ECON 1220A:
Introductory Macroeconomics –
L2. Macro Data and Issues
Gross Domestic Product (GDP)
1
What is GDP?
• Definition:
The Gross Domestic Product of a country in a given period of time is:
① ② ③
the market value of all final goods and services produced in the country
during the period.
④
Usage:
• It serves as an indicator of the aggregate economic activity of the
country during the period of time
• Some would also use it as a proxy of the size of an economy
2
Detailed Explanation
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1) Final goods and services
Goods and services produced in a country can be classified into two
main categories:
i. Produced for the purpose of consumption
- Consumption goods and services
ii. Produced for the production of other goods and services
- Intermediate goods or capital goods
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èConsumption goods and services and capital goods are considered as
final goods and services but NOT intermediate goods
- If we counted intermediate goods and services as well, ones that were inputs
into another good or service, such as a tire on a truck, then we would end up
double-counting.
☐ 3
2) Produced in the country:
- Only goods and services produced within the domestic boundary are counted
3) Market Value:
- We cannot add together the number of cars, melons, haircuts, and all other goods
and services without agreeing on a common way to measure them
- The best practical way is to value each good and service in monetary terms; and the
best measure of this that we have is the price that each good or service is sold for.
- The final goods and services produced are evaluated at the market prices at which
they are sold whenever possible
4) Produced during a given period of time:
- To measure total output in a given year, we measure the goods and services
produced only in that given year.
4
Components of GDP
① ②
• Recall that GDP
③
is the market value of all the final goods and services
④
produced in a country within a given time period
Q: Who produce the goods and services and who consume them??
Key players in the economy:
1. Households/consumers
2. Firms
3. Government
4. Rest of the World
5
The Circular Flow and the
Measurement of GDP
We start with households and firms
The overall economic activity can be
measured:
• By the amount of money that
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households spend on goods and
services; or
• The income that the households
receive )
The circular flow and the
measurement of GDP
6
Adding Government to
the Flow
The government:
• Takes taxes from Households and ch.ve )
firms
• Uses those taxes to buy goods and
services, and
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• Make transfer payments –
payments to households for which
the government does not receive a
good or service in return The circular flow and the
measurement of GDP
7
Adding the Rest of the World
Economic activity takes place
between households, firms, and
the rest of the world
• Households buy goods and
services from firms and other
countries, these are called
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imports
• Firms sell goods and services to
households in other countries,
these are called exports The circular flow and the
measurement of GDP
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8
Finally, the Financial System
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There are firms that deal specifically
with the flows of money; we label
these firms the financial system
• Households can choose not to
spend all of their income but
instead, save it with the financial
system firms like banks
• The financial system firms lend
money to other firms and the
government The circular flow and the
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measurement of GDP
9
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• Firms utilize factors of production: labor, capital, natural resources,
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and entrepreneurship to produce goods and services to: domestic
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firms and households, foreign firms and households, and the
government.
• