Skip to main content
Loading Explore guides…
Understanding GDP · Acedra
Home
Explore
Economics
Understanding GDP
Sign in to save
Chat
If YouTube asks you to sign in, open the video on YouTube.
Watch on YouTube
Reload player
Transcript
137 segments
Copy
Hide video
0:00
[Music] Hello! I am Dr. William E. Schlosser. You know me as an Economist. You may also know me as an Ecologist. But more than anything, you are going to remember me as an educator. I m Dr. Bill and I welcome to my classroom!
0:37
Welcome to Chapter 4, where we embark on an exploration of Gross Domestic Product, or GDP. In this chapter, we have four key learning objectives that will guide our journey. First, we will understand what GDP is and why it is a crucial indicator of a country's economic health. This includes learning about the different components that make up GDP. Second, we will dive into how GDP is measured, including the distinctions between nominal and
1:06
real GDP, and how these measurements give us insights into economic growth over time. Third, we will explore the limitations of GDP as a measure of economic well-being. This will help us appreciate why GDP, while important, doesn't capture all aspects of a nation's prosperity. Finally, we will examine how GDP data can be used to make comparisons across different countries and over different periods, highlighting
1:34
the economic dynamics at play globally. Let's dive into the fascinating world of GDP, starting with real-world examples like the Great Recession and the COVID-19 recession to see these concepts in action. In the past two decades, the U.S. economy has faced significant challenges, most notably the Great Recession of 2008 and the COVID-19 recession of 2020. The Great Recession, triggered by a financial crisis, led to a severe downturn in economic activity.
2:06
Major auto manufacturers like Ford, General Motors, and Chrysler saw plummeting sales. General Motors and Chrysler declared bankruptcy and only survived due to a $62 billion bailout from the U.S. federal government. Although Ford suffered heavy losses, it managed to avoid direct government aid. Fast forward to the COVID-19 pandemic, which caused an unprecedented global economic shutdown. Industries across the board, including automobile manufacturing, were hit hard.
2:38
The impact was reflected in a sharp decline in GDP, similar to the Great Recession. However, this time, the recovery has been complicated by subsequent hyperinflation from 2020 to 2024. Understanding GDP allows us to see how these economic events affect industries, jobs, and overall economic health. We will explore how Real GDP and potential GDP provide insights into these fluctuations and the economy's capacity to recover and grow. Understanding the unemployment rate is
3:13
crucial for grasping how economic health and GDP are interconnected. The unemployment rate measures the percentage of the labor force that is jobless and actively seeking employment. Throughout recent history, we ve seen significant fluctuations in this rate, such as the peak of 10% during the Great Recession and an even higher crest of 14.8% during the COVID-19 recession. As of 2024, the rate has settled back to a more stable 4.0%. An acceptable level of unemployment
3:47
is generally considered to be around 5%. This level accounts for frictional unemployment, which includes those temporarily between jobs or entering the workforce for the first time. However, those who are permanently out of the workforce, such as discouraged workers who have stopped looking for jobs, are not included in this rate. It s important to recognize how employment directly impacts GDP. Only those who are employed and earning wages can send money,
4:17
driving economic activity and growth. This spending is a vital part of the economic cycle, as it leads to increased demand for goods and services, which in turn stimulates further production and employment. Throughout this class, I encourage you to critically analyze the information you encounter, including statistics like the unemployment rate. While these figures are often discussed in the media, understanding the underlying data and
4:43
the nuances of what they represent will give you a clearer picture of economic conditions. You will learn about the methodologies used to collect and interpret this data, enhancing your ability to evaluate economic health beyond surface-level statistics. Let's delve deeper into how employment and unemployment influence GDP and the broader economy. FRED is the Federal Reserve Economic Data portal from the St. Louis Federal Reserve.
5:12
It is an essential resource for tracking macroeconomic trends. This slide illustrates two critical indices: the Consumer Price Index (CPI) in blue and the Producer Price Index (PPI) in red, from 1980 to 2024. The CPI reflects the costs borne by consumers, covering expenses such as food, electricity, travel, and other goods. Since 2000, we see an accelerating rise in the CPI, reaching a value of 318 in 2024, up from 240 in 2000.
5:49
This indicates a significant increase in consumer costs over the years. Conversely, the PPI, which tracks the average change over time in the selling prices received by domestic producers for their output, shows dramatic fluctuations. Notably, from 2020 to 2022, the PPI surged from 150 to 240, with peaks and troughs reflecting economic turbulence. By 2024, it climbed to 250, revealing the pressures faced by producers. When the PPI rises, it often signals future
6:26
increases in the CPI, as higher production costs typically lead to higher consumer prices. This can result in reduced purchasing volumes and economic activity as costs become prohibitive for consumers and businesses alike. It s crucial to interpret these indices with caution. A sudden drop in the index values doesn't necessarily indicate price reductions; it can also reflect a decrease in economic activity.
