Sunday, January 4, 2015

GDP Components

“…the welfare of a nation can, therefore, scarcely be inferred from a measure of national income…”

                                                                                            Simon Kuznet, 1934, designer of the GDP

GDP  - defined as the value of all final goods and services produced within an economy over a certain period of time, usually a year.

Mjmfoodie - GDP video
3 ways to arrive at the GDP figures.
  1. Output Approach: whereby production (output) is summed across all industries over a period                                  of time.                                                                                                                                            Ex. Primary sector + secondary sector + tertiary sector = GDP
  2. Income Approach: provides information about the proportion of total income earned by                                            laborers in contrast to owners of capital.                                                                                        Ex. wages + profits + interest + rents = GDP
  3. Expenditure Approach: permits us to monitor the level of investment spending through time                                   or the proportion of government expenditures in total economic activity.                                     Ex. C + I + G + X-m = GDP
AP is mainly concerned with the Expenditure Approach.

Components of GDP (Expenditure Approach)
  • C = Household (personal) consumption: durable consumer goods, non-durable consumer                 goods & consumer expenditures for services (think, any final goods purchased)
  •  I  = Private domestic investment: all final purchases of capital business & all construction                (households included) (think, purchases, construction or adding to inventories by                 business and construction by households)
  • G = Government Purchases: (all government spending on products, resources & services)
  • Xn = Net Exports: (exports - imports)

Some things are not counted in the GDP figures:
  • Public transfer payments: (social security, welfare, etc)  - no goods or services are                                                                 provided.
  • Private transfer payments: (monetary gifts, alimony, etc) - nothing is produced
  • Security transactions: (buying and selling of stocks,bonds, etc) But: (brokers                                                                 fees and commissions are included in GDP)
  • Secondhand Sales: (any used goods) - don't reflect current production, as they were counted                                      when they were originally sold.
  • Goods produced outside of the US are not included in GDP (look at the definition)
The GDP figure tries not to Double Count  - if we were to count the prices of intermediate goods (goods used to make final goods, ex. the price of steel and then the price of the car, we would be double counting the price of the steel, as its value is included in the final price of the new car sale) instead of final goods in the Expenditure Approach, since the value of the final goods include the intermediate goods, it would constitute a counting of the same thing multiple times, making GDP higher than it really is.

AP 2000 Macroeconomics Exam

Answer (C) The government increases its domestic purchases of food for use by the military.

(A) is not correct as Security Transactions (purchase of stock) is just a transfer of ownership, nothing has been produced.
(B) is not correct as GDP is goods that have been produced within the domestic economy.
(D) is not correct as GDP is current year production of goods and services.
(E) is not correct as GDP does not include secondhand sales.

Gross Domestic Product (GDP): is the tally of all money spent by individuals, households, business and government usually in a year.  GDP attempts to measure the size of an economy and is used as a comparison between countries. It also inherently implies that a growing GDP is indicative of a country that is increasing its well-being. 

There are some problems with using the GDP figure:

 1. GDP treats goods and services as homogenous
    GDP ultimately cannot tell us if spending has been for real wealth creation or capital consumption.

2.   If you marry your maid, you lower GDP
                  -GDP fails to take into effect the underground economy, bartering, volunteer services, and child-rearing, do-it-yourself improvements. A higher well-being might be achieved without expenditures and therefore not translate into a higher GDP.

3.   Burn Paris and you make GDP grow
                  -GDP only includes positive values. This has led to all types of politicians, newscasters and economists (who should know better) to state that natural disasters will benefit a country because rebuilding will stimulate production. See (Broken Window Fallacy) below. 

4.   GDP is insensitive to distribution of income.
                  -A country may be oil rich and have small ruling elites, a large population of poor and have a high GDP. A country with a comparable GDP might have a thriving economy with much lower income inequality.

5.   “If the government decides to build a pyramid and spends a trillion dollars then GDP will rise by a trillion dollars”. 
      -The inclusion of government spending in GDP implies that all government spending must increase the welfare of its people. Thus pyramid building, wars, ever growing government increases GDP but does not necessarily increase welfare. The comparisons between private spending and government spending are confused by a failure to understand that government spending must be funded by forced taxation or monetary printing.

AP 2005 Macroeconomic Exam
Answer (E) Additions to business inventories. (produced within a country) not sold.

(A) government transfer payments are not added to GDP, as nothing is produced
(B) Purchases of used goods are not included as second hand sales are not added to GDP.
(C) Childcare by househusband, not included (shortcomings of GDP)
(D) Total value of business inventories, (produced this year & some inventories are intermediate                                                                          goods.)

     AP 2005 Macroeconomic Exam

Answer (C)

Welker GDP Video: always great.
2007 AP Macroeconomic Exam Question, #3