ECON 100 Lecture 21 Monday, December 1

Announcements Answer key to PS #8 is posted on webpage. PS#9 will be posted later in the week. Webpage : https://ais.ku.edu.tr/course/25089/Default.html

GDP Gross Domestic Product Today’s lecture

GDP defined The formal definition of GDP is “the market value of all final goods and services produced in the country in a given period of time”.

Each of the following would be included in (the US) GDP except the car you bought from General Motors. the DVD you bought from Amazon.com. the flour sold to Pizza Hut. the CD you bought at the music store. the car General Motors produced but did not sell. ANSWER: C (not a final good)

A steel company sells some steel to a bicycle company for $100 A steel company sells some steel to a bicycle company for $100. The bicycle company uses the steel to produce a bicycle, which it sells for $200. Taken together, these two transactions contribute a. $200 and $300 to GDP, depending on the profit earned by the bicycle company when it sold the bicycle. b. $300 to GDP. c. $100 to GDP. d. $200 to GDP. ANSWER: $200

Real vs. Nominal GDP

Real versus Nominal GDP Nominal GDP values output using current prices. Nominal GDP is not corrected for inflation. Real GDP values output using the prices of a base year. Real GDP is corrected for inflation.

Real versus Nominal GDP Inflation can distort economic variables like GDP. So we have two versions of GDP: One is corrected for inflation, the other is not.

Nominal and Real GDP in the U.S., 1965-2005 Real GDP (base year 2000) The source I used: http://research.stlouisfed.org/fred2/ The original source: U.S. Department of Commerce: Bureau of Economic Analysis Note: I created this graph in Excel. If you wish, you may be able to access the original Excel file simply by double-clicking on the graph. (I have embedded the full Excel file on this slide, rather than simply making a copy of the finished graph.) Note: This graph is different than the one in this chapter of the textbook. The one in the textbook excludes nominal GDP, but includes shaded vertical bars over the dates of each recession. Since you have just finished covering real vs. nominal GDP, it might be worthwhile pointing out the following to your students: The graph shows that nominal GDP rises faster than real GDP. This should make sense, because growth in nominal GDP is driven by growth in output AND by inflation. Growth in real GDP is driven only by growth in output. The two lines cross in the year 2000 (the base year for the real GDP data in this graph). This should make sense, because real GDP equals nominal GDP in the base year. (Better yet, ask your students whether there’s anything significant about the point where the two lines cross.) Before the base year, real GDP > nominal GDP. For example, in 1970, nominal GDP is about $1 trillion, while real GDP is about $3.8 trillion (in 2000 dollars). This should make sense, because prices were so much higher in 2000 than in 1970, so using those high 2000 prices to value 1970 output would lead to a bigger result than valuing 1970 output using 1970 prices. Similarly, after 2000, nominal GDP is higher than real GDP, because prices are higher in later years than they were in 2000. Nominal GDP

Let’s compute both versions of GDP for a simple economy Pizza Iced latte

Compute (the nominal) GDP for 2002, 2003, and for 2004. Pizza Latte (buzlu) year P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 In year 2002 they produce 400 pizzas. At $10 a pizza the market value of these pizzas is $4000. In year 2002 they also produced 1000 lattes. At $2 a latte, the market value of these lattes is $2000. The nominal GDP in year 2002 is $4000 + $2000 = $6000 This example is similar to that in the text, but using different goods and different numerical values. Suggestion: Ask your students to compute nominal GDP in each year, before revealing the answers. Ask them to compute the rate of increase before revealing the answers. In this example, nominal GDP grows for two reasons: prices are rising, and the economy is producing a larger quantity of goods. Thinking of nominal GDP as total income, the increases in income will overstate the increases in society’s well-being, because part of these increases are due to inflation. We need a way to take out the effects of inflation, to see how much people’s incomes are growing in purchasing power terms. That is the job of real GDP.