6:56
Understanding these dynamics helps us grasp the broader economic picture, including periods of inflation, hyperinflation, and recessions. The interplay between CPI and PPI underscores the complex relationship between consumer costs and producer prices, and their collective impact on the economy. Real GDP per capita is a crucial metric that provides a clear picture of a country's economic performance and standard of living. This graph from the FRED database illustrates the trajectory of real
7:30
GDP per capita in the United States from 1980 to 2024, measured in chained 2017-dollar values. We observe a noticeable dip during the COVID-19 recession in 2020, where real GDP per capita fell sharply from $63,257 in 2019 to $57,383 in 2020. Despite this significant downturn, the economy rebounded quickly, returning to pre-pandemic levels by 2021 and continuing its upward trend to reach $65,650 by the end of 2021. By early 2024, real GDP per capita surpassed
8:14
$67,646, though the rate of growth slowed. Real GDP per capita is an essential measure because it adjusts for inflation, providing a more accurate reflection of economic growth and individuals' purchasing power over time. It accounts for the total economic output divided by the population, giving a per-person view of economic productivity. This metric helps us understand whether the economic growth of a country is keeping pace
8:44
with population growth, which in turn affects living standards and economic stability. In this class, you will delve deeply into the components that constitute GDP, how each element is measured, and the implications of these measurements. Understanding GDP and its per capita variant is fundamental to grasping the broader concepts of macroeconomics, and it will be integral to your assignments, quizzes, and exams.
9:12
Be prepared to engage with this pivotal concept throughout the course as it forms the backbone of our exploration into economic health and policy. Microeconomics is the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices. It delves into individual decision-making processes and the factors influencing economic behavior on a smaller scale. In contrast, macroeconomics examines the economy as a whole.
9:45
It uses indicators such as inflation, unemployment, and GDP to understand the broader economic environment. Macroeconomics helps us see the big picture of how national policies and global events impact the overall economy. In macroeconomics, several key terms help us understand economic activities and trends: Business Cycle: Refers to the fluctuations in economic activity that an economy experiences over a period of time, marked by phases of expansion and contraction.
10:21
Expansion: A phase in the business cycle where economic activity is increasing, characterized by rising GDP, higher employment rates, and increased consumer spending. Recession: A period of economic decline during which GDP falls, unemployment rises, and consumer spending decreases. Economic Growth: The ability of an economy to increase the production of goods and services over time, usually measured by the growth rate of GDP.
10:51
Inflation Rate: The rate at which the general level of prices for goods and services is rising, and subsequently, how purchasing power is falling. These terms provide a framework for analyzing economic conditions and forecasting future economic performance. They are crucial for understanding how the economy functions and for making informed decisions in both business and policy-making contexts. In this chapter, we start building the tools to articulate the health of the economy.
11:25
Pay close attention to new terms and phrases that have specific economic meanings. Central to our study of macroeconomics is the Gross Domestic Product, or GDP. It serves as the pinnacle of our analysis, integrating the efforts and outcomes of various economic activities into a single, comprehensive measure. Understanding GDP is essential because it reflects the aggregate economic activity and helps us assess the overall economic performance. Throughout this course, we'll explore how GDP
11:58
connects with other macroeconomic indicators, such as inflation, unemployment, and economic growth, providing a complete picture of the economy's dynamics. By the end of this chapter, you'll have a solid grasp of how GDP is measured and why it is so vital in the field of macroeconomics. This knowledge will be fundamental as we explore more complex economic concepts and their real-world applications in the chapters to come. What's the best way to measure our country's economic growth and the
12:30
prosperity of its citizens? Some think the U.S. government is using the wrong yardstick, particularly amid concerns about income inequality and other quality of life issues. Our economics correspondent, Paul Solman. In 1968, then-presidential candidate Robert Kennedy blasted our country's main measure of economic progress, called GNP. In those days, it counts napalm, and it counts nuclear warheads. If the Gross National Product does not
13:00
allow the health of our children, the quality of their education, or the joy of their play, it measures everything, in short, except that which makes life worthwhile. These days, we rely on GDP, Gross Domestic Product, GNP's near proxy, which measures the total dollar value of goods and services sold in the U.S. in a year, plus exports minus imports. The measure still leaves out the things Kennedy emphasized, but that's because they're just too tough to measure. They're very large, and they
13:38
requite uncertain in their magnitude. Steve Landefeld runs the Bureau of Economic Analysis, the BEA, which tallies the GDP. The BEA sticks to measures of market transactions, and the data has become fundamental. It is used by the Federal Reserve Board for economic policy. Our consumer spending inflation rate comes from us. The entire federal budget is based on the baseline that comes out of BEA's data. GDP has become the king of all statistics,
14:08
and the king for almost all countries, adds economics writer Zachary Karabell. Governments rise and fall on their ability to say, "I enhanced GDP," or the populace's ability to say, "No, you didn't. GDP went down under your watch." But how does GDP still hold its lofty status? We're with Robert Kennedy's 1968 critique, or with more recent evidence of its limits, which Nobel economist Joseph Stiglitz has pointed out. Thirty years ago, we weren't talking about climate change.
