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Page 90 (page 498 in Economics)
1. Define GDP and distinguish between a final good and an intermediate good. Provide examples.
GDP is the market value of all the final goods and services produced within a country in a given time period. A final good or service is an item that is sold to the final user, that is, the final consumer, government, a firm making investment, or a foreign entity. An intermediate good or service is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service. For instance, bread sold to a consumer is a final good, but wheat sold to a baker to make the bread is an intermediate good. Distinguishing between final goods and services and intermediate goods and services is important because only final goods and services are directly included in GDP; intermediate goods must be excluded to avoid double counting them. For example, counting the wheat that went into the bread as well as the bread would double count the wheat—once as wheat and once as part of the bread.
2. Why does GDP equal aggregate income and also equal aggregate expenditure?
GDP equals aggregate income because one way to value production is by the cost of the factors of production employed. The cost of the factors production employed—wages, interest, rent, and profit— equal aggregate income and therefore aggregate income equals GDP. GDP equals aggregate expenditure because another way to value production is by the price that buyers pay for the production in the market. Aggregate expenditure equals the sum of consumption expenditure, investment, government expenditure, and exports minus imports, which is the total amount spent buying the production in the market. Therefore GDP equals aggregate expenditure.
3. What are the distinctions between domestic and national, and gross and net?
“Domestic” means that the production being measured is within a country no matter by whom; “national” means that the production is produced by residents of the nation anywhere within the world. “Gross” means before subtracting depreciation. “Net” means after subtracting depreciation. The terms apply to investment, business profit, and aggregate production.
Page 93 (page 501 in Economics)
1. What is the expenditure approach to measuring GDP?
The expenditure approach measures GDP by focusing on aggregate expenditures. Data are collected on the different components of aggregate expenditure and then summed. Specifically, the Bureau of Economic Analysis collects data on consumption expenditure, C, investment, I, government expenditure on goods and services, G, and net exports, X M. These expenditures are valued at the prices paid for the goods and services, called the market price. GDP is then calculated as C + I + G + X M
2. What is the income approach to measuring GDP?
The income approach measures GDP by focusing on aggregate income. This approach sums all the incomes paid to households by firms for the factors of production they hire. The National Income and
* * This is Chapter 21 in Economics.
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Product Accounts divide income into five categories: compensation of employees; net interest; rental income; corporate profits; and proprietors’ income. Adding these income components does not quite equal GDP, because it values the output at factor cost rather than the market price and omits depreciation. So, further adjustments must be made to calculate GDP: Indirect taxes and depreciation must be added and subsidies subtracted.
3. What adjustments must be made to total income to make it equal GDP?
Total income is net domestic product at factor cost. To convert it to gross domestic product at market prices, we must add the depreciation of capital and add indirect taxes minus subsidies.
4. What is the distinction between nominal GDP and real GDP?
Nominal GDP is the value of final goods and services produced in a given year valued at the prices of that year. Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year. By comparing the value of production in the two years at the same prices, we reveal the change in production.
5. How is real GDP calculated?
The traditional method of calculating real GDP is to value each year’s production using the constant prices of a fixed base year and then sum all the values.
Page 99 (page 507 in Economics)
1. Distinguish between real GDP and potential GDP and describe how each grows over time.
Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year. Potential GDP is the maximum amount of real GDP that can be produced while avoiding shortages of labor, capital, land, and entrepreneurial ability that would bring rising inflation. So real GDP is the actual amount produced with the actual level of employment of the nation’s factors of production while potential GDP is the amount that would be produced if there were full employment of all factors of production with no shortages. Real GDP fluctuates from one year to the next, though it grows more often than it shrinks. Potential GDP grows from one year to the next because the quantity of the nation’s resources and technology increase from one year to the next.
2. How does the growth rate of real GDP contribute to an improved standard of living?
A benefit of long-term economic growth is the increased consumption of goods and services that is made possible. Growth of real GDP also allows more resources to be devoted to areas such as health care, research, and environmental protection.
3. What is a business cycle and what are its phases and turning points?
The business cycle is a periodic but irregular up-and-down movement of total production and other measures of economic activity. A business cycle has two phases: recession and expansion. The turning points are the peak and the trough. A business cycle runs from a trough to an expansion to a peak to a recession to a trough and then back to an expansion.
