Main Macroeconomic Aggregates (I) Lecture 14 – academic year 2014/15 Introduction to Economics Fabio Landini

Where are we?... Part I (lect. 1-7) – Microeconomics: individual decisions and individual interactions Part II (lect. 8-16) – Macroeconomics: forces and tendencies that influence the economy as a whole

Topic of the day: gross domestic product (GDP) What’s the gross domestic product (GDP)? How is it measured? Why is it relevant? How does its composition evolve over time? Questions of the day

Definition of gross domestic product (GDP) The GDP is the market value of final goods and services produced within a country in a given period of time

Components of the definition: a) GDP is a measure of the value of production Value of a good = price x quantity Value of the economy’s total product = p 1 q 1 + p 2 q 2 + … p 1 – price of good 1 q 1 – quantity produced of good 1 … Definition of gross domestic product (GDP)

GDP is a measure of the value and not of the quantity produced Two reasons: Goods are heterogeneous (they have different units of measure) Goods have different value Definition of gross domestic product (GDP)

Using value we can do two things: We can sum homogeneous quantities (using the Euro as the unique unit of measure) We can weight the quantities produced by their price (Problem: which prices?) Definition of gross domestic product (GDP)

b) GDP is a measure of production in a given period of time It refers to goods produced in a given time interval not to the goods that exist in a certain instant The period of time that is usually considered is one year Definition of gross domestic product (GDP)

c) In computing the GDP only final goods and services are considered Intermediate goods that are used in the production of other goods are excluded Aim: to avoid duplication (the value of an intermediate good is included in the final good) Definition of gross domestic product (GDP)

Numeric example Farmer Economy = 3 sectors Miller Baker a) Farmer She does not use raw material or input She produces wheat = 100 b) Miller She buys wheat = 100 She uses the wheat to produce flour = 150 Definition of gross domestic product (GDP)

c) Baker She buys flour = 150 She uses flour to produce bred = 250 What’s the GDP of the economy ? It is not equal to the sum because some are intermediate goods The correct computation excludes intermediate goods (wheat and flour) Definition of gross domestic product (GDP)

GDP = Value of bread = 250 Important: The value of bread includes also the value of flour and the value of wheat. Definition of gross domestic product (GDP)

Alternative definitions of GDP 1)GDP is equal to the market value of final goods and services produced in the economy 2) GDP is equal to the sum of the value added by the different sectors of the economy 3) GDP is equal to the sum of the incomes obtained in the economy

Numerical example Production of wood Economy = 2 sectors Production of tables a) Production of wood It does not use raw material or intermediate goods It produces wood = 100 Let’s consider two other components of the sector: The value added by the sector (A.V.) The distribution of the revenues Alternative definitions of GDP

Value added by the sector (A.V.) A.V. = Value of production –  In this case: A.V.= 100 – 0 = 100 Alternative definitions of GDP

Distribution of the revenues To produce wood we use labour = wages Wages = 50 Revenue = 100 Revenue = 50 Alternative definitions of GDP

b) Production of tables It uses wood as an input = 100 It produces table = 500 Value added = Value of tables – Value of input (wood) = 500 – 100 = 400 Distribution of revenues: Purchasing costs = 100 Revenue = 500 Wages = 300 Profit = 100 Alternative definitions of GDP

How much is the GDP of the economy ? 1) GDP = value of final goods: tables = 500 2) GDP is equal to the sum of the value added by the different sectors of the economy Indeed, A.V. wood sector = 100 A.V. table sector = 400 Total A.V. = 500 = GDP Alternative definitions of GDP

3) GDP is equal to the sum of the incomes obtained in the economy Wood sector Wage = 50 Profit = 50 Table sectorWage = 300 Profit = 100 Total income= 500 = GDP Important: In this computation taxes are included Alternative definitions of GDP

Intuition: Tot. A.V. = GDP = Total contribution of the different sectors to the final product Total Income = GDP = Total remunerations of those who contributed to production Alternative definitions of GDP

Statistics on GDP The data on GDP are collected by the national institutes of statistics (e.g. Istat, Eurostat, etc.) The main variables related to GDP are: 1 ) The absolute level of GDP = “dimension of the economy” Example: GDP US = 9000 mld USD GDP Italy = 1000 mld USD GDP Sub-Saharan Countries < 50mld USD (approximately, high heterogeneity) The Italian economy is nearly 1/9 of the US’s one

2) GDP per capita = individual average income Example: GDP per capita US = USD GDP per capita Italy = USD GDP per capita Sub-Saharan country < 1000 USD The average income in the US is nearly two times the one in Italy Statistics on GDP

3) GDP growth = dynamics Growth is usually positive (economic expansion) In some period growth can be negative (economic recession) (technically there is a recession if growth is negative for two consecutive trimesters) Growth rate can vary across countries and periods Statistics on GDP

The evolution of GDP over time The level of GDP of a country changes every year The dynamics of GDP over time exhibits some properties that are common to all industrialized economies To illustrate these phenomena let’s consider the dynamics of Italian GDP

GDP Italy

By looking at the graph we can see that GDP grows during all the considered period 1° Phenomenon: Long-period trend (30 anni) = GDP grows over time

We can draw a line that represents the long-period trend Growth is sometime fatser and sometime slower than the long period trend

Let’s consider the variation with respect to the long-period trend GDP fluctuates around the long-period trend = 2° Phenomenon: Economic cycles

Let’s consider the annual growth of GDP in different countries 3° phenomenon: the growth of GDP in an economy changes significantly year after year

Why do we observe the described phenomena? Some answers during the remaining parts of the course…. The evolution of GDP over time