14:39
Environmental degradation was not as important as it is today. In 2009, Stiglitz chaired an international panel tasked with finding better measures of progress that included the environment and economic inequality. GDP has been going up per capita, but most Americans are actually worse off. Median household income is actually falling. Like them or not, better prosperity gauges are hardly a novel innovation. Since the 1970s, for example,
15:12
in the Himalayas, the Buddhist Kingdom of Bhutan, with GDP per person less than that of the Congo, has used Gross National Happiness instead. Its GNH score turns out to be as elevated as its location. Then back down here at sea level, there's the GPI. It simply takes into account not only our economy but the health of our environment, the health of our society. One synthetic number that purports to describe lived reality with an average has
15:48
to make choices about what you include. What do you add, what do you exclude? But you can't include everything, and so long as you don't, you can't really quantify human well-being, especially if there's any truth to the maxim that the best things in life are free.
16:08
[Music]
16:15
Economists use Gross Domestic Product (GDP) to measure total production in an economy. GDP represents the market value of all final goods and services produced within a country during a specific time period, usually one year. This measure helps economists and policymakers understand the overall economic activity and health of a nation. In the United States, the Bureau of Economic Analysis (BEA) is responsible for compiling the data used to compute GDP.
16:48
By examining GDP, we gain insights into the country's economic performance, allowing for informed decision-making and policy development. Economists use GDP to measure total production. GDP is the market value of all final goods and services produced in a country during a period of time, typically one year. In the United States, the Bureau of Economic Analysis, or BEA, compiles the data used to compute GDP.
17:17
This comprehensive measure helps us understand the economic health and performance of the nation. Economists measure total production in an economy by taking the value, in dollar terms, of all goods and services produced. GDP includes only final goods and services. A final good or service is a good or service purchased by a final user. An intermediate good or service is a good or service that is an input into another
17:45
good or service, such as a tire on a truck. If we included the value of intermediate goods and services in GDP, we would be double counting. For example, counting the value of ice cream bought by a store and also when sold to a consumer would result in double-counting the wholesale value. Therefore, GDP includes only final goods and services produced during the indicated time period, excluding used goods. These are important distinctions to understand: Do not count used good value in the GDP,
18:20
and do not include something that will become a part of a final good because its value will be included in that item s value. When we add up the value of total production in the economy by calculating GDP, we are simultaneously measuring the value of total income. Not surprisingly, total income is measured by the Internal Revenue Service. Each year these totals are made and serve as one way of checking the values measured in the GDP. It makes for a decent checks-and-balances
18:54
measurement between the two approaches. The circular-flow diagram is a powerful tool that illustrates the interaction between firms and households in markets. In this simplified model, households and firms are the primary economic actors. We can measure the overall economic activity by examining two main flows: expenditures and income. Households spend money on goods and services provided by firms, represented by the green arrow from households to firms.
19:25
This expenditure is one way to measure GDP. Firms, on the other hand, make payments to households in the form of wages, interest, and profits, shown by the green arrow from firms to households. This income is another way to measure GDP. Both methods, measuring expenditures and measuring income, ultimately give us the same GDP value. This circular-flow model is essential for understanding how money moves through the economy
19:55
and how we measure total economic activity. In this expanded circular-flow model, we introduce the government as a key player in the economy. The government interacts with both households and firms, adding a complexity to the flow of economic activity. Households and firms pay taxes to the government, depicted by the arrows pointing towards the government. In return, the government makes payments back to these sectors in the form of wages, interest, and transfer payments.
20:25
These interactions show how the government collects revenue and redistributes it within the economy. The addition of the government sector highlights its role in influencing economic activity through taxation and spending. Taxes collected from households and firms are used to fund various government activities, including public services and social programs, which are critical components of the overall economic system. This model helps us understand
20:53
the multifaceted flow of money and how government policies can impact the economy.
21:02
This slide builds on our previous circular flow diagrams by adding the component of the global economy. Here, we introduce the "Rest of the World," which interacts with both households and firms. Households buy goods and services from international firms, known as imports. Conversely, domestic firms sell goods and services to foreign households, known as exports. This global interaction is crucial for understanding how interconnected our economy is with the rest of the world.
21:33
This model helps illustrate the flow of goods and services across borders and its impact on our GDP.
21:43
In our circular flow model, we now introduce the financial system, which plays a crucial role in connecting households, firms, and the government through monetary transactions. Households may choose to save part of their income in financial institutions like banks. These institutions, in turn, lend the money to firms for investment and to the government for public spending. This flow of savings and loans is essential for maintaining the economic cycle,
22:12
ensuring that funds are available for business expansions, and supporting government projects. Understanding this financial component is key to grasping the full picture of economic interactions within the circular flow model.
22:28
The BEA divides its statistics on GDP into four major categories of expenditures. Economists use these categories to understand why GDP fluctuates and to forecast future GDP. Personal consumption expenditures, or consumption, is spending by households on goods and services, not including spending on new houses. We will frequently come back to this formula in this class. Understand it, commit it to your memory, and be able to reproduce what it means.
22:59
I cannot repeat this part too much: know this will appear on assignments, quizzes, and exams when you address macroeconomics. Consumption expenditures are divided into expenditures on services, nondurable goods, and durable goods. Gross private domestic investment, or investment, is spending by firms on new factories, office buildings, machinery, and additions to inventories, plus spending by households and firms on new houses. Government consumption and gross investment,
23:32
or government purchases, are spending by federal, tribal, state, and local governments on goods and services. Net exports of goods and services or net exports are equal to exports minus imports. Now we look at each of these in more detail.
