https://hawken-my.sharepoint.com/:b:/g/personal/hrudo_hawken_edu/EeIsUMuYRLhHlkvYsHkhRb4B3c6CGPldFwZK_jbL9nOxeQ?e=OAhTFO1. Would you characterize each of the following expenditures as intermediate goods, investment goods, or consumption goods:a spare tiresurgery to repair a broken armBOTOX to remove forehead wrinklesvoice lessonsexpenses due to college educationExplain your reasoning. Would your answers change if the purchaser was a professional singer? Why or why not?2. Over the past forty years, growing numbers of women have entered the work force. As a result, many women hire people or pay for childcare and housekeeping. What impact does this have on measures of GDP? Explain.3. Over the past forty years as well, levels of water and air pollution in the United States have declined substantially. Would these improvements be reflected in reposted measures of well being or happiness? Would the be reflected in GDP?4. Are nations with large underground economies likely to be happier or unhappier than expected based on their given MEASURED levels of real per capita GDP? Explain.
CHAPTER 6 What Should GDP Include? Economists disagree about a lot. One important point of disagreement has to do with how to measure things. For example, suppose you were inter- ested in how the economy was doing, either over time or in comparison to other nations. Or perhaps you want to know how well different people across the country feel they are doing. The most common way of address- ing such issues would be with a measure linked to gross domestic product (GDP). For example, almost all macroeconomic policy is driven by policy- makers' perceptions of what is happening to a few key variables, and GDP is on just about everyone's list of key variables. Moreover, as you saw in Chapter 4, the human condition varies dramatically around the globe, varia- tion that can be understood only if we start with a clear awareness of what is being measured. That measurement starts with GDP. WHAT DOES GDP MEASURE? GDP is defined as the market value of new, domestically produced, final goods and services. There are four key elements of this definition 1. Market value-The GDP is calculated by multiplying the prices of goods and services by their quantities. Thus, it can rise or fall just because of changes in the prices of goods and services. Most of our discussion will focus on real gross domestic product (real GDP), which adjusts GDP for changes in the price level. This way. we know that we are talking about the actual amounts of goods and services that are being produced. 2. New-The only goods and services that get into GDP are those that are newly produced during the current accounting period, which 39 40 CHAPTER SIX What Should GDP Include? normally is the current calendar year. Even though used cars, old Germany added illegal activities to its GDP, the increase was only 0.1 houses, and even antiques are a source of satisfaction for many percent. Why? Because in that nation, prostitution has been legal for a people, GDP focuses on those goods and services that are currently number of years and was already being measured in their GDP. produced. 3. Domestically produced-If you were to look carefully at the compo- THERE IS MORE TO THE UNDERGROUND nents of a new car, you would find that much of that car was actually ECONOMY THAN ILLEGAL ACTIVITIES made in other nations, even if it is an "American" car. Similarly, much of the typical "Japanese" car sold in America is actually made Illegal activities of the sort just mentioned are typically considered part in America. The GDP of a nation includes only those parts of cars of the shadow or underground economy. But there are plenty of legal (and other goods and services) that are made in that nation. goods and services transacted in the underground economy on a scale 4. Final goods and services-Lots of intermediate steps go into pro- that dwarfs the trade in drugs or sexual services. Indeed, recent esti- mates indicate that between 10 and 13 percent of all legally produced ducing goods and services, and typically many of these steps show up as separate transactions across the country. Nonetheless, because goods and services in the United States is not included in the offi- cial GDP statistics. This activity entails chiefly cash or barter deals on the value of each intermediate step is embedded in the value of the items including landscaping, construction, food and beverages, indeed. final product, we include only that final value in our measure of almost anything you can think of. The goods and services themselves GDP. Otherwise, we would be double-counting the final good and are lawful, but the transactions go unrecorded and thus unmeasured, all of the components that go into it. usually because the market participants want to co ceal them from the government. WHAT'S MISSING? Over the last twenty years, the share of total activity that is going unrecorded is believed to have risen substantially. There are a variety Real GDP, that is, GDP corrected for changes in the price level, is the of reasons. For example, during the recession of 2008-2009, the dura- official measure of new. domestically produced, final goods and services tion of government unemployment benefits was hiked from 26 weeks to in an economy. Although this number is widely used, you should be 99 weeks. Many people lost jobs and some who could not find a similar aware that it excludes some important economic activity. For example. one wanted to eat but didn't want to let their work skills deteriorate do-it-yourself activities are not included in the official GDP measure, badly. Hence, they signed up for unemployment benefits and also picked even though they clearly yield valuable output. The biggest category of up a job "off the books"-getting paid in cash and invisible to govern- such services consists of those performed in the house by homemakers. ment accountants. It is widely estimated, for example, that the weekly value of a home- In a similar vein, it has become much easier in recent years for peo- maker's services is several hundred dollars, none of which is included ple to collect tax-free disability payments from the federal government, in the official statistics. a matter discussed more fully in Chapter 10. Some of the people collect- Then there is the matter of the huge volume of transactions- ing these benefits are