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Measuring Economic Activity: GDP and Unemployment

PART 2 Macroeconomics: Issues and Data. chapter 5. Measuring Economic Activity: GDP and Unemployment. Jenny Xu, Simon Fraser University. Gross Domestic Product: Measuring the Nation’s Marketed Output. What can measurement of the GDP tell us? What can GDP measurement not tell us?

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Measuring Economic Activity: GDP and Unemployment

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  1. PART 2 Macroeconomics: Issues and Data chapter 5 Measuring Economic Activity: GDP and Unemployment Jenny Xu, Simon Fraser University

  2. Gross Domestic Product: Measuring the Nation’s Marketed Output What can measurement of the GDP tell us? What can GDP measurement not tell us? Three approaches: Value added (production), expenditure, income

  3. Measuring GDP (a) • Gross domestic product, GDP • = The market value of the final goods and services produced in a country during a given period • Using market values of different goods and services • Allows economists to aggregate the quantities of many different goods and services • Non-marketed public service are valued in GDP according to the market value of the inputs used to produce them. • Non-market activities will not be counted. • Agricultural society (large share of products goes to subsistence) • Modern economies: Unpaid housekeeping and childcare, studying, gardening, etc will not be counted. • Predicting the total value of marketed output is useful because: • Helps governments to predict tax revenue and expenditures • The number of paid jobs in the economy depends on GDP www.AssignmentPoint.com

  4. Measuring GDP (Not all goods and service with market value will go to GDP total) • Final goods or services (e.g. sandwich) • Goods or services consumed by the ultimate user • the end products of the production process • Total final sales = GDP • Intermediate goods or services • e.g. wheat in flour production; • flour in bread production; • bread in sandwich production • = Goods or services used up in the production of final goods and services, • Not separately counted as part of GDP, in order to avoid double-counting • Hairstylist and her assistant: $20 to hairstylist and she give her assistant $4. • A good can be either intermediate or final www.AssignmentPoint.com

  5. Capital Goods: A special type of good that is hard to classify as final or intermediate goods • Machinery, Equipment & Structures • Long-lived goods, which are themselves produced and then used to produce other goods and services • Not final goods, as their purpose is to produce other goods; • Not intermediate goods, as they are not used up during the production process. • Newly produced capital goods counted in “Investment” component of GDP www.AssignmentPoint.com

  6. Value Added • To add up GDP • {or to administer a value added tax like the GST} • Have to compute “value added” at each stage of production • Value added: • Is the market value of a firm’s product or service minus the cost of inputs purchased from other firms • The summing of the value added by all firms in the economy yields the total value of final goods and services www.AssignmentPoint.com

  7. TABLE 5.1 Value Added in Bread Production • Each stage of production adds value • But if we add up the total sales made at all stages of production we will double count intermediate inputs • Value of final sales = the total value added at all stages of production www.AssignmentPoint.com

  8. FIGURE GDP Monthly Economic Indicatorshttp://strategis.ic.gc.ca/epic/internet/ineas-aes.nsf/en/h_ra01898e.html www.AssignmentPoint.com

  9. Measuring GDP • The “Domestic” in “Gross Domestic Product” means “produced within a given country” • GDP measures economic activity within a given country • - all production taking place within Canadian borders, even if produced in a foreign-owned plant • During a given period; • Normally a year www.AssignmentPoint.com

  10. II. The Expenditure Method for Measuring GDP Any goods or services that is produced will also be purchased and used by some economic agent.