4. What is PPP and how does it help us to make valid international comparisons of real GDP?
PPP is purchasing power parity. To make the most valid international comparisons of real GDP, we need to value each nation’s production using the same prices rather than by using exchange rates and the prices within each country because relative prices within different countries can vary widely. As a result, if the real GDP of each country is valued using the same prices then the comparison of real GDP among the countries is more accurate.
5. Explain why real GDP might be an unreliable indicator of the standard of living.
Real GDP is sometimes used to measure the standard of living but real GDP can be misleading for several reasons. Real GDP does not include household production, productive activities done in and around the house by the homeowner. Because these tasks often are an important component of people’s work, this omission creates a major measurement problem. Real GDP omits the underground economy, economic
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activity that is legal but unreported or that is illegal. In many countries the underground economy is an important part of economic activity, and its omission creates a serious measurement problem. The value of leisure time is not included in real GDP. People value their leisure hours and an increase in people’s leisure that enhances people’s economic welfare can lower the nation’s real GDP. Environmental damage is excluded from real GDP. So an economy wherein real GDP grows but at the expense of its environment, as was the case with Eastern European countries under communism, falsely appears to offer greater economic welfare than a similar economy that grows slightly more slowly but at less environmental cost.
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1. Classify each of the following items as a final good or service or an intermediate good or service and identify each item as a component of consumption expenditure, investment, or government expenditure on goods and services:
• Airline ticket bought by a student.
Airline tickets are intermediate goods that are used for the final service, airline flights. They are part of consumption expenditure.
• New airplanes bought by Southwest Airlines.
New airlines purchased by Southwest Airlines are a final good. They are part of investment.
• Cheese bought by Domino’s.
Cheese bought by Domino’s is an intermediate good.
• Your purchase of a new iPhone.
This purchase is a final good. It is part of consumption expenditure.
• New house bought by Bill Gates.
A new house purchased by Bill Gates is a final good. It is part of investment. Use the following figure illustrates the circular flow model.
2. During 2014, flow A was $13.0 trillion, flow B was $9.1 trillion, flow D was $3.3 trillion, and flow E was –$0.8 trillion. Calculate (i) GDP and (ii) Government expenditure.
(i) Flow A is aggregate income. GDP equals aggregate income, so GDP is $13.0 trillion.
(ii) Government expenditure is $1.4 trillion. Aggregate expenditure equals GDP, which from part (i) is $13.0 trillion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E). Therefore government expenditure equals aggregate expenditure minus consumption expenditure minus investment minus net exports. Government expenditure equals $13.0 trillion minus $9.1 trillion minus $3.3 trillion minus $0.8 trillion, which is $1.4 trillion.
3. Use the following data to calculate aggregate expenditure and imports of goods and services.
• Government expenditure: $20 billion
• Aggregate income: $100 billion
• Consumption expenditure: $67 billion
• Investment: $21 billion
• Exports of goods and services: $30 billion
Aggregate expenditure equals aggregate income, so aggregate expenditure equals $100 billion. Aggregate expenditure also equals consumption expenditure plus investment plus government expenditures on goods and services plus exports of goods and services minus imports of goods and services , so imports of goods and services equals consumption expenditure plus investment plus government expenditure on goods and services plus exports minus aggregate expenditure. Using this formula gives imports of goods and services equals $67 billion + $21 billion + $20 billion + $30 billion $100 billion, which is $38 billion.
4. The table lists some national accounts data for the United States in 2014.
a. Calculate U.S. GDP in 2014.
GDP equals consumption expenditure plus investment plus government expenditure plus net exports, so GDP equals $11,729 billion + $2,714 billion + $3,139 billion $538 billion, or $17,044 billion.
b. Explain the approach (expenditure or income) that you used to calculate GDP.
The expenditure approach was used. Use the following data to work Problems 5 and 6. Tropical Republic produces only bananas and coconuts. The base year is 2016, and the tables give the quantities produced and the prices.
5. Calculate nominal GDP in 2016 and 2017.
In 2016, nominal GDP is $5,600. In 2017, nominal GDP is $6,100.