able-bodied and, in fact, are working, perhaps for hundreds of billions of dollars per year-in markets for illegal goods cash or in trade for goods and services. Either way, their production is and services, including prostitution, illegal gambling, and drugs. In the unrecorded in the GDP figures. United States we have made no effort to accurately incorporate this The underground economy has also grown because government- activity in our measure of GDP, But some nations, including Ireland, licensing requirements have increased. About 30 percent of all occupa- Britain, the Netherlands, Germany, and Italy have started including ille- tions require a license. Many of these licenses require that the licensees gal activity in their official GDP numbers. Soon, many other members undertake costly training courses that are partly or largely "make of the European Union will probably do likewise. work," designed chiefly to reduce competition in the fields involved. We are not talking about small sums. When Britain revised its num- Some people would rather forgo the time and cost of obtaining such bers, accounting for prostitution, illegal drugs, and gambling added licenses. So they work off the books, unlicensed and unrecorded in the 0.7 percent to GDP. In Ireland, the bump was almost 1 percent. But when statistics. 42 CHAPTER SIX What Should GDP Include? 43 Finally, state and federal marginal tax rates have increased. Those between measures of income (such as real per capita income (real increases have raised the incentives for individuals to get paid in cash- GDP per capita) and measures of happiness. Stevenson and Wolfers cash that is not reported and thus not taxed, But unrecorded cash deals found that there is indeed a strong and consistent positive relationship also don't show up in the GDP numbers, between real GDP per capita and reported levels of happiness. Using data spanning many decades and covering well over one hundred coun- tries, the authors show that when per capita real GDP is higher, reported RESEARCH, DEVELOPMENT, AND LADY GAGA measures of satisfaction or happiness are higher also. Notably. there is Research and development (R&D) is an essential part of the innovative no "satiation" point-that is, it appears that even the richest and happi- process, as we noted in Chapter 2. Historically, R&D expenditures have est people have the opportunity to become even happier as their incomes been treated as intermediate goods, consumed in the production pro- rise further. cess and thus not counted separately as part of GDP. Recently, however, As you might imagine, there are numerous ways to do the measur- the U.S. government has decided to reclassify R&D expenditures as ing, and the authors tried a wide variety of them to cross-check their investment, which, like consumption, is counted as part of GDP. The results. One simple measure is the proportion of people at each income result has been an upward bump in the official GDP numbers. level who report that they are "very satisfied" with their lives. It turns Something similar has been done for the intellectual investment out that when income doubles, this measure of happiness increases by that occurs during the artistic process. Lady Gaga, J. K. Rowling, and 25 percent, and this pattern seems to be consistent across all income other artists, writers, and performers devote great effort to their creative levels. Thus, when annual incomes per person double from $5,000 to endeavors. Historically, the value of such activity has been picked up $10,000, happiness rises by 25 percent. And when income doubles from only in the final sales of the recordings, books, or paintings that resu $10,000 to $20,000 or from $20,000 to $40,000, happiness rises by Now, however, U.S. government accountants have added a measure 25 percent with each doubling-and it does so even when we look, say, of this activity to GDP. Lacking information on how long Lady Gaga at a move from $250,000 to $500,000 per year. spends on her songwriting, the accountants have taken the tack of esti- Obviously, real income is not the only factor that influences happi- mating how her sales might do in the future. Many economists are con- ness, Gender, age, and many difficult-to-measure variables are important cerned about the speculative nature of such estimates. Nevertheless, the also. Moreover, it is entirely possible that some other factor is respon combined effect of taking into account R&D and creative activity has sible for simultaneously creating high levels of income and happiness. been to raise the official estimates of GDP by 3.6 percent. This is the It may be true that these same institutions that foster high per capita equivalent of almost two years' worth of economic growth, all done with GDP (as discussed in Chapter 1) also happen to make people happier, the bureaucratic stroke of a computer key. perhaps because they enhance personal liberty. Nevertheless, even if "money can't buy happiness," the results of Stevenson and Wolfers make one point clear: Despite all of its imperfections, real GDP per capita is BRINGING IN HAPPINESS strongly linked to well-being, at least as perceived by the human beings Even as economists have been focused on the GDP, a variety of other being asked about such matters. Thus, although GDP may not be a per- researchers-such as sociologists, psychologists, and political scien- fect measure of anything, we keep on using it because it seems to beat tists-have been asking people how happy or satisfied they are with all of the alternatives. their lives. Now, answers to questions such as these must be taken with a big dose of caution, because "talk is cheap." That is, when you go to the FOR CRITICAL ANALYSIS store to buy something, you must make a real sacrifice to obtain the item. But when a person conducting a poll asks you about your happiness, it 1. How does one determine what is a final good or service and what is a costs no more to check the box next to "happy" than it does to check the regrettable necessity or an intermediate good? In other words, where box next to "unhappy." does one draw the line? Keeping this caution in mind, economists Betsey Stevenson and 2. Why is it important to carefully distinguish between GDP and real Judson Wolfers thought it might be useful to see if there was any link GDP? Answer the same query for real GDP versus per capita real GDP
