta Nominal \approx \% \Delta Real + \% \Delta Prices

  • Nominal GDP changes when either real output or inflation changes.

  • Nominal GDP can increase even if real output stays the same due to a rise in inflation.

Global Comparisons

  • Per capita GDP is a better measure for comparing countries.

  • "Constant GDP per capita" is a way to compare countries (minor differences).

  • Examples of constant GDP per capita (using 2010 U.S. dollars):

    • United States: Increasing trend over time.

    • Canada: Similar to Alabama which is roughly $42,000.

    • Mexico: Slower growth compared to the U.S. and Canada.

    • Russia: Impacted by events like the fall of the Berlin Wall.

    • China: Significant growth due to market reforms.

    • Haiti: No clear trend.

    • Ethiopia: No clear trend.

Limitations of GDP

  • GDP does not capture all economic activity and treats all recorded activity the same.

  • Nonmarket economic activity:

    • Goods and services without a paper trail/receipt are not counted.

    • Example: Washing dishes at home vs. washing dishes at a restaurant.

  • Illegal or underground economic activity:

    • Goods and services produced without a paper trail are not counted.

    • Examples: Marijuana (legal in Colorado, not in S.C.), undocumented labor.

    • "Under the table" payments in cash.

  • Quality vs. Quantity:

    • GDP counts quantity, not necessarily quality.

    • What's the value of clean air?

    • Is increased spending on police or oil spill cleanups a positive?

  • Standards of living:

    • Some measures of a better standard of living are hard to calculate.

  • The Joy of Doing Nothing:

    • The value of leisure or cultural differences is not reflected in GDP.

    • Example: Mandatory vacation time in the U.S. vs. extended vacations in Europe.

GDP Correlation

  • While not perfect, GDP provides valuable insights:

    • Countries with higher GDP/per capita GDP tend to have:

      • Higher life expectancy, education levels, and literacy rates.

      • Lower infant mortality rates, less corruption, and less crime.

      • More teachers and doctors per capita.

    • Higher real per capita GDP generally correlates with a "better life."