Nominal GDP in 2016 is equal to total expenditure on the goods and services produced by Tropical Republic in 2016. Expenditure on Tropical Republic on bananas is 800 bunches of bananas at $2 a bunch, which is $1,600. Expenditure on coconuts is 400 bunches at $10 a bunch, which is $4,000. Total expenditure is $5,600, so nominal GDP in 2016 is $5,600.
Nominal GDP in 2017 is equal to total expenditure on the goods and services produced by Tropical Republic in 2017. Expenditure on Tropical Republic on bananas is 900 bunches of bananas at $4 a bunch, which is $3,600. Expenditure on coconuts is 500 bunches at $5 a bunch, which is $2,500. Total expenditure is $6,100, so nominal GDP in 2017 is $6,100.
6. Calculate real GDP in 2017 expressed in base-year prices.
Real GDP in 2017 using base-year prices is $6,800. The base-year prices method calculates the market value of the 2017 quantities at the base-year prices of 2016. To value the 2017 output at 2016 prices, real expenditure on Tropical Republic on bananas is 900 bunches at $2 a bunch, which is $1,800, and real
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expenditure on coconuts is 500 bunches at $10 a bunch, which is $5,000. Adding these two expenditures shows that real GDP in 2017 using the base-year prices method is $6,800.
7. Use the table to work out in which year the U.S. standard of living (i) increases and (ii) decreases. Explain your answer.
The standard of living is measured by real GDP per person. The standard of living increased in 2007 because real GDP per person increased. The standard of living decreased in 2008 and 2009 because in both years real GDP per person decreased.
8. An island economy produces only fish and crabs. Calculate the island’s chained-dollar real GDP in 2017 expressed in 2016 dollars.
2008
Real GDP in 2017 is $27,300. The chained-dollar method uses the prices of 2016 and 2017 to calculate the growth rate in 2017. The value of the 2016 quantities at 2016 prices is $25,000. The value of the 2017 quantities at 2016 prices is $1,100 tons of fish × $20 a ton + 525 tons of crab × $10 a ton, which is $27,250. Using 2016 prices, the increase in GDP for these two years is $2,250, so the percentage increase is ($2,250 ÷ $25,000) × 100, which is 9.0 percent.
Next the value of the 2016 quantities at 2017 prices is 1,000 tons of fish × $30 a ton + 500 tons of crab × $8 a ton, which is $34,000. The value of the 2017 quantities at 2017 prices is $37,200. Using 2017 prices, the increase in GDP for these two years is $3, 200 so the percentage increase is ($3,200 ÷ $34,000) × 100, which is 9.4 percent.
The chained dollar method calculates the growth rate as the average of these two percentage growth rates, which means that the growth rate in 2017 is 9.2 percent. So real GDP in 2017 is equal to $25,000, which is real GDP in the base year (and is equal to nominal GDP in that year) multiplied by one plus the growth rate. Real GDP in 2017 is $27,300.
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9. Classify each of the following items as a final good or service or an intermediate good or service and identify which is a component of consumption expenditure, investment, or government expenditure on goods and services:
• Banking services bought by Google
The banking services are an intermediate service.
• Security system bought by the New York Stock Exchange
The security system is a final good. It is part of investment.
• Coffee beans bought by Starbucks
Coffee beans bought by Starbucks are an intermediate good.
• New coffee grinders bought by Starbucks
A new coffee grinder bought by Starbucks is a final good. It is part of investment.
• Starbuck’s grande mocha frappuccino bought by a student
The Starbuck’s drink is a final good. It is part of consumption expenditure.
• New battle ship bought by the U.S. navy
The battleship is a final good. It is part of government expenditure on goods and services. Use Figure 4.2 to work Problems 10 and 11.
10. In 2013, flow A was $1,000 billion, flow C was $250 billion, flow B was $650 billion, and flow E was $50 billion. Calculate investment.
Investment is $50 billion. Aggregate expenditure equals aggregate income, which is flow A, $1,000 billion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E). Therefore investment equals aggregate expenditure minus consumption expenditure minus government expenditure on goods and services minus net exports. Investment equals $1,000 billion minus $650 billion minus $250 billion minus $50 billion, which is $50 billion.
