AA

Chapter 6: GDP and the Measurement of Progress

GDP: Definition and Purpose

  • GDP is the market value of all finished goods and services produced within a country in a year.

  • Used to gauge economic activity, measure progress, and compare across countries/time.

Real vs Nominal GDP

  • Nominal GDP uses current prices; Real GDP uses prices from a base year to remove inflation.

  • Real GDP growth isolates changes in production from price changes.

  • Real GDP per capita = \frac{\text{Real GDP}}{\text{Population}}; approximate living standards per person.

Growth Rates

  • Growth rate of GDP (year t relative to t−1):
    \text{Growth rate} = \frac{GDPt - GDP{t-1}}{GDP_{t-1}} \times 100\%

  • Real GDP growth per capita ≈ Real GDP growth − population growth.

  • Example: if GDP2017 = 19.4 and GDP2016 = 18.6, then
    \frac{19.4 - 18.6}{18.6} \times 100\% = 4.3\%.

GDP in Practice: The Expenditure Approach

  • National Spending (Expenditure) Approach: Y = C + I + G + NX

  • Net Exports: NX = \text{Exports} - \text{Imports}

  • There is no double counting because intermediate goods are excluded.

Components of GDP (Expenditure Approach)

  • Consumption (C): private spending on final goods/services (households and some nonhousing services like medical care, education).

  • Investment (I): private spending on capital (tools, plants, equipment) and new housing; not stocks/bonds.

  • Government Purchases (G): spending by all levels of government on final goods/services; transfers are not included.

  • Net Exports (NX): exports add to GDP, imports subtract from GDP.

  • Typical shares (illustrative):

    • Consumption: roughly \approx 0.66\text{ of real GDP}

    • Investment: roughly \approx 0.17\text{ of real GDP}

    • Government purchases: roughly \approx 0.21\text{ of real GDP}

    • Net exports: often negative (e.g., around -0.013\times\text{Real GDP})

The Factor Income Approach

  • GDP can also be written as: Y = Wages + Rent + Interest + Profit

  • This reflects the idea that money spent on goods/services is received by different factors of production.

  • Labor share of income ≈ 0.67; Capital share ≈ 0.33.

Why split GDP into components?

  • Different components behave differently over time; helps analyze fluctuations.

  • Cross-checks and error checking: different methods should roughly agree.

Real GDP per Capita and Living Standards

  • Real GDP per capita is a rough proxy for living standards; higher real GDP per capita tends to be associated with:

    • Longer life expectancy, better health, higher literacy, and sometimes better environmental outcomes.

  • GDP misses many welfare-relevant factors (health, leisure, inequality, environmental quality, etc.).

Problems with GDP as a Measure of Output and Welfare

  • Underground economy: illegal/trade not counted; some legal activities under the table are omitted.

  • Nonpriced production: home production, volunteer work, and informal services aren’t captured.

  • Leisure: GDP ignores the value of leisure time; hours worked vary across countries.

  • Bads: pollution, resource depletion, and crime are not subtracted from GDP.

  • Distribution: GDP/GDP per capita may rise while inequality worsens; not all individuals benefit equally.

  • Health and well-being: GDP does not measure health outcomes directly.

Real GDP Growth and Population Growth

  • Real GDP growth per capita depends on both economic growth and population growth:
    \text{Real GDP per capita growth} \approx \text{Real GDP growth} - \text{Population growth}

  • Long-run trend in the U.S. real GDP growth is around 3.2\% per year historically; real GDP per capita growth depends on population trends.

Quick Takeaways

  • GDP measures market activity and is useful for tracking growth and fluctuations, but it does not capture welfare perfectly.

  • Real GDP and real GDP per capita are better for comparing living standards over time and across countries.

  • The expenditure approach (C + I + G + NX) is the standard way to compute GDP; the factor income approach is an alternative cross-check.

  • Be mindful of the limitations: underground economy, nonpriced production, leisure, bads, and income distribution.

Quick Formulas to Memorize

  • Growth rate: \frac{GDPt - GDP{t-1}}{GDP_{t-1}} \times 100\%

  • Real GDP (base-year prices): Real\ GDPt = Ps \cdot Q_t (prices from base year s, quantities in year t)

  • GDP identity (expenditure): Y = C + I + G + NX with NX = Exports - Imports

  • Real GDP per capita: \frac{Real\ GDP}{Population}

  • Real GDP per capita growth: \text{Real GDP growth} - \text{Population growth}