  11. Expenditure Method • GDP measures the quantity of goods and services produced by an economy • GDP also measures what will be purchased • Four buyers of final goods and services • Households • Firms • Governments • Foreign sector www.AssignmentPoint.com

  12. Measuring Equivalently • GDP can be measured with equal accuracy by either • Adding up the market values of all the final goods and services produced • Adding up the total amount purchased by Households, Firms, Governments and Foreigners and subtracting spending on imports • Remember – any market transaction always can be seen from two sides {as a sale by the seller OR as a purchase by the buyer} – so we can calculate GDP from either perspective AND GET THE SAME ANSWER www.AssignmentPoint.com

  13. Consumption Expenditure • Consumption expenditure: • Spending by households on goods and services, such as food, clothing, and entertainment • Consumer durables: long-lived goods for households use, such as cars, furniture • Semi-durables: consumer goods that would typically be used on multiple occasions and be expected to last for a year or more, such as clothing and footwear; • Non-durables: consumer goods that would typically be used only once or be expected to last less than a year, such as food, gasoline • Services: haircuts, legal services, education www.AssignmentPoint.com

  14. Investment • Investment • Spending by firms on final goods and services • Spending primarily on capital goods and housing • Business fixed investment: Purchase of new capital goods • New machinery and new factories • Residential investment • New homes and apartment buildings, no matter it is for personal living or for rental income • Inventory investment • Change in inventories (desired or not) • The goods a firm produce but does not sell during the current period are treated, (for accounting purpose), as if the firm had bought those goods for itself. • This makes sure production=expenditure. www.AssignmentPoint.com

  15. “Investment” • In economics • Purchases of stocks or bonds are called “financial investments” • Financial investment does not necessarily mean the creation of new physical capital • When measuring GDP • We measure investment in REAL assets • Investment does NOT include purchases of stocks or bonds www.AssignmentPoint.com

  16. Government Purchases • Government purchases • Purchases by federal, provincial, and local governments of final goods and services • Does not include transfer payments • Does not include interest payments on government debt • Transfer payments • Payments made by the government in return for which no current goods or services are received • E.g. Canada Pension Plan, EI • When the households that receive transfers or interest income spend that money, it is counted as “Household Consumption” www.AssignmentPoint.com

  17. Net Exports • Net Exports • Equal exports minus imports • Exports • Domestically produced final goods and services that are sold abroad • Imports • Purchases by domestic buyers of goods and services that were produced abroad www.AssignmentPoint.com

  18. Equation for GDP Y = C + I + G + NX Y = gross domestic product, or output C = consumption expenditure I = investment G = government purchases NX = net exports www.AssignmentPoint.com

  19. TABLE 5.2 Expenditure Components of Canadian GDP, 2003 (billions of dollars) www.AssignmentPoint.com

  20. III. GDP and the Incomes of Capital and Labour Third way to think of GDP: The market value of goods and services produced must equal the incomes of the factors of production.

  21. GDP as Income (a) • A third way to think of GDP • “Follow the Money” – all the revenue that firms receive from sales must end up somewhere - in somebody’s hands – i.e. • Incomes of capital and labour • Whenever a good or service is sold, the revenue is distributed to the • Workers • Owners of the capital used in the production • GDP = labour income + capital income www.AssignmentPoint.com

  22. GDP as Income (b) • Statistics Canada actually breaks down GDP into 5 income categories: • Wages, salaries and supplementary labour income • supplementary labour income: Money value of fringe benefits • Net farm and small business income (includes most rental income): Net income of farmers and unincorporated business • Corporate profits before taxes: net earning of firms after deducting the capital consumption allowance. • Interest and miscellaneous investment income • Capital consumption allowances: • Allowance for using up fixed capital in the production process. • Corresponds to the part of income required to place the depreciated capital. • Last 4 categories correspond roughly to capital income www.AssignmentPoint.com

  23. TABLE 5.3 Income Components of Canadian GDP, 2003 (billions of dollars) www.AssignmentPoint.com

  24. Putting It All Together • GDP is the same amount whether we measure it by expenditures or incomes, or in terms of market values of final goods and services; • This is not a coincidence • There is a circular flow relationship between expenditures and incomes www.AssignmentPoint.com

  25. FIGURE 2.9 The Circular Flow • This diagram links income and expenditure in a highly simplified model of the economy. The outer set of arrows in red indicates money or dollar follows in the economy. The inner set of arrows in blue indicates flows of real inputs and goods and services. wages received (labour income) wages paid labour supplied labour hired goods and services acquired goods and services supplied household spending on goods and services (consumer expenditure) firm revenue from sale of goods and services www.AssignmentPoint.com