11. In 2014, flow D was $2 trillion, flow E was –$1 trillion, flow A was $10 trillion, and flow C
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was $4 trillion. Calculate consumption expenditure. Consumption expenditure is $5 trillion. Aggregate expenditure equals aggregate income, which is flow A, $10 trillion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E). Therefore consumption expenditure equals aggregate expenditure minus investment minus government expenditure on goods and services minus net exports. Consumption expenditure equals $10 trillion minus $2 trillion minus $4 trillion minus $1 trillion, which is $5 trillion.
Use the following information to work Problems 12 and 13.
Mitsubishi Heavy Industries makes the wings of the new Boeing 787 Dreamliner in Japan. Toyota assembles cars for the U.S. market in Kentucky.
12. Explain where these activities appear in the U.S. National Income and Product Accounts. When the Dreamliner wings are sent from Japan to the United States, they are counted in the U.S. National Income and Product Accounts as imports, which is a negative entry in the expenditure approach to U.S. GDP.
Toyota’s production of cars in Kentucky is included in U.S. GDP because it represents production within the United States. Expenditure on the cars is counted as part of consumption expenditure (if the cars are purchased by U.S. consumers) or investment (if the cars are purchased by U.S. firms) or government expenditure (if the cars are purchased by a government) in the expenditure approach to GDP. If any of the parts of the cars are imported from Japan, the value of these parts is included among U.S. imports. The incomes earned by the factors of production that produce the cars are part of the wages, interest, rent, and profit income that are used in the income approach to GDP.
13. Explain where these activities appear in Japan’s National Income and Product Accounts. Mitsubishi Heavy Industries’ production of Dreamliner wings in Japan is included in Japanese GDP because it represents production within Japan. When these wings are sent to the United States, they are counted in the National Income and Product Accounts as part of Japanese exports. If any of the parts of wings are imported into Japan, the value of these parts is included among Japanese imports. The incomes earned by the factors of production that produce the wings are part of the wages, interest, rent, and profit income that are used in the income approach to GDP.
Toyota’s production of cars in Kentucky is not directly included in Japan’s GDP unless some of the parts for these cars are exported from Japan to the United States. In that case the value of the parts are included in Japan’s GDP as exports.
Use the following news clip to work Problems 14 and 15, and use the circular flow model to illustrate your answers.
Three Indian firms are producing components for Boeing fighter jets F15 and F18 and for the Chinook heavy-lift helicopter in Bangalore, Hyderabad, and other places in India.
Source: The Economic Times, February 17, 2016
14. Explain how Boeing’s activities and its transactions affect U.S. and Indian GDP. Goods and services produced within the United States are part of U.S. GDP. Boeing’s decision to produce parts in India means that this production is not produced within the United States and so it is not part of U.S. GDP. This production is, however, part of India’s GDP. The parts of the fighters and helicopters that are produced in India, purchased by Boeing, and sent to the United States for final assembly add to India’s GDP as exports and subtract from U.S. GDP as imports. When the U.S. government purchases the jet fighters from Boeing, the purchases are classified as government expenditure.
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In terms of the circular flow diagram in Figure 4.3 and U.S. GDP, Boeing’s purchase of parts for its jet fighters and helicopter from firms in India is flow is Flow A, an import into the United States. This flow travels through the goods market and goes to Boeing as Flow B. In terms of Indian GDP, the Boeing’s purchase of parts from Indian firms is an Indian export. This flow is the reverse of Flow B and of flow A because this flow is an export for the Indian economy.
15. Explain how the Indian firms’ activities and its transactions affect U.S. and Indian GDP. The Indian firms’ production of components is counted in Indian GDP as exports. Boeing’s purchase of these parts is counted in U.S. GDP as imports. In terms of the circular flow and U.S. GDP, in Figure 4.3, Boeing’s purchase of parts for its jet fighters and helicopter from firms in India is flow is Flow A, an import into the United States. This flow travels through the goods market and goes to Boeing as Flow B For the Indian economy, the exports are represented by the reverse of Flow B and then flow A. Flows C and D for the Indian economy indicate that the Indian firms are paying households (through the factor market) for the factors of production the households supply to them.
Use the following data to work Problems 16 and 17.
The table lists some macroeconomic data for the United States in 2016.
