Limitations of GDP Estimations
I. What does GDP Miss?
GDP only includes all products sold in legal markets.
It neglects household and illegal production.
Do it yourself housework such as childcare or meal production are not
counted in GDP.
--An economy where homemakers are largely self sufficient will have a
much lower GDP.
--An economy where more people specialize and sell goods and services
to one another will have a higher GDP.
--In lesser developed economies more economic activity is do it yourself
type, and the extended family plays a much larger role—This is mostly
ignored by GDP, so these types of societies have lower GDPs than
actual production of goods and services.
GDP also ignores the underground economy—activity that isn’t reported
because it’s illegal or one does not want to pay taxes.
--The underground economy is called “The Black Market”—working off
the books.
GDP indicates the value of all goods and services produced in the
economy, and this gives economists an idea of the economy’s standard
of living.
--This is the level of economic prosperity.
We have seen over the years an increase in leisure time in America.
--This is not included in GDP, because it can’t be bought and sold on the
market.
--The GDP also does not record changes in quality of existing goods and
services and the availability of new goods and services.
Some goods wear out over time with usage such as cars or computers.
Some goods like computers become obsolete with introduction of new
technology.
Depreciation measures the value of capital stock that gets used up or
becomes obsolete.
Gross domestic Product does not take into account depreciation.
There are two types of investment:
--Gross investment measures the value of all investments made in a
given year and is used in computing GDP.
--Net investment is gross investment minus depreciation.
Gross Domestic Product reflects gross investment but net domestic
product reflects net investment.
Both GDP and net national product do not include the depletion of
natural resources to produce goods and services.
II. Adjusting GDP for Price Changes
GDP measures the dollar value of all goods and services produced—this
is measured in current dollars.
--This is the current dollar value at the time the goods and services were
produced.
The current dollar GDP is called Nominal GDP and is based on prices
when the goods and services were produced.
--Nominal GDP gets distorted over time due to the effects of inflation.
Real GDP is GDP adjusted for inflation.
Inflation is an economy’s increase in prices due to a declining value of
the currency.
Economists like to compare prices over a given time period.
To do this they need a reference point or a base year to compare to.
An index number compares the value of a variable in a given year to its
value in the base year.
This permits comparisons between two different years.
--For example, in 2005 a 40 inch television sold for $500.00, but in 2007
it sold for $625.00.
--$625.00 is divided by $500.00 and then multiplied by 100 which is
$125.00.
--If that same television sold for $645.00 in 2008, we divide $645.00 by
$500.00 and multiply by 100, and our answer is 129.
--This is illustrated below in the following chart:
Year
Price of TV in
base year
$500
Price Index
2005
Price of TV in
current year
$500
2007
$625
$500
125
2008
$645
$500
129
100
Practice Chart: To be completed in class.
Year
Price Index
With the price index we can compare prices of an item between any two
years.
The consumer price index measures changes over time of buying a set of
goods and services by a typical family.
To compute the consumer price index in a given year one only has to
divide the prices of items in the current year by the prices in the base
year and then multiply by 100.
The GDP Price index is a more comprehensive price index.
--It includes all goods and services produced.
--It is calculated by dividing the nominal GDP by the real GDP and
multiplying by 100.
--Nominal GDP is the dollar value of all goods and services in current
year prices, and real GDP is the dollar value of this year’s GDP in base
year prices.