Economic Growth and GDP

Using the AD/AS model to illustrate Economic Growth Economic growth = increase in the amount of goods and services produced in an economy (Shown as an increase in Real GDP) Gross Domestic Product (GDP) = Total value of all goods and services produced in an economy in a year Nominal GDP = Current dollar value of the production of goods and services produced Real GDP = Nominal GDP with the effects of inflation removed

Nominal GDP VS Real GDP Quantity of Pizzas Price of pizzas Quantity of pies Price of pies $1015$ $1230$6 Imagine the economy only produces pizzas and pies. Calculate GDP in year as the market value of production GDP 2000=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175 GDP 2004=(20pizzasX$12/pizza) + (30piesX$6/pie)=$420 Looking at these two GDPs what would you conclude? BUT Looking closely you can see the quantities produced of pizzas and pies in 2004 are twice that produced in 2000 If eco activity exactly doubled why do the calculated values of GDP show a greater increase? Prices as well as quantities rose!

Nominal and Real GDP Notes Nominal GDP= the actual dollar value of all goods and services produced in a year Inflation = These values cannot be meaningfully compared from year to year Increase’s in the price level

Consumer Price Index (CPI) Measures the price level of a ‘basket’ goods and services purchased by the average NZ household The data on prices comes from household surveys conducted by Statistics New Zealand CPI is then released quarterly Used as a general measure of inflation Indicates the effect of price changes on the purchasing power of households To calculate and index =Expenditure Now Expenditure Base Year

Consumer Price Index YearCPI% price level change % 30% 130% Measures rate of change in price level from the base year (2002). Rate of change between 2003 and 2004 is 1300 – 1222 * %

Change in CPI An increase in the CPI is called inflation. The price level increases. The purchasing power of money decreases. A decrease in the CPI is called deflation. Disinflation refers to a decrease in the inflation rate. The CPI is increasing at a decreasing rate.

Real Values Calculated using constant prices. –prices used for one year is used to calculate values for all years Are inflation adjusted. Can be meaningfully compared from year to year Real GDP = Nominal ValueX 1000 CPI

Real GDP and Nominal GDP Nominal GDP= the actual dollar value of all goods and services produced in a year Real GDP= is nominal GDP adjusted for inflation. This measure allows for comparison of changes in the value of national output without price changes distorting the data.

Real GDP In order to calculate RGDP the effect of price increases need to be removed. We will use the CPI index to do this: both the base year value (1000) and the value for the year we are calculating the RGDP for. The part of the equation in which this is taken into account is the GDP deflator: (taking inflation out of GDP value) » CPI base CPI year1

Real GDP equation

Real GDP Quantity of Pizzas Price of pizzas Quantity of pies Price of pies $1015$ $1230$6 Using the data in the table above and assume year 2000 is the base year find real GDP fro years 2000 and 2004 How much did real output grow between 2000 and 2004 Year 2000 real GDP=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175 Year 2004 real GDP=(year 2004 quantity pizza's X year 2000 pizza prices) + (Year 2004 quantity pies X year 2000 pie prices) = (20X$10) + (30X$5) =$350 By using real GDP we have eliminated the effects of price changes and obtained a reasonable measure of actual change in physical production

Measuring the % Change

Measuring the rate of Economic Growth Rate of growth= GDP 2 nd year-GDP 1 st year x 100 GDP 1 ST year Rate of inflation= CPI 2 ND year - CPI 1 ST year x 100 CPI 1 ST year Calculating the rate of inflation

Limitations to GDP In groups give an opinion into how well GDP is as a measure of the standard of living. Think about – Unpaid work? Non-market activities? If it is not sold it is not counted – Merit and demerit goods – The distribution of wealth. Standard of living - the degree to which people have access to goods and services that make their lives easier, healthier, safer and more enjoyable

Limitations to GDP as a measure of Standard of Living Non market activity – GDP excludes Voluntary Labour Cash transactions, barter Illegal transactions Relative Merits of production – There is no distinction in GDP whether goods being produced are merit goods or demerit goods e.g. a dollar spend on cigarettes has the same weight as a dollar spent on education Distribution of Income – GDP is a total. – Does not tell us how this total is distributed e.g. a country may have high GDP but there also may be large numbers of people living in poverty.

GDP per capita Use GDP per capita (per head of population). GDP per capita = GDP Total Population Shows how much of the economies total production each person would receive if it was divided equally