2-GDP – Measuring a Nation’s Income Chapter 5 - Mankiw The National Accounts is a series of statistics prepared to measure the overall health of the economy. The most publicized of these statistics is the GDP or Gross Domestic Product. The GDP measures the market value of all of the final goods and service produced in Canada. If the GDP is rising then, given a constant population and zero inflation, the citizens of the country are wealthier. The GDP is used by businesses to forecast market activity. These forecasts are necessary when considering outlay for capital equipment and investment in general. The GDP is measured quarterly. Should GDP decline for two successive quarters, we are said to be in a recession. How GDP is measured can best be viewed by referring back to the diagram presented below. Revenue Spending Markets for Goods or Services • Firms Sell H h ld B Goods & Services Sold Goods & Services Bought Firms • • Households Produce & Sell Goods & Services Hire & Use Factors of Production • Inputs for Production Wages Rent & Profit • • Buy & Consume Goods & Services Land, Labor & Capital Markets for Factors of Production Households Sell Firms Buy Income → = Flow of Goods & Services = Inside → = Flow of Dollars = Outside The Expenditure Approach to Calculating GDP • On the right side of the diagram above we have households. We can measure GDP using the expenditure approach, determining the amount of money spent, by households, on goods and services. • The GDP using the expenditure approach can be calculated as follows: GDP = C + Ig + G + X – M You will need to know this formula Where: C = Consumption spending by households Ig = Gross investment by business and government (capital expenditures & changes in the levels of inventory) G = Government purchases of goods and services (transfer payments not included) X = Exports M = Imports Mankiw’s formula is Y = C + I + G + NX where NX = X - M The Income Approach to Calculating GDP • On the left side of the diagram we have firms. Using the income approach, we can determine GDP by determining all of the money businesses spend on the goods and services they require. • The GDP using the income approach can be calculated as follows: GDP = (Wages & Salaries) + Interest + Rent + Corporate Profits Before Taxes* + Income from Unincorporated Enterprises + Indirect Taxes + Capital Consumption Allowance *Corporate Profits Before Taxes = Corporate Income Taxes + Dividends + Retained Earnings • Whether you use the Income Approach or the Expenditure Approach to calculate you should come up with the same number for GDP It is important to keep the following in mind when studying GDP statistics: 1. It is important to distinguish between nominal GDP and real GDP. Real GDP takes into consideration the difference in the price level. GDP will rise substantially during inflationary times but are we better off? 2. To truly understand whether we are becoming wealthier we need to calculate GDP on a per capita basis. This takes population changes into account. 3. GDP does not measure those things that do not have a market price – vegetable gardens. Nor does it capture barter items. 4. GDP measures the value of all goods and services as long as they have a market price. GDP does not make value judgments – does a Brittney Spears doll make us a wealthier nation? 5. Illegal items are not captured in GDP. I believe the marijuana growing industry in B.C. is a $5 billion a year industry. 6. GDP measures wealth as the value of goods and services. The production of some of those goods and services causes pollution. Are we a wealthier nation if the nation is polluted? 7. Leisure is not counted in GDP. Leisure has value. 8. GDP does not measure changes in product quality. As quality goes up, so does our standard of living. 9. GDP does not say anything about income distribution. GDP per capita may rise, but most of the rise in GDP may be going in to a few pockets. Real versus Nominal GDP Calculation Year 2017 2018 2019 • • • • • Price of Cell Phones $100 $125 $175 Qty of Cell Phones 5000 7500 10000 Price of Stereos Qty of Stereos $1000 $1200 $1500 500 750 900 Calculating Nominal GDP (current year prices and quantities) o 2017 – ($100 X 5000) + ($1000 X 500) = $1,000,000 o 2018 – ($125 X 7500) + ($1200 X 750) = $1,837,500 o 2019 – ($175 X 10,000) + ($1500 X 900) = $3,100,000 Calculating Real GDP (base year 2007) – use current year quantities and base year prices o 2017 – ($100 X 5000) + ($1000 X 500) = $1,000,000 o 2018 – ($100 X 7500) + ($1000 X 750) = $1,500,000 o 2019 – ($100 X 10,000) + ($1000 X 900) = $1,900,000 Calculating the GDP Deflator – (Nominal divided by Real)100 o 2017 – ($1,000,000/$1,000,000)100 = 100 (always equals 100 in base yr) o 2018 – ($1,837,500/$1,500,000)100 = 122.5 o 2019 – ($3,100,000/$1,900,000)100 = 163.16 The GDP Deflator reflects what’s happening to price not quantity – prices rose by 22.5% from 2017 to 2018 If we were to divide $1,837,500 (2018) by $1,000,000 (2017), one might conclude that GDP rose by 83.75% but when we factor in inflation, we can see that GDP rose by only 50% ($1,500,000/$1,000,000) for 2018 over 2017 and by 26% ($1,900,000/$1,500,000) for 2019 over 2018.