  26. IV. Nominal GDP vs. Real GDP

  27. GDP - Monthly Economic Indicatorshttp://strategis.ic.gc.ca/epic/internet/ineas-aes.nsf/en/h_ra01898e.html www.AssignmentPoint.com

  28. GDP comparisons • We can compare GDP across • Different locations • Province-by-province GDP • Different times • 1997 GDP to 2001 GDP • Comparing GDP over time may be misleading • Because of inflation • I.e., GDP is calculated using market values, which are influenced by inflation or the price changes • To take out the effects of inflation, economists use a base year • A particular year – e.g. 1997 www.AssignmentPoint.com

  29. An Example • in 1997, country A produce 10 pizzas and 15 calzones, price of pizza is $10, and price of calzone is $5; • GDP in 1997= 10*10 pizzas+5*15 calzones=$175 • In 2005, country A produce 20 pizzas and 30 calzones, price of pizza is $12, and price of calzone is $6; • GDP in 2005= 12*20 pizzas+6*30 calzones=$420 • GDP increase from 1997 to 2005: 420/175=2.4 times. • But real products just increase by 2 times. • Why? Prices as well as quantities rise between 1997-2005. • So we need some methods to exclude the effect of price changes. • If we measure the GDP in both 1997 and 2005 using the 1997 prices of pizza and calzone, then we will not have this kind of problem. www.AssignmentPoint.com

  30. Real and Nominal GDP • Real GDP • Measure of GDP in which the quantities produced are valued at the prices of a base year rather than at current prices • Measures the actual physical volume of production • Is not influenced by inflation • Nominal GDP • Measures the quantities produced valued at current-year prices • Measures current dollar value of production • Nominal GDP includes both inflation and real growth • Current dollar value from year to year will reflect both changing quantities and changing prices www.AssignmentPoint.com

  31. GDP Deflator • A measure of the price level of goods and services included in GDP • Statistics Canada use a fixed weight GDP price index before 2001, now they use an implicit chain price index, both are called GDP deflator. • Real GDP= ( Nominal GDP/GDP deflator ) *100 • So that is why it is called deflator, it is used to deflate nominal GDP to get real GDP. www.AssignmentPoint.com

  32. V. GDP and Economic Well-Being

  33. Real GDP is Inappropriate as the Sole Economic Goal • Real GDP is an imperfect measure of economic well-being • It captures only those goods and services that are priced and sold in markets • Some shortcomings of interpreting real GDP as economic well-being: • Ignores the number of individuals or households • Ignores the distribution of income • Includes capital income of foreign firms located in Canada • GNP measures the market value of goods and services produced by factors of production owned by the residents of a country. • In Canada, GNP is usually less than GDP, partially due the high degree of foreign ownership of corporations operated in Canada • Includes investment devoted to replacing worn out or obsolete capital goods but does not include investment in human capital or R & D • Counts the income obtained from depleting non-renewable resources (e.g. mining) but does not count the depletion of assets or impacts on the environment www.AssignmentPoint.com

  34. Questionable Proposals for Increasing GDP • Some people have suggested that we increase GDP at the expense of • Non-working (leisure) time • Environmental quality and resource depletion • Quality of daily life and working life • But these things also affect our well-being • Example: • GDP would increase substantially if we all had to work 7 days a week rather than 5 – but would we really be better off if we never had any weekends? • GDP will increase if we increase the age at which people become eligible for public pensions. But again, increase GDP at the expense of non-working time. www.AssignmentPoint.com

  35. Real GDP Per Capita is Related to Living Standards • Real GDP per person does tend to be positively related to things people value • High material standard of living • When comparing rich and poor countries, higher GDP enables, see Table 5.5: • Better health and life expectancies • Better education • Human Development Index includes Education and Life Expectancy as key components of well-being • But among rich nations, the relationship is weaker www.AssignmentPoint.com