16. Calculate U.S. GDP in 2016. GDP equals consumption expenditure plus investment plus government expenditure plus net exports, so GDP equals $12,498 billion + $3,037 billion + $3,254 billion $507 billion, or $18,282 billion.
17. Explain the approach (expenditure or income) that you used to calculate GDP. The expenditure approach was used.
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Use the following data to work Problems 18 to 19. An economy produces only apples and oranges. The base year is 2015, and the table gives the quantities produced and the prices.
18. Calculate nominal GDP in 2015 and 2016.
In 2015 nominal GDP is $50 and in 2016 nominal GDP is $600.
Nominal GDP in 2015 is equal to total value of the goods and services produced in 2015. The value of apples is 60 apples at $0.50 each, which is $30, and the value of oranges is 80 oranges at $0.25 each, which is $20. The total value is $50 so nominal GDP in 2015 is $50.
Nominal GDP in 2016 is equal to total value of the goods and services produced in 2016. The value of apples is 160 apples at $1.00 each, which is $160 and the value of oranges is 220 oranges at $2.00 each, which is $440. The total value is $600 so nominal GDP in 2016 is $600.
19. Calculate real GDP in 2015 and 2016 expressed in base-year prices. Real GDP in 2015 is $50 and in 2016 is $135. Real GDP in the base year, 2015, is equal to nominal GDP. Real GDP in 2016 using base-year prices is equal to the quantities produced in 2016 valued at baseyear, 2015, prices. Real GDP in 2016 is 160 apples at $0.50 each, which is $80, and the value of oranges is 220 oranges at $0.25 each, which is $55. The total value of 2016 production using 2015 prices is $135, so real GDP in 2016 is $135.
Use the following news clip to work Problems 20 and 21.
China’s real GDP increased 6.9 percent in the first quarter of 2017 from a year earlier. Investment grew by 9.2 percent and retail sales by 10.9 percent. In current prices, GDP increased by 11.8 percent from a year earlier.
Source: Bloomberg News, April 17, 2017
20. Explain how China’s real GDP can grow at a 6.9 percent rate when consumption and investment grew faster than 6.9 percent. Even though consumption and investment both grew more rapidly than 6.9 percent, the other components of GDP, government expenditure and net exports grew more slowly, so the net effect from all four parts of GDP was 6.9 percent growth.
21. Explain why the growth rate of GDP in current prices does not provide information about how quickly the economy is really growing.
GDP in current prices can grow because both production grows and prices grow. The growth in prices does represent growth in the economy. Growth in the economy is measured using the growth rate of real GDP because real GDP measures only production.
22. The United Nations’ Human Development Index (HDI) is based on real GDP per person, life expectancy at birth, and indicators of the quality and quantity of education.
a. Explain why the HDI might be better than real GDP as a measure of economic welfare. The HDI might be a better measure of economic welfare because it includes some important factors that affect welfare and which are omitted from GDP. In particular, life expectancy is included in the HDI but not in GDP and on this count the HDI is superior. The HDI also includes direct measures of the quality and quantity of education. These are indirectly included in GDP because they affect GDP per person, but it might be the case that the direct inclusion in the HDI is better.
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The HDI is based on real GDP per person and so directly includes GDP. In addition, the quality and quantity of education affect people’s productivity, which is closely related to GDP per person. So real GDP indirectly includes some of the education effects explicitly included in the HDI.
c. Do you think the HDI should be expanded to include items such as pollution, resource depletion, and political freedom? Explain. Ideally factors such as pollution, political freedom, and so forth should be included in a broad measure of welfare. Two difficulties, however, occur. One difficulty comes when trying to measure these variables. For instance, how can political freedom be measured in a way that is accepted by all? A second difficulty is weighting these factors. For instance, how much political freedom should be weighted relative to GDP per person?
d. What other items should be included in a comprehensive measure on economic welfare?
Aside from the factors listed above, potentially some measure of culture might be included. Another set of factors might attempt to take into account sustainability. Religious freedom, discrimination, and civil and international conflict might also matter. But all these factors are hard to measure and to weight.
The International Monetary Fund reported the following data on gross domestic product per capita, measured in U.S. dollars at market exchange rates in 2016: Canada $42,210, China $8,113, United Kingdom $40,096, and United States $57,436.