Pizza Latte (buzlu) year P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 This is how we compute the nominal GDP in each year: 2002: $10 x 400 + $2 x 1000 = $6,000 2003: $11 x 500 + $2.50 x 1100 = $8,250 2004: $12 x 600 + $3 x 1200 = $10,800 This example is similar to that in the text, but using different goods and different numerical values. Suggestion: Ask your students to compute nominal GDP in each year, before revealing the answers. Ask them to compute the rate of increase before revealing the answers. In this example, nominal GDP grows for two reasons: prices are rising, and the economy is producing a larger quantity of goods. Thinking of nominal GDP as total income, the increases in income will overstate the increases in society’s well-being, because part of these increases are due to inflation. We need a way to take out the effects of inflation, to see how much people’s incomes are growing in purchasing power terms. That is the job of real GDP.

Calculating growth rates year GDP (nominal) Growth rate 2002 $6000 2003 $8250 ($8250 – $6000)/$6000 times 100 2004 $10800 ($10800 – $8250)/$8250 times 100

Pizza Latte (buzlu) year P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 % increase: : 2002: $10 x 400 + $2 x 1000 = $6,000 2003: $11 x 500 + $2.50 x 1100 = $8,250 2004: $12 x 600 + $3 x 1200 = $10,800 This example is similar to that in the text, but using different goods and different numerical values. Suggestion: Ask your students to compute nominal GDP in each year, before revealing the answers. Ask them to compute the rate of increase before revealing the answers. In this example, nominal GDP grows for two reasons: prices are rising, and the economy is producing a larger quantity of goods. Thinking of nominal GDP as total income, the increases in income will overstate the increases in society’s well-being, because part of these increases are due to inflation. We need a way to take out the effects of inflation, to see how much people’s incomes are growing in purchasing power terms. That is the job of real GDP. 37.5% 30.9%

Now The “real” GDP

We compute the real GDP in each year, using 2002 as the base year: Pizza Latte (buzlu) year P Q 2002 $10 400 $2.00 1000 2003 $11 500 $2.50 1100 2004 $12 600 $3.00 1200 $10 $2.00 We compute the real GDP in each year, using 2002 as the base year: Increase: This example shows that real GDP in every year is constructed using the prices of the base year, and that the base year doesn’t change. The growth rate of real GDP from one year to the next is the answer to this question: “How much would GDP (and hence everyone’s income) have grown if there had been zero inflation?” Thus, real GDP is corrected for inflation. 2002: $10 x 400 + $2 x 1000 = $6,000 2003: $10 x 500 + $2 x 1100 = $7,200 2004: $10 x 600 + $2 x 1200 = $8,400 20.0% 16.7%

Let’s see the nominal and the real GDP numbers in one table…

The nominal v. the real GDP and their growth rates year Nominal GDP Real GDP 2002 $6000 2003 $8250 $7200 2004 $10,800 $8400 37.5% 30.9% 20.0% 16.7% The change in nominal GDP reflects both the change in prices and in quantities. Again, the growth rate of real GDP from one year to the next is the answer to this question: “How much would GDP (and hence everyone’s income) have grown if there had been zero inflation?” This is why real GDP is corrected for inflation. The change in real GDP is the amount that GDP would change if prices were constant (i.e., if zero inflation). Hence, real GDP is corrected for inflation.

Please compute the real GDP for your economy with the given base year.

There is also something called the GDP deflator Deflate: to release air or gas from <deflate a tire> to reduce in size, importance, or effectiveness

nominal GDP 100 x real GDP The GDP Deflator GDP deflator = Definition: The GDP deflator can be used as a measure of the overall level of prices. The economy’s inflation rate can be computed as the percentage increase in the GDP deflator. The GDP Deflator gets its name because it is used to “deflate” (i.e., take the inflation out of) nominal GDP to get real GDP.

Inflation is defined as an increase in the average level of prices Inflation is defined as an increase in the average level of prices. The rate of inflation is the % increase in the average price level.

