Main Topic: Gross Domestic Product (GDP), Per Capita GDP and Quality of Life.
- Discuss the question: "Is GDP a good measure of national economic well being?" after reviewing the concept and details of computing GDP (attached).
- Then read the articles "Is GDP a Good Measure of Economic Well-Being?"
Is GDP a Good Measure of Economic Well-Being? GDP measures both the economy's total income and the economy's total expenditure on goods and services. Thus, GDP per person tells us the income and expenditure of the average person in the economy. Because most people would prefer to receive higher income and enjoy higher expenditure, GDP per person seems a natural measure of the economic well-being of the average individual. Yet some people dispute the validity of GDP as a measure of well-being. When Senator Robert Kennedy was running for president in 1968, he gave a moving critique of such economic measures: [Gross domestic product] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans. Much of what Robert Kennedy said is correct. Why, then, do we care about GDP? The answer is that a large GDP does in fact help us to lead good lives. GDP does not measure the health of our children, but nations with larger GDP can afford better healthcare for their children. GDP does not measure the quality of their education, but nations with larger GDP can afford better educational systems. GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and enjoy poetry. GDP does not take account of our intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable attributes are easier to foster when people are less concerned about being able to afford the material necessities of life. In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain many of the inputs into a worthwhile life. GDP is not, however, a perfect measure of well-being. Some things that contribute to a good life are left out of GDP. One is leisure. Suppose, for instance, that everyone in the economy suddenly started working every day of the week, rather than enjoying leisure on weekends. More goods and services would be produced, and GDP would rise. Yet despite the increase in GDP, we should not conclude that everyone would be better off. The loss from reduced leisure would offset the gain from producing and consuming a greater quantity of goods and services. Because GDP uses market prices to value goods and services, it excludes the value of almost all activity that takes place outside markets. In particular, GDP omits the value of goods and services produced at home. When a chef prepares a delicious meal and sells it at her restaurant, the value of that meal is part of GDP. But if the chef prepares the same meal for her family, the value she has added to the raw ingredients is left out of GDP. Similarly, child care provided in day-care centers is part of GDP, whereas child care by parents at home is not. Volunteer work also contributes to the well-being of those in society, but GDP does not reflect these contributions. Another thing that GDP excludes is the quality of the environment. Imagine that the government eliminated all environmental regulations. Firms could then produce goods and services without considering the pollution they create, and GDP might rise. Yet well-being would most likely fall. The deterioration in the quality of air and water would more than offset the gains from greater production. GDP also says nothing about the distribution of income. A society in which 100 people have annual incomes of $50,000 has GDP of $5 million and, not surprisingly, GDP per person of $50,000. So does a society in which 10 people earn $500,000 and 90 suffer with nothing at all. Few people would look at those two situations and call them equivalent. GDP per person tells us what happens to the average person, but behind the average lies a large variety of personal experiences. In the end, we can conclude that GDP is a good measure of economic wellbeing for most but not all purposes. It is important to keep in mind what GDP includes and what it leaves out. Erskine S. Walther, Ph.D. GROSS DOMESTIC PRODUCT GDP: Defined GDP: The market value of all final goods and services produced in an economy in a specific period of time. Market Value: The measurement is in current prices, this known as Nominal GDP or just GDP. Final Goods and Services: Goods and services that have reached their final usage. They are not used to produce another good or service. Goods that are used in that way are Intermediate Goods. Intermediate Goods and Services are those that are used as inputs into the production of other goods and services. There are not directly counted in GDP as their value is included in the value (price) of the final goods and services. Thus, counting them directly would double count the same output. However, if the intermediate good has not been sold, it is counted in GDP as inventory. GDP Defined: continued Specific Period of Time: GDP can be computed for a month, a quarter or a year. The most common measures are annually and quarterly. Formal, Legal Markets: Only goods and services that are traded in formal, legal markets are counted in GDP. Underground Economy: The underground economy is composed of economic