GDP and national income accounting is a useful system for 5.3 What Isn’t Measured by GDP? GDP and national income accounting is a useful system for taking the temperature of the economy. However, it is not perfect, and it necessarily leaves out a lot of details. © 2015 Pearson Education, Inc

GDP omits depreciation of the physical capital stock and resources.

GDP excludes home production of cleaning, cooking, and child care done in the household. Instructor: Tell the students that paid maid service, restaurant cooking, and day care are included in GDP since these are market transactions.

5.3 What Isn’t Measured by GDP? GDP does not capture transactions conducted in the underground economy. Instructor: In developed economies, the underground economy is estimated to be 10% of GDP.

GDP does not count negative externalities such as pollution, noise, and crime. Externalities are economic activity that spills over to other people not directly engaged in that activity. However, purchases to prevent negative externalities like smokestack scrubbers, mufflers, and security devices are counted as positive contributions to GDP.

GDP does not record leisure.

19.3 What Isn’t Measured in GDP? GDP does not include production by U.S. workers and U.S. capital abroad.

Gross domestic product, or GDP, records production in the United States regardless of whose labor and capital (domestic or foreign) is used. Gross national product, or GNP, records production of domestically owned labor and capital in the United States and abroad.

Why is this distinction important? U.S. GDP was $16.8 trillion in 2013. U.S. GNP was $17.1 trillion in 2013.

5.3 What Isn’t Measured by GDP? Do all these limitations mean that GDP is a poor measure of well-being of an economy? Why don’t we ask people how happy or satisfied they are and compare these responses to GDP? The asking of people in surveys to determine well-being is called the ‘Happiness Literature’

Exhibit 5.6 GDP per Capita and Life Satisfaction There is a positive relationship in that an increase in GDP per capita (moving left to right) is associated with an increase in life satisfaction (moving bottom to top). Exhibit 5.6 GDP per Capita and Life Satisfaction

We therefore need to distinguish between nominal GDP and real GDP. 5.4 Real vs. Nominal An increase in GDP will record both increases in actual production (and income) and increases in prices of those goods and services. We therefore need to distinguish between nominal GDP and real GDP.

Nominal GDP The total value of production using current market prices to determine the value of each unit that is produced. Real GDP The total value of production using market prices from a specific base year to determine the value of each unit that is produced.

Nominal GDP for 2009: Nominal GDP for 2013: Real vs. Nominal The government multiples the quantity of each good or service by its current price to calculate nominal GDP. © 2015 Pearson Education, Inc

Real GDP for 2009 (base year 2009): Nominal GDP for 2013 (base year 2009): The government multiples the quantity of each good or service by the price in the base year to calculate real GDP. © 2015 Pearson Education, Inc

Calculate nominal GDP for 2012 and 2013. Calculate real GDP for 2012 and 2013.

Nominal GDP for 2012: Nominal GDP for 2013:

Real GDP for 2012: Real GDP for 2013:

GDP deflator The price level of the overall economy. The ratio of nominal GDP to real GDP:

Consumer Price Index (CPI) The price level of a particular basket of consumer goods and services: © 2015 Pearson Education, Inc

The GDP deflator and the CPI formula look nearly identical. Question: What are the differences? Hint: Think about what is in each “basket” of goods and services.

The GDP deflator includes things not purchased by households, like trains, subways, and submarines. The CPI includes imports like Chinese laptops. Housing-related expenditures like shelter and utility bills have a large weight in the CPI.

GDP and the price level are more often quoted in growth rates. A growth rate is defined as a percentage change:

The percentage change in a price index. Inflation rate The percentage change in a price index. one can use either the GDP deflator or the CPI as the price index

negative inflation (or deflation) in the 1930s and the high inflation in the late 1940s and 1970s. Exhibit 5.5 The Relationship Between the Saving Rate and the Investment Rate (1929–2013)

We can use a price index to make meaningful comparisons across time: In 1909, then U.S. President William Howard Taft was paid $75,000. In 2013, current U.S. President Barack Obama was paid $400,000.

We can convert Taft’s salary to 2013 dollars by applying this formula:

Question: Which president earned more? 5.4 Real vs. Nominal Question: Which president earned more? Taft did since his salary in 1909 could buy $1.9 million of goods and services, while Obama’s salary would buy only $400,000 of goods and services. president today receives a lifetime pension, medical care, and security detail, so the difference may not be as great as indicated by the income alone.