ECO120 Macroeconomics
Rod Duncan
Lecture 4- Measuring GDP, but
what does it mean?
Measuring GDP
• In the last lecture we introduced the concept of
GDP, which is a measure of the value of all the
goods and services produced in an economy in
a year.
• We found that GDP is correlated with better
human outcomes in terms of health and
education (and political rights and lots of other
nice things), but it is not correlated with
measures of happiness.
• Happiness seems to be based on people’s
history and expectations- and also envy!
Problems with using GDP
measures
• We assume that higher GDP is better.
• But is GDP the right way to measure economic
output?
• GDP only counts things which are valued in
markets- so only those have market prices.
– If we dirty our water, pollution is generally unpriced,
so this would not come into GDP calculations.
– A parent taking care of his or her own children is not
paid in the market, so is not counted as part of GDP.
– Black market/illegal activities are not measured or
counted as part of GDP.
Measurement of GDP
• Example: In the 1980s, Italy engaged in major
reforms of its regulatory practices- slashing a lot
of red tape. Italian GDP growth rates were
among the highest in Europe. So can we say
that Italian reforms greatly increased the welfare
of Italians?
– Problem: Much of the expansion in GDP was simply
new reporting from firms that had been operating in
the black market due to the difficulty of regulations
becoming “legit” after the reforms. This was not new
output.
Women moving into the workforce
Labour Force Participation by Sex at Ages 35-44
120
Participation rate (%)
100
80
Males
60
Females
40
20
0
1965
1970
1975
1980
1985
1990
1995
2006
Women moving into the workforce
• What is the economic impact of all these women
moving out of unpaid labour (at home) into paid
labour (at a workplace)?
– The measured level of economic activity will go up, as
all those earned salaries will add to GDP.
• But a large number of those women are working
at child care centres to take care of other
people’s children, rather than staying at home to
take care of their own children.
• What are the social consequences, HRM
consequences or political consequences of a
large shift in the work women do?
Aside: Using graphs
• Let’s look at a table showing some of the
changes in the male/female labour force
participation rates (from the Australian
Bureau of Statistics (ABS)).
• This table has too much information for
most audiences. How are we going to
present this data in a graph instead?
LABOUR FORCE PARTICIPATION RATES (%)
By age
Males
Females
Age
group
1986-87
2006-07
1986-87
2006-07
15-19
60.6
58.2
59.8
61
20-24
90.5
85.7
76.1
78.1
25-34
95
92.1
61.2
72.5
35-44
94.5
91.1
65.2
74.5
45-54
89.8
88.5
55
76.6
55-64
61.7
67.9
21.9
48.4
65 and
over
8.6
12.8
2.4
4.6
75.6
72.2
48.7
57.6
Total
Male LFP Changes from the 1980s to the 2000s
100
90
80
70
60
1986-87
50
2006-07
40
30
20
10
0
15-19
20-24
25-34
35-44
Age
45-54
55-64
65 and
over
Female LFP Changes from the 1980s to the 2000s
90
80
70
60
50
1986-87
40
2006-07
30
20
10
0
15-19
20-24
25-34
35-44
Age
45-54
55-64
65 and
over
Changes in LFP from the 1980s to 2000s
100
90
80
70
Males 1986-87
60
Males 2006-07
50
Females 1986-87
40
Females 2006-07
30
20
10
0
15-19
20-24
25-34
35-44
Age
45-54
55-64
65 and
over
Which graph to use?
• The choice of the best graph depends on
the story that you want to tell.
• Do you want to talk about changing male
and female expectations about the
workforce (closer to graph 3)?
• Do you want to talk about changing
expectations for child-rearing and work
(graph 2)?
Sample exam question
QUESTION : B.1
(5 + 5 = 10 marks)
The last 50 years have seen a large
increase in the proportion of women who
work outside the home.
a) What effect would this change have on
the measurement of GDP?
b) What effect would this change have on
our measurement of unemployment?
Measuring GDP
• Alternative methods of calculating GDP
– Expenditure approach: add up the total
spent by all members of the economy (value
of all goods and services bought)
– Income approach: add up the incomes of all
members of the economy (value of all goods
and services sold)
– Value-added approach: add up the value
added to goods at each stage of production
Expenditure approach
• GDP is calculated as the sum of:
– Consumption expenditure by households (C)
– Investment expenditures by businesses (I)
– Government purchases of goods and services
(G)
– Net spending on exports (Exports – Imports)
(NX)
Aggregate Expenditure: AE = C + I + G + NX
Expenditure approach
• Later on in the subject we will introduce
the aggregate demand-aggregate supply
model (AD-AS). The expenditure
approach underlies the AD curve in the
AD-AS model.
• Factors that shift components of demand
will then also shift the AD curve.
– If income taxes change, household
consumption (C) will change, so the AD curve
will shift.
The big picture
P, Wealth, H/h Expectations,
H/h Taxes
C
P, i, Business Expectations,
Business Taxes
I
AE
Government policy, and?
P, and?
G
NX
AD
Income approach
• The income approach is probably the next most
straight-forward way of measuring economic
activity.
• When you buy a good, the cash that you pay
(the market value) to a firm doesn’t stay with the
firm. The value gets returned to households.
– The firm pays its employees (households).
– The firm pays other firms for its purchases.
– The rest gets returned as profits to shareholders
(households).
Firms as fictions
• In that sense, firms don’t really exist. They are
just convenient accounting fictions.
• A firm is a representation of the households who
own the shares in the firm (or for a private firm,
own it outright).
• Firms were invented as a way of allowing people
to own a business, but not be personally liable if
the business fails.
• To say “firms don’t pay enough taxes” is really to
say “shareholders don’t pay enough taxes”.
Income approach
• We measure the value of the income earned by
households in the production of goods- think of
the cash a firm receives on a sale:
– Wages paid to employees (suppliers of labour)
– Profits/rent/bonds payments returned to suppliers of
capital
– Indirect taxes (GST) paid to government
• Since the Tax Office collects all these details to
calculate income taxes, we can have a
reasonably good measure of this.
Value-added (production) approach
• This approach is probably the most difficult to
understand.
• Why can’t we simply add up the value of all the
goods and services bought in a year? The
problem is that a lot of sales of goods are
“intermediate” goods- that is goods that will be
used to make other goods.
• If we simply added up the sales of all the goods
in a year, we would wildly over-calculate GDP.
Ford as a car assembler
• Ford is more of a car-assembler than a carmaker. Ford buys seats from one supplier,
brake systems from another and tires from a
third.
• Imagine Ford uses $20,000 worth of
components in a $30,000 car. Adding up the
sales, we get $50,000, but the consumer buys a
$30,000 car!?!
• The answer is that Ford adds only $10,000
worth of value. The rest of the value of the car is
the $20,000 in components.
Valuing economic activity
• In the end, we can either value (1) the
$30,000 car purchased by the consumer,
(2) the $30,000 income returned by Ford
to workers, capitalists and suppliers, or (3)
the $20,000 in components plus the
$10,000 in value-added by Ford.
• All 3 approaches result in the same
answer… $30,000- the value of the car.