transactions involving activities that are not legal activities in a given society. These are not included in GDP. Illegal drugs and illegal gambling are common examples. Informal Economy: These are legal activities that do no go through formal markets. They are not included in GDP. Income not reported for taxation purposes or work done for barter are examples of informal economic activities. Some authors include legal activities as part of the underground economy definition. GDP Defined: continued Household Production: Productive activities done in and for the household are not counted in GDP as there is no direct monetary payment for such activities. (If you give children an allowance for household chores that would be part of the informal economy. If you clean your own home, that is household production.) Leisure Activities: Leisure activities that do not involve the purchase of goods and services are not counted in GDP. Spending an afternoon with family and friends that does not involve buying goods or services would not be counted in GDP as no economic transaction has occurred. A vacation involving paid activities does count in GDP as goods and services are purchased. GDP: Purpose The Purpose of GDP is to measure the total output of goods and services in any economy during a specific period of time. GDP is Value Neutral: It makes no judgments regarding product quality or whether or not a good or service is \"good\" for you. Those judgments are left to the consumer who is assumed to be able to make intelligent decisions that reflect their own personal tastes, preferences and values. Changes in GDP measure economic growth. Economic growth is the increase in the output of goods and services in an economy over a specific period of time. This must be done using Real GDP values. GDP: Real vs. Nominal Nominal GDP is GDP measured in current prices. This is referred to simply as GDP. Real GDP is Nominal GDP adjusted for price changes. To compare across time, Real GDP is required otherwise price changes will distort the values and lead to incorrect analysis. GDP (Price) Deflator or just the GDP Deflator is the price index used to adjust Nominal GDP for price changes. This adjustment produces Real GDP values. This is the broadest measure of price changes in the economy as it includes everything that is included in GDP. GDP: Computation GDP is a measure of total output. However, the production of output simultaneously involves the creation of income as the input (resources) used in the production process must be paid. That payment is income to the resource owners. Thus, GDP can be computed as a Sum of Income created by the production process. While this is a useful computation, it is also a bit complicated. GDP can also be computed as a Sum of Expenditures. This is a more straight forward approach which also has several analysis advantages. Thus, the GDP measure tells us the National Income of the country as well as the production activity and the amount of spending in the economy. GDP: The Expenditure Streams: PCE GDP is composed for four Expenditure Streams. The major categories of spending. Personal Consumption Expenditures (Consumption): This is the spending of the household sector of the economy. It is also referred to a Consumer Spending. In the developed world it is the largest of the expenditure streams. In the US it has normally been about 2/3's of GDP. But in the last few years it has increased to 70% to 72% of GDP. Thus, it is a very important component of GDP, but it is relatively stable. In addition to the household sector, the spending of private non-profit organizations is counted under PCE. GDP: The Expenditure Streams: GPDI Gross Private Domestic Investment is the spending of the business sector. It is commonly known simply as Investment Spending. This is the most changeable of the spending streams. It tends to be the leading factor in movements into recessions and in movements out of recessions. Thus, it is closely watched. It is sensitive to interest rates and to expectations about the future. Business confidence is a widely used measure of expectations about the future. Investment spending is critical to long term economic growth. It is a primary source of new technologies. GDP: The Expenditure Streams: GPGS Government Purchases of Good and Services is the spending the by government sector. It is commonly called Government Spending. It includes spending by all levels of government. It includes all types of expenditures by all levels of government. It counts everything from paper clips to welfare to highways to national defense, etc. Be sensitive to the context when you hear or read about government spending. Many speakers/authors only mean federal government spending when they use the term. But for GDP purposes it includes all levels of government. GDP: The Expenditure Streams: NX Net Exports is Exports - Imports. This is sometimes referred to as \"the rest of the world\". It is the international component of GDP. Exports are goods produced domestically, but sold internationally. Imports are goods produced internationally (in a foreign country), but sold domestically. Exports bring money into the economy and produce domestic jobs