Economics
Session 7: Measuring
National Income.
GDP. Implications and
limits.
Luis Maldonado
Macroeconomics
What does an economy need to growth?
How can we diagnose an economy?
Debates around fiscal and monetary policy.
1
Gross Domestic Product
(GDP)
2
The Measurement of Gross Domestic Product (GDP)
GDP is the market value of all final
goods and services produced within
a country in a given period of time.
It needs to use prices!!
3
The measurement of Gross Domestic Product (GDP)
GDP can be calculated by adding expenditure or by
adding income. Both ways of computing GDP yield
the same result.
4
The measurement of Gross Domestic Product (GDP)
Output is valued at market prices.
It records only the value of final goods, not
intermediate goods (the value is counted
only once).
It includes both tangible goods (food,
clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits).
Produced within a country.
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What is not counted in GDP?
• GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
• Excludes non-market goods or services: e.g. the value of
health, the value of the environment
– In fact, expenditures are counted but the value of the
good it is not (e.g., medical expenses are part of the
GDP but the value of a healthy life-style is not counted)
• It excludes items produced and sold illicitly, such as
illegal drugs.
• It excludes underground economy.
6
Large underground economy distorts GDP figures
7
Other Measures: Gross National Product
Gross national product (GNP) is the total income
earned by a nation’s permanent residents (called
nationals).
It differs from GDP by including income that our
citizens earn abroad and excluding income that
foreigners earn here.
8
The components of GDP
GDP (computed as expenditure) (Y ) is the sum of
the following:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX):
Exports-Imports
Y = C + I + G + NX
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The components of GDP
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of new
houses.
Investment (I):
The spending on capital equipment, inventories
(unsold goods), and structures, including new
housing.
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The components of GDP
Government Purchases (G):
The spending on goods and services by local,
state, and federal governments.
Net Exports (NX):
Exports minus imports
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Problems of using prices to measure GDP
P x Q (output valued at market
prices)
Two problems of using P:
1. Cross country comparisons (different level of prices in different
countries) – solution: PPP adjusted GDP.
2. Increase in prices across time (inflation) – solution: Real instead of
Nominal GDP.
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The problem with prices I: The Problem of Cross Country
Comparisons
PIBChina
GDP = PChina * QChina
PIBUS
GDP = PUS * QUS
PIBUS
GDP - GDP
PIBChina = PUS * QUS - PChina * QChina
Differences in the unit of
account: yuan versus US$
Price differences, not only differences in the level of
output production, explain differences in GDP. Even with the same unit of
account, differences in the level
of prices. Some countries are
more expensive than others.
Solution:
1. Convert each country’s currency into a common currency. For example, use the current exchange rate
between the US$ and the other currencies to express the GDP of all nations in terms of US$.
2. Purchasing Power Parity measure – takes the idea above one step further. Use instead of the current
exchange rate, the long-term equilibrium exchange rate. This is the exchange rate that is supposed to
equate the cost of living in the two nations.
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GDP Measures
$US versus PPA $US:
PPP takes into account the relative cost of living and
the inflation rates of different countries.
The Purchasing-power-parity (PPP) between two
countries is the rate at which the currency of one
country needs to be converted into that of a second
country to ensure that a given amount of the first
country's currency will purchase the same volume of
goods and services in the second country as it does in
the first.
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PPP versus current $ GDP
If country X’s GDP measured in terms of
PPP is bigger than measured in current $:
The cost of living in country X is lower than in
the U.S.
Country X’s currency is undervalued relative
to the U.S. $ (comparing today’s exchange rate
with the long-term exchange rate between the
two currencies).
15
The Big Mac Index
http://www.economist.com/content/big-mac-index
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The Problem with prices II: measuring changes across time -
Real versus Nominal GDP
Nominal GDP values the production of goods and
services at current prices.
Real GDP values the production of goods and services at
constant (or base-year) prices.
The change in the real GDP gives a more accurate (real)
measure of the change in economic activity in one country
during a given period of time.