23:52
I keep coming back to this simple equation as it sums up the components of GDP: Y=C+I+G+NX The equation tells us that GDP (Y) equals consumption (C) plus investment (I) plus government purchases (G) plus net exports (NX). Household final consumption expenditure also called private consumption, is the market value of all goods and services, including durable products like cars, washing machines, and home computers, purchased by households.
24:29
It excludes purchases of dwellings but includes imputed rent for owner-occupied dwellings. It also includes payments and fees to governments to obtain permits and licenses. Here, household consumption expenditure includes the expenditures of nonprofit institutions serving households. Consumption is the largest component of GDP and is divided into three categories: services, nondurable goods, and durable goods. Services include spending on medical care, education, and haircuts.
25:06
Nondurable goods include food and clothing, while durable goods encompass items like cars and furniture. This classification helps us understand where households are allocating their spending and how it impacts overall economic activity. Investment is another critical component of GDP. It includes business fixed investment, which is spending by firms on new factories, office buildings, and machinery. Residential investment involves spending by households and firms on new houses,
25:40
both single-family and multi-family. Changes in business inventories reflect goods that have been produced but not yet sold. These investments are essential for future economic growth as they increase the productive capacity of the economy. Government purchases are expenditures by federal, state, and local governments on goods and services. This includes defense spending, public education, and infrastructure projects. These purchases play a significant
26:11
role in the economy by providing essential services and infrastructure that support economic activity and growth. Net exports are the value of a country's exports minus its imports. Exports are goods and services produced domestically and sold to other countries, while imports are goods and services produced abroad and purchased domestically. Net exports can be positive or negative, depending on whether a country exports more than it imports.
26:42
This component of GDP helps us understand a country's trade balance and its impact on overall economic activity. The circular-flow diagram shows the interaction between households and firms in markets. Firms sell goods and services to households, foreign entities, and the government, using factors of production supplied by households. Transfer payments from the government to households don't count as new goods or services.
27:11
By measuring either total expenditures or total income, we get the same GDP value, showcasing the economy's flow. Adding the government to the circular flow model illustrates how it interacts with households and firms. Governments collect taxes from both entities and provide wages, interest, and transfer payments to households. This interaction affects overall economic activity and GDP measurement. International trade introduces the rest of
27:45
the world to the circular flow model. Households import goods and services, while firms export to global markets. These transactions affect net exports and overall GDP, highlighting the global economy's interconnectedness. The financial system connects all circular flow model components by managing money flows. Households save with financial institutions, which lend to firms and the government. This interaction is crucial for maintaining economic stability and supporting growth.
28:20
The federal government established the Department of Homeland Security after September 11, 2001, to guard against future terrorist attacks within the United States. Spending by this department is intended to increase the security of the nation s borders and transportation system, identify and arrest terrorists within the United States, and gather intelligence on potential terrorist threats. FEMA is also the nexus of natural disaster
28:48
mitigation and recovery for the entire nation. Through the identification of natural disaster risks such as wildland fires, flooding, earthquakes, landslides, hurricanes, and associated natural disasters, the Federal Government has transferred funds to Indian Tribes, States, Counties, and Cities. These recipients provide matching funds to the Federal Dollars. Most jurisdictions then contract the work to specialists in the private sector, where consumption spending is
29:20
further increased, adding to the GDP. We will talk more about this multiplier effect in spending in a later lecture for this macroeconomics class!
29:31
Over time, the share of consumption in the United States as a percentage of GDP has exhibited noticeable trends. In the 1950s, consumption was around 66% of GDP but experienced fluctuations, dropping to as low as 58% in the mid-1950s. The share of consumption consistently hovered between 60% and 63% through the 1960s and 70s. From the mid-1980s, consumption began to increase steadily, reaching above 67% in the early 2000s.
30:07
The great recession saw a significant impact, causing fluctuations again, but the percentage rose to 68% by 2021, with the current trend showing tight fluctuations around 68%. Understanding this historical trend highlights the increasing importance of personal consumption expenditures in calculating GDP. Consumption plays a critical role in the economy, reflecting how much households spend on goods and services, thereby driving economic activity.
30:40
Final goods and services are those purchases made by the ultimate consumers, that is, they are neither intended for resale, nor consumed in a subsequent production process. GDP excludes intermediate goods and services, which are used up in the same period they themselves were produced. There is a significant exception when accounting for government expenditures. The government may spend money for which it does not receive any good or service in return.
31:12
Transfer payments, such as social security benefits, unemployment compensation, and various welfare benefits, are excluded from government spending in GDP accounting because they do not reflect productive activity in the period in which they occur. Similarly, interest payments on the national debt are not counted as part of government spending in the GDP accounts. GDP is the nation s expenditures on all FINAL goods and services produced during the year at market prices.
31:44
The Value-Added method of calculating GDP makes an addition of value created by a manufacturer preparing the good for final sale. Intermediate goods and services, which are used in the production of final goods and services, are not included in the Value-Added approach to GDP because expenditures on intermediate goods and services are included in the market value of expenditures made on final goods and services. Including expenditures on both intermediate and
32:15
final goods and services would lead to double counting and an exaggeration of the true market value of GDP. Using the value-added method to calculate GDP, the value added is the market value each firm adds to a product. It is equal to the difference between the price for which the firm sells a good and the price it paid other firms for intermediate goods. At each phase of production, a value is added to the product. By doing this for each phase of
32:46
production, the total value added is summed to show the increase to GDP.