% change in the GDP deflator year Nominal GDP Real GDP GDP Deflator % change in the GDP deflator 2002 $6000 2003 $8250 $7200 2004 $10,800 $8400 2002: 100 x (6000/6000) = 100.0 100.0 14.6% 2003: 100 x (8250/7200) = 114.6 114.6 12.2% 2004: 100 x (10,800/8400) = 128.6 128.6 Compute the GDP deflator in each year:

A digression

Why so much attention to the GDP Why so much attention to the GDP? High GDP per capita means people enjoy a higher standard of living. Is this really true?

GDP and Happiness Happiness Index Income per Person ($) Source: Inglehart and Klingemann(2000) Income per Person ($)

Perhaps the most famous and eloquent critique of GDP came from Robert F. Kennedy (Kansas March 18 1968). http://www.jfklibrary.org/Research/Research-Aids/Ready-Reference/RFK-Speeches/Remarks-of-Robert-F-Kennedy-at-the-University-of-Kansas-March-18-1968.aspx “Too much and for too long, we seem to have surrendered personal excellence and community value in the mere accumulation of material things.

What is counted in the GDP Our Gross National Product ... counts air pollution and cigarette advertising and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and it counts nuclear warheads, and armored cars for the police to fight riots in our cities.

What is not counted in the GDP Yet the Gross National Product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile.”

GDP Does Not Value: the quality of the environment an equitable distribution of income leisure time non-market activity, such as the child care a parent provides his or her child at home Much of what Robert Kennedy said about GDP is correct.

Quality of life Health Education and learning Job security Political freedom and security Gender equality Income equality

U.N. Human Development Index Health Income Learning

Human development index (HDI) The HDI measures a nation's achievement in three dimensions of human development: long and healthy life (indicated by life expectancy at birth), knowledge (indicated by literacy and school enrollment rates), decent standard of living (indicated by GDP per capita).

Human development index rankings In 2008 Top 10 countries: Iceland, Norway, Canada, Australia, Ireland, Netherlands, Sweden, Japan, Luxembourg, Switzerland. Bottom 10 countries: Sierra Leone, Central African Republic, DR of Congo, Liberia, Mozambique, Niger, Burkina Faso, Burundi, Guinea-Bissau, and Chad.

GDP and quality of life Having a large GDP means that a country can afford better schools, a cleaner environment, better health care, etc. Many indicators of the quality of life are positively correlated with GDP. Then why do we care about GDP? Because a large GDP does in fact help us to lead a good life. GDP does not measure the health of our children, but nations with larger GDP can afford better health care for their children. GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and enjoy poetry. GDP does not take account of our intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable attributes are easier to foster when people are less concerned about being able to afford the material necessities of life. In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life.

GDP and Life Expectancy in 12 Countries Life expectancy (in years) Japan U.S. Germany Mexico China Brazil Indonesia Russia India Pakistan This figure and the two that follow are from the data in Table 23-3 of the textbook. See that table for a full list of the included countries. Real GDP per capita figures are expressed in U.S. dollars. Source: Human Development Report 2004, United Nations. Bangladesh Nigeria Real GDP per capita, 2002

GDP and Adult Literacy in 12 Countries Adult Literacy (% of population) Russia China U.S. Japan Mexico Germany Brazil Indonesia Nigeria India Pakistan Source: Human Development Report 2004, United Nations. Bangladesh Real GDP per capita, 2002

HDI rankings: Turkey in 2011 is Number 92

Turkey’s HDI value for 2012 is 0 Turkey’s HDI value for 2012 is 0.722—in the high human development category—positioning the country at 90 out of 187 countries and territories.  http://www.undp.org/content/turkey/en/home/presscenter/news-from-new-horizons/2013/03/15/turkey-ranks-90th-in-hdi/

Health and education Between 1980 and 2012, Turkey’s life expectancy at birth increased by 17.7 years. Average years of schooling increased by 3.6 years. Expected years of schooling increased by 5.5 years.

This concludes our discussion of GDP! Remember: All of this is MT2 + Final Exam material with probability 1.

End of the lecture