Source: International Monetary Fund, World Economic Outlook Database, April 2017
23. Explain the special complications involved with attempting to compare the economic welfare in China and the United States by using the GDP for each country. This comparison does not determine which nation has a higher standard of living. One reason is that the analysis uses the exchange rate to transform prices in one country into prices of the other country. But a more accurate analysis uses purchasing power parity (PPP) prices to value the goods and services in both countries. Relative prices in China and the United States are quite different. When looking at prices of identical or near-identical goods, more of these prices are lower in China than in the United States. So even if China and the United States produced the exact same quantities of these goods and services, China’s GDP, using China’s lower prices, would value China’s production at a smaller amount than would U.S. GDP, using U.S. higher prices. To have a valid comparison of Chinese and U.S. GDP, PPP prices must be used to value Chinese and U.S. production because then prices are the same for China and the United States. By using PPP prices, the analysis can better measure the goods and services available to citizens of each country.
Additionally, looking only at GDP per person omits the effects from household production, leisure time, and environmental quality, differences that probably loom large when comparing the United States and China. Because China is significantly less advanced than the United States, household production is probably larger in China than in the United States. On this count, Chinese economic welfare is closer to that in the United States than GDP per person would indicate. But U.S. residents enjoy more leisure time and better environmental quality than do their counterparts in China, which makes the relative U.S. standard of living higher than measured by GDP per person.
24. Explain why the data reported here might be a poor indicator of the differences in economic welfare among Canada, the United Kingdom, and the United States, but nevertheless provide the correct ranking of the countries.
Using GDP per person to measure the economic welfare in Canada, the U.K. and the United States omits other factors, such as household production, underground economic activity, the value of leisure time, and
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environmental quality. Because Canada, the U.K. and the United States are all developed nations, the differences in these four factors are probably small, and almost surely are smaller than the differences in real GDPs per person. So, using real GDP per person will provide the correct the correct ranking of the counties.
India, with the world’s largest population of poor people, is creating millionaires at a rapid pace and by 2018 is projected to have 437,000 millionaires measured in U.S. dollars. That is 1 millionaire for about 1,600 people living on less than $2 a day.
Source: The Times of India, July 8, 2015
There are a few reasons why this measurement of real GDP per person misrepresents the standard of living of the average Indian. First GDP includes only goods and services bought and sold in markets. In India many goods and services are produced by the household itself and this home production, while boosting the household’s standard of living, is not included in GDP. Second the prices used to value Indian production and thereby calculate Indian GDP are likely quite different than the prices used to value U.S. production and calculate U.S. GDP. When looking at prices of identical or near-identical goods, it is likely that more of these prices are lower in India than in the United States. So, even if the actual quantities produced are the same, using Indian prices means that India’s production would be valued less than U.S. production and India’s GDP would be less than U.S. GDP. If the same prices, such as purchasing power parity prices, were used to value India’s GDP and U.S. GDP, India’s GDP per person would be closer to U.S. GDP per person.
b. Why might $2 a day underestimate the standard of living of the poorest Indians?
One important reason why the $2 a day estimate undervalues the standard of living of the poorest Indians is because much of these people’s transactions do not occur in markets. GDP is calculated using only goods and services bought and sold in markets. So if a poor, self-sufficient farmer grows only enough food for his or her family and does not buy or sell food in the market, the farmer will be estimated to have a very low income. But this low income vastly understates the farmer’s standard of living because it omits all the food the person produced on his or her land. Another reason why the standard of living of the poorest Indians is under estimated is because the estimate is made using prices that prevail in India and then compared to the standard of living in the United States. Prices in India are often much lower than in the United States, so comparing what the income can purchase in the United States understates the standard of living.
26. After you have studied Economics in the News on pp. 100–104 (508–509 in Economics), answer the following questions.
a. What does Martin Feldstein say is wrong with the growth rate of real GDP per person as a measure of the growth rate of the standard of living?
Mr. Feldstein says that GDP undervalues the quality improvements that are available in today’s products. If the quality improvements were correctly valued, then today’s real GDP would be higher and therefore the growth rate of real GDP per person would be higher.
b. How does the price of a smartphone today compared with the 1991 prices of items it has replaced support Feldstein’s argument?