  36. GDP Per Capita & Well-Being? • GDP - useful thing to measure because Household welfare is affected by level of public services, unemployment and the consumption of goods • GDP measurement enables budget forecasting • Tax Revenue depends on marketed output • GDP determines number of paid jobs available • Market Incomes enable consumption of purchased goods and services • GDP should co-exist with other measures, not be replaced by them www.AssignmentPoint.com

  37. What is the relationship between GDP and Economic Well-Being? • Economic Well-Being < Human Well-Being • Economic Well-Being > GDP • Economic output > Marketed output • GDP omits value household labor, value of leisure, length of life, etc. • GDP includes “regrettable expenditures” • Costs of pollution, crime, etc • GDP is a useful concept because: • Market Consumption is an important part of well-being • GDP trends determine paid employment • GDP trends determine tax revenues & government expenditures • BUT GDP per capita ≠ WELL-BEING www.AssignmentPoint.com

  38. Human Well-being Increases in Human Well-being may be the ultimate objective of policy, but the concept is hard to define www.AssignmentPoint.com

  39. Economic well-being is something less than “Human Well-Being” E.g. political and legal freedom makes people better off – but this is not a $ issue Economic Well-being Economic Well-being www.AssignmentPoint.com

  40. GDP measures market production Less than “economic well-being” Well-being and GDP GDP GDP Economic Well-being www.AssignmentPoint.com

  41. GDP includes cost of some “economic regrettables” Like pollution clean-up “Social regrettables” “Social regrettables” GDP GDP Economic Well-being www.AssignmentPoint.com

  42. VI. The Unemployment Rate

  43. Unemployment • Sensitive indicator of conditions in the labour market • Direct indicator of unused labour resources • Low unemployment is correlated with • More Job security • Jobs are easier to find • Improving wages and working conditions www.AssignmentPoint.com

  44. Measuring Unemployment • The unemployment rate is calculated monthly, by Statistics Canada • Surveys approx 54,000 randomly selected households • Each person 15 or older is asked: • Did you do any paid work? • If “Yes” – counted as “Employed” • If “No” – then asked: “Did you look for work?” • If “Yes” – counted as “Unemployed” • If “No” – counted as “Not in the labour force” • All persons of working age assigned to one of: • “Employed” OR “Unemployed” OR “Not in Labour Force” www.AssignmentPoint.com

  45. Employed OR Unemployed OR NLF (Not in Labour Force) • Employed • Worked for pay (even for a few hours) during the past week • Includes those who did unpaid work for a family farm or business • Includes those on vacation or sick leave from a regular job • Unemployed • Did not work during the preceding week but was available and made some effort to find work in the past 4 weeks • NLF = Not in the labour force • Did not work in the past week • Did not look for work in the past 4 weeks • Full-time students who do not work • Unpaid homemakers • Retirees • People unable to work because of illness www.AssignmentPoint.com

  46. Unemployment Rate • Labour force • The total number of employed and unemployed people in the economy • Unemployment rate • The number of unemployed people divided by the labour force • No. of unemployed workers does not equal to the No. drawing EI benefits. In Nov 2003, 44% of the unemployed receive EI. www.AssignmentPoint.com

  47. Participation Rate • Participation rate • The percentage of the working-age population which is in the labour force • That is, the percentage that is either employed or looking for work • The gap between male and female participation rates has narrowed since 1976. www.AssignmentPoint.com

  48. FIGURE 5.3 Canada’s Unemployment Rate and Pronounced GDP Slowdowns Since 1960 Vertical blue lines are starting points of recessions www.AssignmentPoint.com

  49. Current Unemployment and Monthly Economic Indicatorshttp://strategis.ic.gc.ca/epic/internet/ineas-aes.nsf/en/h_ra01898e.html www.AssignmentPoint.com

  50. Why does Unemployment sometimes rise suddenly? • Why did Canada have higher unemployment in 1982-84 and in 1991-1995 ? •  Monetary policy: • High interest rates in 1980/81 & 1989/90 • With a lag, demand for goods declined, implying general lack of labor demand • Objective was to reduce inflation – •  Success in reducing inflation – but Public Policy Issue: • How large are the Costs of Inflation compared to the Costs of Unemployment ? www.AssignmentPoint.com

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