and income. Imports send money out of the economy and produce jobs and income in other countries. (That may, in turn, increase the market for exports.). GDP: Sum of Expenditures: Equation GDP computed as a Sum of Expenditures can be summarized in the following equation: GDP = C + I + G + NX This can also be written as: Y = C + I + G + NX where Y is GDP or National Income, we'll treat these different expressions as interchangeable. Where: C = Consumption I = Investment G = Government NX = Net Exports GDP: Per Capita GDP: Standard of Living Per Capita GDP is GDP/Population Per Capita GDP is normal measure of Standard of Living. This is an average and tells us the amount of output that the economy produces per person. It does not mean that each individual in the society receives that amount of output. It is not a measure of Income Distribution, just of what is potentially available to each individual. Therefore, it is not a measure of Quality of Life (however that is defined). But it does tell us about the potential that an economy has to provide for it's members. A higher GDP means a greater potential that people have more opportunities, more goods and services available to them and that the public sector can offer more services as it has a larger tax base. GDP: Composition What is demanded is what is produced. Thus, the specific goods and services that make up GDP are a reflection of those goods and services demanded by the expenditure streams. In a market based economy, consumers are the primary determiners of what is demanded and; therefore, of what is produced. Consumer income determines how what is produced is distributed across the economy. In a command economy, the government determines what is produced and how it is distributed across the economy. Mixed economies have a market based element and a government based element. Developed economies are normally mixed economies. The relative mix of free market and government decision making varies widely across the developed world and more so in the developing world. GDP: International Comparisons When comparing the GDPs of different nations an adjustment must be made for the use of different currencies in order to put the values into the same currency, normally US Dollars. Exchange Rate Method - this approach uses the current exchange rate to convert the GDP into US Dollars. While this method is the easiest to calculate, it's accuracy is diminished by the variability of exchange rates during any given year and the reality that exchange rates do not always reflect the domestic purchasing power of a currency. Purchasing Power Parity (PPP) - this approach adjusts exchange rates for differences in the domestic purchasing power of different currencies. The core concept is that it should take the same amount of purchasing power (opportunity cost) to buy good X regardless of the country of purchase or the currency used. This is the preferred method for calculating and comparing GDPs internationally. GDPs calculated in this way will be noted as GDP (PPP). GDP (PPP) values will be expressed in a common currency, normally US Dollars. GDP: International Comparisons: continued Other factors that influence the ability to compare GDP values across countries include: Accuracy of GDP data collection - This is not a problem with developed world countries as they have sophisticated data collection systems. However, it is a factor with developing country values. In the developing world, data collection methods are not as well developed and the informal economy can be a significant part of total economic activity. There is nothing that can be done about this difficulty and for our purposes it can be ignored even in cases with the numbers may be significant. Different legal structures - Since GDP only includes legal activities and only legal activities are counted in GDP, national law differences can impact GDP values. Activities that are illegal in the US, for example, may well be legal in other countries. The differences this would create are usually too small to be of significance, thus, they be safely ignored. GDP: Summary of Key Points GDP is the market value of all final goods and services produced in an economy during a specific time period. Nominal GDP is GDP in current prices. Real GDP is Nominal GDP adjusted for price changes and must be used for any cross-temporal comparisons. The adjustment is made using the GDP Price Deflator - which is the broadest measure of price changes in use. GDP: Summary of Key Points: continued GDP is composed of four spending streams of which Consumption is the largest, but Investment is the most variable. GDP includes only economic activity that is legal and occurs in formal markets. GDP makes no value judgments about the non-monetary worth of what is produced. Per Capita GDP is the measure of Standard of Living. GDP: Summary of Key Points: continued Purchasing Power Parity is the preferred method for calculating foreign GDP values for conversion into US Dollars for international comparisons. GDP is the most widely used overall measure of economic performance and is essential for measuring economic growth. Per Capita GDP is the normal measure of a nation's Standard of Living
