ECO120 Macroeconomics
Rod Duncan
Lecture 3- Measuring GDP
Announcements
• Tutorials start this week. Tutorial
allocations are on the Interact website
under Resources.
• The assignment for Tutorial 1 is to print out
your registration on the Course Compass
webpage.
• Tuesday tutorials changed to C3-401
(upstairs in the Library).
What are the big questions?
• What drives people to study
macroeconomics? They want solutions to
problems such as:
– Can we avoid fluctuations in the economy?
– How can we make the economy grow faster?
– Can we lower the unemployment rate?
– Why do we have inflation?
– How can we manage interest rates?
– Is the foreign trade deficit a problem?
Economic output
• Gross domestic product- The total market
value of all final goods and services
produced in a period (usually the year).
– “Market value”- so we use the prices in
markets to value things
– “Final”- we only value goods in their final form
(so we don’t count sales of milk to cheesemakers- “intermediate goods”)
– “Goods and services”- both count as output
Nominal versus real GDP
• We use prices to value output in
calculating GDP, but prices change all the
time. And over time, the average level of
prices generally has risen (inflation).
– Nominal GDP: value of output at current
prices
– Real GDP: value of output at some fixed set
of prices
Measuring GDP
• Are we 40 times (655/16) better off than
our grandparents?
– Australian GDP in 1960- $15.6 billion
– Australian GDP in 2000- $655.6 billion
• What are we forgetting to adjust for?
Measuring GDP
• Population- Australia’s population was 10
million in 1960 and 19 million in 2000.
– GDP per person in 1960 = $15.6 bn / 10m
= $1,560
– GDP per person in 2000 = $655.6 bn / 19m
= $34,500
• Prices- $1,000 in 1960 bought a better lifestyle than $1,000 in 2000.
Nominal versus real GDP
• So how to correct for rising prices over
time?
– Measure average prices over time (GDP
deflator, Consumer Price Index, Producer
Price Index, etc)
– Deflate nominal GDP by the average level of
prices to find real GDP
Real GDP = Nominal GDP / GDP Deflator
Some Australian economic history
Australian GDP 1950-1995
600 000
500 000
Million A$
400 000
GDP
300 000
GDP Change
Real GDP
200 000
100 000
0
1950
1960
1970
1980
1990
2000
Measuring GDP
• Real GDP -If we instead use 1996-1997
prices to calculate GDP then Australia
GDP in 1960 was $138 billion while
Australian GDP in 2000 was $631 billion.
• Real GDP per person
– 1960: $138bn/10m = $13,800
– 2000: $631bn/19m = $33,200
• So we are 2.5 times better off than our
grandparents.
Measures of economic output
• Gross domestic product- The total market
value of all final goods and services produced in
a period (usually the year) within a country.
• Gross national product- The total market value
of all final goods and services produced in a
period (usually the year) by Australians.
– So an Australian lawyer working overseas for 6
months would include his overseas earnings as
Aussie GNP but not Aussie GDP.
• Important: GDP/GNP figures use “market
prices” to value things and do not count
intermediate goods.
Why measure GDP?
• What are the goals of economics?
– Answer: Achieve the greatest happiness (welfare or
utility) for individuals in society.
– Problem: We can’t measure happiness.
• Second best: We measure the resources and
opportunities available to members of society.
– We assume that happiness is related to the range of
choices individuals have within society. The more
choices people have, the more likely they are to find a
choice they are happy with.
Why measure GDP?
• We can’t measure the range of choices, so we
measure the value of what we produce and
assume that a greater value of production meant
that we had more opportunities.
• Paradox of happiness: Richer people report
themselves as happier than poorer people
around them. But average happiness in rich
societies is not greater than average happiness
in poor societies.
– So how can we say we are measuring happiness
when more GDP does not make people happier?
Rod’s holiday snaps
• Rod was hired to write an economic
survey of the Solomon Islands and
Vanuatu.
• AusAID, which is a department of the
Australian government (paid for by the
Australian taxpayers), partly paid for the
surveys.
Actually Madang (but reasonably
close to Solomons/Vanuatu)
Actually Madang (but reasonably
close to Solomons/Vanuatu)
So how do people fare living on an
island paradise?