32:54
As we conclude section 4.1, let's recap the key concepts. Gross Domestic Product (GDP) is a vital measure of a nation's economic activity, representing the market value of all final goods and services produced within a country during a specified period. The main components of GDP include consumption, investment, government purchases, and net exports. Understanding the value-added method is crucial for accurately calculating GDP.
33:23
This method involves summing the value added at each stage of production, ensuring we avoid double-counting intermediate goods. Additionally, it's important to note that GDP excludes intermediate goods, used goods, and transfer payments, as they do not reflect current productive activities. While GDP is a comprehensive measure of economic activity, it has notable limitations. It does not account for income inequality, meaning it can mask significant disparities in wealth distribution.
33:58
Non-market transactions, such as household labor and volunteer work, are excluded, even though they contribute significantly to societal well-being. Furthermore, GDP does not consider environmental degradation, which can result from economic activities. Lastly, GDP does not measure the quality of life or happiness of a population, which are essential components of true economic prosperity. This concludes our discussion on GDP in section 4.1. As we move forward, remember the importance
34:33
of using complementary indicators to gain a more holistic understanding of economic well-being.
34:42
[Music]
34:48
Economists use GDP to measure total production in the economy. Most economists believe that GDP does a good but not flawless job of measuring production. We recognize how GDP provides only a rough measure of well-being. Remember Chapter 1 when we talked of Normative and Positive discussions in Economics. We strive to put our measurements into the Positive arena of discussions using facts and figures. Well-being is normally expressed in Normative terms, and although we can
35:24
make general comments about it, these make opinions from inferences about the suitability of the economic measurements. When the BEA calculates GDP, it does not include two types of production: production in the home and production in the underground economy. Household production refers to goods and services people produce for themselves. These are neither bought in a marketplace, nor are they sold in one.
35:52
The garden grown at home produces food that if bought in a store would be included in GDP, but since it does not move through the economy, instead staying in the household, it is not in GDP. Does consumer well-being increase? Yes, mostly it does, but the measurements of GDP completely miss this part of the equation.
36:15
The underground economy refers to buying and selling of goods and services that are concealed from the government to avoid taxes or regulations, or because the goods and services are illegal. An interesting recent change in the legalization of marijuana in several states and the District of Columbia has modified the previously illegal underground economy to legalize it and bring the contributions of marijuana sales into the realm of state sales tax and inclusion in the GDP.
36:48
In 2012, the first year of legalized marijuana sales in Washington State, $70 million in tax revenue was generated statewide from marijuana sales. The Washington State Liquor Control Board, which oversees the state's cannabis industry, reported that dispensaries sold more than $257 million worth of legal marijuana in Washington State. This is a net GDP addition. The legalization of marijuana has significantly impacted state economies and GDP. This slide shows the first-week sales of legal
37:24
marijuana in Oregon, Colorado, and Washington, highlighting the initial economic impact of legalization. In 2012, the first year of legalized marijuana sales in Washington State, $70 million in tax revenue was generated statewide. Dispensaries sold more than $257 million worth of legal marijuana. This shift brings previously underground sales into the taxable economy, contributing to GDP growth. Next, we will see the continued trend
37:56
and its impact on state revenues and GDP. Legalizing marijuana transitioned sales from the underground economies to the legal market, bringing economic benefits and transparency. For instance, Washington State's first year of legalized sales generated $70 million in tax revenue, with dispensaries selling over $257 million worth of marijuana. This not only increased transparency but also added to GDP, reflecting the true economic potential of the industry. The trend shows consistent growth,
38:33
illustrating how legislation can positively influence economic measures like GDP. By 2024, the impact of legalization is even more evident. Colorado represented $67 million, Washington $580 million, and the entire USA $5.8 billion in tax revenues from marijuana sales. These figures highlight the substantial economic contribution of the marijuana industry to state and national economies. The overall trend shows how legal marijuana sales and associated tax revenues have grown
39:14
significantly, providing a more accurate picture of economic health and activity. This transition has not only benefited state economies through increased tax revenues but has also provided valuable insights into the economic contributions of the marijuana industry. Understanding these trends helps illustrate the broader economic impact and potential of legalized marijuana. Let's take a look at how the
39:41
legalization of marijuana has influenced tax collections and spending in Washington State. On one hand, traditional taxes such as fuel tax and cigarette excise tax continue to contribute significantly to state revenues. However, cannabis sales have introduced a substantial new revenue stream. In 2023, cannabis sales in Washington averaged over $2 million a day, generating projected tax revenues of $270 million annually.
40:13
These funds are allocated across various sectors. The majority supports healthcare, accounting for over half of the cannabis tax revenue. Other significant allocations include state government funding, local government support, and enforcement. This diversified spending not only highlights the economic impact of legalized marijuana but also shows its role in supporting essential public services. When we compare these figures to traditional tax revenues, we can see how cannabis sales
40:43
have become an integral part of the state's financial landscape, contributing to public health, safety, and education. This shift illustrates the dynamic nature of tax policies and their ability to adapt to new economic activities, ultimately enhancing the state's fiscal health and its citizens' well-being. The US economy is made of people and business working through the circular flow model concept.