E.g., suppose that the nominal GDP has increased by 10%
but that the average level of prices has increased by 9%,
by how much has the real production of goods and
services increased?
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Real vs. Nominal GDP
GDP2012 = P2012 * Q2012 Solution: use for the 2013 GDP
calculation, the level of prices in
GDP2013 = P2013 * Q2013 2012, effectively freezing prices
from a statistical point of view.
GDP2013 - GDP2012 = P2013 * Q2013 - P2012 * Q2012
GDP2013 - GDP2012 = P2012 * Q2013 - P2012 * Q2012
The change in the level of prices,
not only the change in the level of
output or production, explain the
change in the GDP.
110
0%
by1
d
rease The inflation rate, the increase in prices,
c
DP in was approximately 7%
G
inal
m
No
103
GDP: 100 creased by 3
%
Pin
Real GD
2012 2013 18
Nominal GDP Growth in Perú: 1980-2018
5000%
4000%
3000% The high rate of growth of Nominal
GDP is only due to the high rate of
inflation. This illustrates the
2000%
necessity of deflating the GDP
measures.
1000%
0%
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Fuente: IMF World Economic Outlook Database, October 2013. 19
Real GDP Growth in Perú: 1980-2018
15
10
0
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
14
16
18
19
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-5
The economy, measured by
real GDP and real GDP
growth, collapsed during the
-10
hyperinflation episode of
1988-1990
-15
Source: IMF World Economic Outlook Database. 20
Global GDP Growth 2024
21
0
1
2
3
4
5
6
Germany
Luxembourg
Japan
Germany: 1,1%
Austria
Greece
Italy
Portugal
France
Korea
Poland
Spain
Spain: 1,7%
Netherlands
Denmark
Finland
Slovenia
Ireland
Source: OCDE Economic Policy Papers N. 3
Russia
Belgium
(next 50 years) / 2011-2060
Hungary
Slovak Republic
Sweden
Switzerland
Czech Republic
United Kingdom
United States
US: 2,1% Canada
Iceland
Norway
Estonia
Annual rate of growth of GDP in real terms
Australia
Israel
New Zealand
Argentina
Chile
Brazil
Turkey
Mexico
South Africa
Saudi Arabia
China
Indonesia
China: 4.0%
India
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India: 5,1%
The world is going to look very different in 40 years from now
2022 2060
US United
Rest of 23% Rest of States
countries countries 17%
29% 25% Euro
Area
9%
Euro Japan
Japan Area 3%
7% 17%
India
China China
18%
India 17% 28%
7%
Source: OCDE Economic Policy Papers N. 3 23
GDP and quality of life
Ta
PIB real
Real GDPpor LifeEsperanza Adultos que
Literacy Use of Uso de
internet
per capita
persona (2007) de vida
expectancy (% adult
saben leer Internet
(% adult
(years) population) population)
El PIB y
País ($) (años) (% de la población) (% de la población)
de vida
Estados Unidos 45.592 79 99 63 La tabla m
Alemania 34.401 80 99 45 persona y
Japón 33.632 83 99 67 de la calid
Rusia 14.690 66 99 15 grandes p
México 14.104 76 93 18
Brasil 9.567 72 90 19
China 5.383 73 93 9
Indonesia 3.843 71 92 7
India 2.753 63 66 3
Pakistán 2.496 66 54 7
Nigeria 1.969 48 72 4
Bangladesh 1.241 66 54 0,3
Fuente: Human Development Report 2009, Naciones Unidas. Los datos sobre el PIB real, la esperanza de vida y el porcentaje de adul-
tos que saben leer se refieren a 2007. Los datos sobre el uso de internet corresponden a 2005.
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Debate: Is GDP the best way to measure Prosperity?
https://www.economist.com/news/leaders/21697834-gdp-bad-gauge-material-well-being-time-fresh-approach-how- 25
measure-prosperity
Limits of GDP as a measure of well-being
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Conclusions
GDP is the best measure of growth of an economy, but:
q Welfare is not measured.
q Ignores the distribution of wealth.
q Ignores some externalities (eg. environmental quality)
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