A smartphone is included in today’s GDP at its price, roughly $200. But the smartphone replaces 13 items in 1991’s GDP that together are valued at $5,292 2016 dollars. These calculations indicate that the quantity improvement from 1991 in today’s smartphone in today’s smartphone is worth $5,292 dollars,
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much more than the $200 dollars that it counts toward today’s GDP. Properly valuing the quality improvements would increase today’s GDP by a significant amount.
c. How does the falling share of household production in total production modify Feldstein’s argument?
Because household production is not counted in GDP, as people switch from household production to the labor force, where their production is counted, GDP rises even if total production does not change. Consequently the falling share of household production leads to measured production—GDP—increasing at a faster rate than does actual total production,
d. What other reasons not addressed in the news story make the growth rate of real GDP per person an incomplete measure of the standard of living
The news article mentions another reason that makes real GDP per person an incomplete measure of the standard of living. Specifically, many tasks that used to take time and effort, such as depositing a check at a bank or even an ATM, can now be done with a click of the camera on a smartphone. The increased convenience of such chores adds to the standard of living but because they are free they are not included in real GDP.
Speaking at the World Economic Forum, Stewart Wallis, a self-described advocate of a new economic system, suggested five economic indicators that he says are better than GDP. His five are Good jobs, Well-being, Environment, Fairness, and Health.
Source: World Economic Forum, April 19, 2016
a. Explain the factors that the news clip identifies as limiting the usefulness of GDP as a measure of economic welfare.
GDP focuses on the amount of goods and services produced. While goods and services lead to improving people’s welfare, there are other factors that also come into play. Mr. Wallis suggests that his five economic indicators—good jobs, well-being, environment, fairness, and health—are included, at best, only indirectly in GDP and their omission limits the usefulness of GDP as a measure of economic welfare.
b. What are the challenges involved in trying to incorporate measurements of those factors in an effort to better measure economic welfare?
There are two major difficulties. First, measuring some of these variables, say “good jobs,” or “well-being,” or “fairness”, would be very difficult. Second, even if the variables could be accurately measured determining the weighting scheme to be used is very difficult. For instance, how much should “good jobs” be weighted compared to “health”?
c. Explain whether the United Nations’ Human Development Index captures any of the five indicators.
The Human Development Index includes people’s health. It also includes education, which is probably correlated with Mr. Wallis’ category of good jobs.
d. Explain which of the five indicators are included in GDP and increase the likelihood of a high correlation between GDP and Wallis’ indicators of economic welfare. Presumably Mr. Wallis believes “good jobs” are high-paying jobs. High-paying jobs will be jobs in which people are productive and produce more goods and services, so real GDP and “good jobs” are correlated. Spending on environmental protection is also part of real GDP but pollution-creating production is also part of GDP. For advanced countries, it is likely that production of environmental protection is larger than production of pollution-intensive products, so Mr. Wallis’ measure of “environment” might be correlated with real GDP. So, too, for spending on health. Richer nations tend to spend more on health than do poorer nations, so “health” is probably also correlated with real GDP.
28. Use the information in Problem 18 to calculate the chained-dollar real GDP in 2016 expressed
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in 2015 dollars.
Real GDP in 2016 is $135.70. The chained-dollar method uses the prices of 2015 and 2016 to calculate the growth rate in 2016. The value of the 2015 quantities at 2015 prices is $50. The value of the 2016 quantities at 2015 prices is $135. Using 2015 prices, the increase in GDP for these two years is $85, so the percentage increase is ($85 ÷ $50) × 100, which is 170.0 percent.
Next the value of the 2015 quantities at 2016 prices is 60 apples × $1.00 per apple + 80 oranges × $2.00 an orange, which is $220. The value of the 2016 quantities at 2016 prices is $600. Using 2016 prices, the increase in GDP for these two years is $380 so the percentage increase is ($380 ÷ $220) × 100, which is 1.727 × 100, which is 172.7 percent.
The chained dollar method calculates the growth rate as the average of these two percentage growth rates, which means that the growth rate in 2016 is 171.4 percent. So real GDP in 2016 is equal to $50, which is real GDP in the base year (and is equal to nominal GDP in that year) multiplied by one plus the growth rate. Real GDP in 2016 is $135.70.
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