41:11
Because the factors of production in the US economy, and the relative size of household production, it is expected that the loss of measured household production is not a factor changing between years so the net change in GDP is most likely not biased by omitting these measurements. However, over longer periods, these shortcomings might be more impactful. For example, in 1950, a stay-at-home parent provided valuable services to the household economy not reflected in GDP.
41:43
Today, with both parents typically in the workforce and utilizing paid childcare, contributions to GDP include both their employment and the value of childcare services. Thus, while annual GDP growth comparisons remain valid, long-term GDP growth might overstate actual increases in total production due to these structural changes. In developing countries, the underground economy, often referred to as the
42:14
informal sector, plays a significant role. Unlike the formal sector, the output of goods and services in the informal sector is not measured. In many developing countries, this informal sector can account for over 50% of total output. This large informal economy often results from high taxes, excessive regulations, and low confidence in the security of private property from government seizure. The underground economy provides a
42:44
critical source of income for many households, especially in times of economic uncertainty.
42:52
At the Manek Chowk market, in this Indian city's congested center, vendors peddle everything from beans to brass pots from a row of derelict stalls as monkeys scramble overhead. One man sharpens knives using a spinning blade attached to a moving bicycle wheel. In many cities across the developing world, informal labor plays a critical role. From a roadside beverage vendor in Bangkok to a sidewalk seamstress booth in Ahmedabad,
43:11
India, many individuals are creating their own job market in the face of factory closings and waning employment opportunities in the formal economy. Economists studying these regions note that such informal sectors can be as large as, or even larger than, the formal sectors of their economies. This reliance on informal labor can stem from high taxation and regulation, making it difficult for small
43:28
businesses to operate within the formal economy. It can also be a result of limited trust in the government or financial institutions to protect private property or enforce contracts fairly. As a result, these economies function in a way that is not captured by GDP measurements, yet they play a vital role in sustaining livelihoods and contributing to the overall economic activity. The main purpose of GDP is to measure a country s total production.
43:50
Although increases in GDP often lead to increases in the well-being of the population, GDP is not a perfect measure of well-being. The value of leisure is not included in GDP, and GDP is not immediately adjusted for pollution. GDP is not adjusted for crime and other social problems, and GDP may not provide good information about the goods and services consumed by the typical person. Be cautious of using economic measurements to
44:21
quantify feelings of well-being. GDP is a Positive tool, only weakly applied to Normative issues.
44:31
The expenditures for World War II and later for the Department of Homeland Security increased as measured GDP and GDP per person. However, this doesn t necessarily mean that the welfare of the average person improved. During World War II, the high production levels included a significant amount of military goods, which did not contribute to consumer well-being. Post-war, the decline in GDP was accompanied by a rapid increase in the production of consumer goods, highlighting a
45:03
shift back to peacetime prosperity. This historical example teaches us to critically evaluate GDP increases and consider whether they reflect actual improvements in people s well-being, a question that often leads us into normative territories.
45:22
In this section, we explored the various shortcomings of GDP as both a measure of total production and well-being. We learned that GDP does not capture important aspects like household production and the underground economy, nor does it reflect income distribution, leisure time, or the negative effects of production. We also discussed how GDP per capita, while useful, is not a perfect measure of well-being. For instance, societal improvements such as reduced crime can lower GDP
45:57
but improve quality of life. Lastly, the historical context of World War II illustrated how high GDP due to military production did not equate to increased consumer well-being. The post-war period saw a shift to consumer goods, offering a more accurate reflection of prosperity. These insights remind us to critically assess GDP figures and consider the broader context when evaluating economic well-being.
46:27
[Music]
46:34
The slide shows an image of a $1 bill and a line graph illustrating the purchasing power of the US dollar since 1774. The graph highlights key points such as peaks and troughs corresponding to historical events. A step-by-step calculation is shown on the slide to demonstrate how to adjust nominal prices to real prices using CPI values. I introduce you to an important concept in economics: Real values versus Nominal Values.
47:05
Understanding these terms and how to apply them is crucial for analyzing economic data. Nominal values are the actual prices we see during transactions. For instance, if you purchased a gallon of gasoline for $3.25 in June 2012, this is the nominal price. However, to make a fair comparison of this price over time, we need to adjust for inflation, which gives us the real price. To restate the 2012 price in 2024 terms, we first remove the effects of inflation
47:40
using the Consumer Price Index (CPI). The CPI for June 2012 was 224.116, and for May 2024, it was 313.225. Here's the calculation to adjust for inflation: The 2012 Gasoline Cost Real 2024 = (($3.25 x 313.225) / 224.116) = $4.54 This measures that $3.25 per gallon in June 2012 is equivalent to $4.54 per gallon in May 2024 in real terms. By understanding the real price, we can compare the cost of goods and services over time, accounting for inflation.
48:33
This concept is essential for comparing GDP from year to year, as it allows us to distinguish between changes in production and changes in prices. Understanding real versus nominal values helps us make meaningful economic comparisons over time, removing the distortions caused by inflation. This concept is vital for analyzing changes in GDP and other economic indicators.
