ECO120 Macroeconomics Rod Duncan Lecture 4- Measuring GDP, but what does it mean?

Measuring GDP In the last lecture we introduced the concept of GDP, which is a measure of the value of all the goods and services produced in an economy in a year. We found that GDP is correlated with better human outcomes in terms of health and education (and political rights and lots of other nice things), but it is not correlated with measures of happiness. Happiness seems to be based on people’s history and expectations- and also envy!

Problems with using GDP measures We assume that higher GDP is better. But is GDP the right way to measure economic output? GDP only counts things which are valued in markets- so only those have market prices. –If we dirty our water, pollution is generally unpriced, so this would not come into GDP calculations. –A parent taking care of his or her own children is not paid in the market, so is not counted as part of GDP. –Black market/illegal activities are not measured or counted as part of GDP.

Measurement of GDP Example: In the 1980s, Italy engaged in major reforms of its regulatory practices- slashing a lot of red tape. Italian GDP growth rates were among the highest in Europe. So can we say that Italian reforms greatly increased the welfare of Italians? –Problem: Much of the expansion in GDP was simply new reporting from firms that had been operating in the black market due to the difficulty of regulations becoming “legit” after the reforms. This was not new output.

Women moving into the workforce

What is the economic impact of all these women moving out of unpaid labour (at home) into paid labour (at a workplace)? –The measured level of economic activity will go up, as all those earned salaries will add to GDP. But a large number of those women are working at child care centres to take care of other people’s children, rather than staying at home to take care of their own children. What are the social consequences, HRM consequences or political consequences of a large shift in the work women do?

Aside: Using graphs Let’s look at a table showing some of the changes in the male/female labour force participation rates (from the Australian Bureau of Statistics (ABS)). This table has too much information for most audiences. How are we going to present this data in a graph instead?

LABOUR FORCE PARTICIPATION RATES (%) By age MalesFemales Age group and over Total

Which graph to use? The choice of the best graph depends on the story that you want to tell. Do you want to talk about changing male and female expectations about the workforce (closer to graph 3)? Do you want to talk about changing expectations for child-rearing and work (graph 2)?

Sample exam question QUESTION : B.1(5 + 5 = 10 marks) The last 50 years have seen a large increase in the proportion of women who work outside the home. a) What effect would this change have on the measurement of GDP? b) What effect would this change have on our measurement of unemployment?

Measuring GDP Alternative methods of calculating GDP –Expenditure approach: add up the total spent by all members of the economy (value of all goods and services bought) –Income approach: add up the incomes of all members of the economy (value of all goods and services sold) –Value-added approach: add up the value added to goods at each stage of production

Expenditure approach GDP is calculated as the sum of: –Consumption expenditure by households (C) –Investment expenditures by businesses (I) –Government purchases of goods and services (G) –Net spending on exports (Exports – Imports) (NX) Aggregate Expenditure: AE = C + I + G + NX

Expenditure approach Later on in the subject we will introduce the aggregate demand-aggregate supply model (AD-AS). The expenditure approach underlies the AD curve in the AD-AS model. Factors that shift components of demand will then also shift the AD curve. –If income taxes change, household consumption (C) will change, so the AD curve will shift.

The big picture P, Wealth, H/h Expectations, H/h Taxes P, i, Business Expectations, Business Taxes C Government policy, and? G P, and? NX AEAD I

Income approach The income approach is probably the next most straight-forward way of measuring economic activity. When you buy a good, the cash that you pay (the market value) to a firm doesn’t stay with the firm. The value gets returned to households. –The firm pays its employees (households). –The firm pays other firms for its purchases. –The rest gets returned as profits to shareholders (households).

Firms as fictions In that sense, firms don’t really exist. They are just convenient accounting fictions. A firm is a representation of the households who own the shares in the firm (or for a private firm, own it outright). Firms were invented as a way of allowing people to own a business, but not be personally liable if the business fails. To say “firms don’t pay enough taxes” is really to say “shareholders don’t pay enough taxes”.

Income approach We measure the value of the income earned by households in the production of goods- think of the cash a firm receives on a sale: –Wages paid to employees (suppliers of labour) –Profits/rent/bonds payments returned to suppliers of capital –Indirect taxes (GST) paid to government Since the Tax Office collects all these details to calculate income taxes, we can have a reasonably good measure of this.

Value-added (production) approach This approach is probably the most difficult to understand. Why can’t we simply add up the value of all the goods and services bought in a year? The problem is that a lot of sales of goods are “intermediate” goods- that is goods that will be used to make other goods. If we simply added up the sales of all the goods in a year, we would wildly over-calculate GDP.

Ford as a car assembler Ford is more of a car-assembler than a car- maker. Ford buys seats from one supplier, brake systems from another and tires from a third. Imagine Ford uses $20,000 worth of components in a $30,000 car. Adding up the sales, we get $50,000, but the consumer buys a $30,000 car!?! The answer is that Ford adds only $10,000 worth of value. The rest of the value of the car is the $20,000 in components.

Valuing economic activity In the end, we can either value (1) the $30,000 car purchased by the consumer, (2) the $30,000 income returned by Ford to workers, capitalists and suppliers, or (3) the $20,000 in components plus the $10,000 in value-added by Ford. All 3 approaches result in the same answer… $30,000- the value of the car.