• Most of the population is subsistence farmers.
Small garden plots can feed a whole family.
There is no evidence of starvation and limited
malnutrition.
• Survival is very easy. Food is relatively plentiful,
and housing does not need to be sophisticated.
• However domestic, clan and political violence
can be common- depending on the area.
• Political corruption is rampant. Public serviceshospitals and education- are very limited.
How to describe an island
paradise?
• We might talk about the number of people on the
island. (Actually each country is made up of lots
of little islands.)
• We might talk about the size of the island (land
area).
• How crowded is it? We might talk about number
of people per square km.
• Are people crowded into the city? We might talk
about what fraction of the population lives in the
urban areas.
Population and geography (in
2006)
Pop.
Area (in
sq. km)
Pop. /
Area
Urban.
(%)
SI
521,000
28,900
18
17%
Vanuatu
213,000
12,200
17.5
23%
Australia
20,700,000 7,741,200
Belgium
10,540,000
30,500
2.7 Over 70%
345.5 Over 70%
How well off are people in an island
paradise? (income)
• We might measure the income of the
people. We are assuming that more
income means a population that is better
cared for.
• We ask “how much do you earn?”
• But are we really interested in how much a
country earns? What we want is how
much the average person earns- “per
capita”.
Gross national income (GNI)
Pop.
GNI (in US$)
GNI/Pop
(in US$)
SI
521,000
$330,000,000
$690
Vanuatu
213,000
$370,000,000
$1,690
Australia
20,700,000
$742,250,000,000
$35,860
1,311,800,000
$2,620,950,000,000
$2,000
China
But where would you rather live?
• China has the largest GNI at $2.6 trillion
US$.
• But Australia has a larger per capita GNI
at $35,860 per person. Why?
– Because Australia’s total GNI is split over 20
million people versus China’s 1.3 billion
people.
• Is this the whole story?
Does income equal quality of life?
• One problem with using income per person is
that money won’t buy the same things in
different places.
• $500,000 will buy a spacious 5 bedroom house
with a large lot in the best suburb in Bathurst.
The same $500,000 will buy a small house in a
poor suburb in Sydney.
• The same fact holds across countries.
Economists try to correct for this by calculating
“purchasing power parity” (PPP) GNI.
HDI Ranking
HDI
Rank
Country
Life expect. Adult
(years)
Literacy
(%)
Enrolment PPP GDP
(%)
per capita
(US$)
1 Iceland
81.5
99%+
95%
$36,510
3 Australia
80.9
99%+
113%
$31,794
81 China
72.5
91%
69%
$6,757
120 Vanuatu
69.3
74%
63%
$3,225
63
77%
48%
$2,031
41.8
35%
45%
$860
129 SI
177 Sierra
Leone
Health statistics
Infant
mortality
(per 1,000
live births)
Australia
Under-five
mortality
(per 1,000
live births)
Probability
of survival to
age 65
(Fem/Male)
Maternal
mortality
(per 100,000
live births)
5
6
F: 92%
M: 86%
4
China
23
27
F: 81%
M: 74%
45
Vanuatu
31
38
F: 76%
M: 68%
68*
SI
24
29
F: 64%
M: 60%
220
165
282
F: 38%
M: 30%
2,100
Sierra Leone
Does GDP = happiness?
• Citizens of richer countries generally:
– Lead longer, healthier lives;
– Are better educated and spend more years in
education;
– Have more leisure time and opportunities;
– Have greater levels of political participation;
– Lead less risky lives from natural or man-made
disasters;
– Breathe cleaner air and drink cleaner water;
–…
• So perhaps asking people about their
“happiness” is not the right question.
Does GDP = happiness?
• Principle of revealed preference
– Definition: If I see someone choosing option A over
Option B, I assume that person is at least as happy
with option A as option B.
• Fact: I observe millions of people risking their
lives, their health and their wealth to leave low
GDP countries to move to high GDP countries. I
observe very, very few people moving in the
opposite direction to better their lives.
• So does revealed preference tell us life is better
in high GDP than in low GDP countries?