49:00
The BEA helps us understand economic growth by distinguishing between price changes and production changes. Nominal GDP measures the value of goods and services at current-year prices. In contrast, Real GDP measures them using base-year prices, allowing us to see true growth by removing inflation's impact. The base year for our current measurements is 2017. However, relative prices change over time, potentially distorting Real GDP calculations.
49:32
To address this, since 1996, the BEA uses chain-weighted prices, which adjust current-year production using the previous year's prices, providing a more accurate economic picture over time. To understand how Real GDP is calculated, let's look at an example. The table on the slide displays the output and prices for the years 2019 and 2024. To calculate the total value of output in 2019, we multiply the quantity of each good by its respective price and sum the results:
50:06
For Good A: 80 x 40 = 3200 For Good B: 90 x 11 = 990 For Good C: 15 x 90=1350 Adding these values together, we get a total GDP for 2019 of $3200+$990+$1350=$5540. This calculation gives us the nominal GDP for 2019, which is the value of goods and services at current prices. By using similar methods, we can calculate the GDP for different years and adjust them to base-year prices to find the Real GDP, providing a clearer picture of economic growth without the distortion of inflation.
50:51
When considering how to calculate Real GDP, the introduction of new products poses a significant challenge. For instance, the latest smartphones in 2024 may have features and capabilities that were unimaginable in 2019. This raises the question of how to account for these new features when converting prices to Chain-Weighted Real terms. One approach could be to assume that the price of the new model is the same as the 2019 model, adjusted for inflation.
51:24
However, this method can quickly become complicated, especially with high-tech products where innovation and enhancements are frequent. The photograph on the slide, showing various smartphone types, illustrates this issue. The constant evolution in technology means that new products often have no direct historical equivalent for price comparison. This is why the base year for GDP calculations is periodically updated. Furthermore, while Chain-Weighted Real GDP provides valuable insights,
51:56
the Consumer Price Index (CPI) adjusted Nominal-to-Real prices are often favored due to their practicality and relevance in capturing current economic conditions. Although it requires more effort to analyze, the resulting data is often more meaningful for understanding economic changes over time. Real GDP per capita is an important measure that helps economists and policymakers understand the average economic
52:26
output per person, adjusted for inflation. By using chained dollars, which are adjusted for inflation and based on a specific base year (in this case, 2017), we can accurately compare economic output over time without the distortion caused by changes in price levels. The graph on this slide shows the trend of Real GDP per capita from 1980 to 2024. Notice the vertical axis labeled "Chained 2017 Dollars," which indicates that all values are
53:00
adjusted to reflect 2017 price levels, allowing for a clear comparison across different years. Real GDP per capita is calculated by dividing the Real GDP by the population of the country. This metric provides a more accurate picture of individual economic well-being than nominal GDP or total GDP alone because it accounts for both inflation and population growth. In this slide, we are comparing Real GDP and Nominal GDP over time.
53:34
The graph shows both metrics from 1980 to 2024, with a vertical line indicating the base year 2017. Nominal GDP is measured using current year prices, reflecting the actual market value of goods and services produced. In contrast, Real GDP is adjusted for inflation, using the prices from the base year, which in this case is 2017. In the base year, Real GDP and Nominal GDP are the same. After the base year, prices generally rise due to inflation,
54:08
making Nominal GDP higher than Real GDP. Before the base year, the opposite is true; Nominal GDP is less than Real GDP because prices were lower. This comparison is crucial because Real GDP provides a more accurate reflection of an economy's growth by stripping out the effects of inflation. When the media reports on GDP growth, they are typically referring to Real GDP growth, which gives a clearer picture of changes in the economy's output and overall health.
54:41
Understanding the difference between these two measures helps us make better economic decisions and policies by focusing on the real changes in production rather than just changes in prices.
54:55
Economists and policymakers are interested not just in the level of production but also in the price level. The price level is a measure of the average prices of goods and services in the economy. The GDP deflator is a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100. GDP Deflator = (Nominal GDP ÷ Real GDP) multiplied by 100 Since nominal and real GDP will be the same in the base year, the GDP
55:32
Deflator will be 100 in that base year. The GDP Deflator is valuable because it reflects changes in the price level and the value of goods and services. Unlike the Consumer Price Index, which is based on a fixed basket of goods and services, the GDP Deflator can change as consumption patterns and the introduction of new goods and services evolve.
55:57
The graph on this slide shows the GDP Deflator over time, highlighting a vertical line at the base year 2017. This graph demonstrates how the GDP Deflator adjusts for changes in the price level, offering a clear picture of inflation and price stability over the years. The GDP Deflator is advantageous because it accounts for changes in consumption patterns and the introduction of new goods and services, providing a more comprehensive measure
56:26
of inflation compared to fixed-basket indices like the Consumer Price Index.
56:32
The GDP deflator is a key indicator used by economists to understand the overall price level changes within an economy. It compares the nominal GDP, which reflects the value of all finished goods and services produced within a country at current prices, to the real GDP, which adjusts for inflation and provides a more accurate reflection by using base-year prices. To calculate the GDP deflator, we divide the
57:01
nominal GDP by the real GDP and multiply by 100. For instance, in 2023, the nominal GDP was $15,534 billion and the real GDP was $15,052 billion, yielding a GDP deflator of 103. In 2024, with a nominal GDP of $16,245 billion and a real GDP of $15,471 billion, the GDP deflator increased to 105. This increase from 103 to 105 indicates a 1.9% rise in the price level over this period. Such an increase means that, on average,
57:44
prices for goods and services were 1.9% higher in 2024 compared to 2023. By analyzing the GDP deflator, economists can gain insights into inflation trends and make informed decisions about economic policies. Unlike other price indices, like the CPI, the GDP deflator is not based on a fixed basket of goods and services. The basket is allowed to change with people's consumption and investment patterns.
58:15
Specifically, for the GDP deflator, the "basket" in each year is the set of all goods that were produced domestically, weighted by the market value of the total consumption of each good. Therefore, new expenditure patterns are allowed to show up in the deflator as people respond to changing prices. The theory behind this approach is that the GDP deflator reflects up to date expenditure patterns. For instance, if the price of fish increases relative to the price of beef,
58:45
it is claimed that people will likely spend more money on beef as a substitute for fish. This makes the adjustments revealed through the GDP Deflator more responsive to consumption responses as people make changes based on price factors.
59:02
[Music]
59:08
FOR A.TV the world is thinking One of the reasons for my interest in this subject is that accounting frameworks affect behavior. We saw that in the United States in the 90s, where people had bad accounting, which affected their behavior. Some of what is going on now is a reflection of bad accounting. More generally, information affects behavior.
59:47
How we gather information about and describe success affects what we strive for. If GDP is what we think is success, people will strive for GDP. Political leaders often say, "Look at what we've done." They always frame it as, "I've succeeded in getting the economy to grow at 6%." Now, what they actually did is hard to figure out, but politicians claim, "I've created X million jobs." This is part of political rhetoric.
1:00:17
The question is, by doing that, they focus policies on things that will increase GDP.
1:00:26
In forming the Commission, we identified many ways in which GDP is not a good measure of economic performance or societal well-being.
1:00:40
National income accounting involves the methods the BEA uses to track total production and total income in the economy. This comprehensive approach ensures that we understand not just the GDP but also other crucial economic indicators. The BEA's National Income and Product Accounts (NIPA) are essential for analyzing economic activity. They use double-entry accounting to capture the monetary value of production and the income distribution it generates. This data is crucial at both
1:01:15
national and industry levels, providing a detailed view of economic performance. Gross National Product, or GNP, is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. GNP includes foreign production by U.S. firms but excludes U.S. production by foreign firms. For the United States, GNP is almost always the same as GDP. In producing goods and services,
1:01:48
some machinery, buildings and equipment wear out and have to be replaced. Depreciation is referred to as the consumption of fixed capital. If we subtract this value from GDP, we are left with national income. Personal income is income received by households. To calculate personal income, we subtract the earnings that corporations retain rather than pay to shareholders in the form of dividends. We add in the payments received by households from the government in the form of transfer
1:02:20
payments or interest on government bonds. Disposable personal income is equal to personal income minus personal tax payments, such as the federal personal income tax. Disposable personal income is the best measure of the income households have available to spend. As we progress through these chart components, we recognize GDP as larger than Gross National Product, since GNP is GDP less depreciation. National Income is more than Personal Income,
1:02:52
which is larger than Disposable Personal Income. Each measurement shows the distribution of production and income throughout the economy, from the national government, to households. We can measure GDP in terms of total expenditure or as the total income received by households. GDP calculated as the sum of income payments to households is sometimes referred to gross domestic income. The largest component of gross domestic income is wages, which are about three times as large as profits.
1:03:28
In 2015, the U.S. GDP was composed of several key components, each reflecting different aspects of economic activity. Personal Consumption Expenditures made up the largest portion, indicating the importance of household spending in driving the economy. Gross Private Domestic Investment followed, highlighting investments by businesses in new equipment, buildings, and inventory.
1:03:53
Government Consumption and Gross Investment showed the role of federal, state, and local governments in economic activity. Finally, Net Exports, which is the difference between exports and imports, reflected the U.S.'s trade relationships. By examining these components, we can understand the economic priorities and conditions of that time. Fast forward to 2024, and we see some shifts in the components of GDP.
1:04:20
While Personal Consumption Expenditures still make up a significant portion, there have been changes in the other components due to various factors such as technological advancements, policy changes, and global economic conditions. For instance, Gross Private Domestic Investment might show an increase due to more investments in technology and infrastructure. Government Consumption and Gross Investment may reflect changes in public spending priorities,
1:04:49
and Net Exports could show the impact of trade policies and international market dynamics. Analyzing these changes helps us understand the evolving nature of the economy and the factors driving growth and development.
1:05:05
Be careful when applying these measurements and using the results. As I have told you before, in economics we strive to collect positive data, based on measurements of the economy like production and prices. Despite this, the results are sometimes applied to normative conditions like where the best place to live is located. Economic data like the Real GDP, or GNP, can be used as supportive information, but generally will not “provide anything” in that realm.
1:05:36
On the other hand, they are spot-on useful for articulating the performance of economic conditions currently, and through time. [Music]
Here to help you learn
Sign in to keep a private conversation with your course tutor.
Ask me anything about the material…
Sign in to chat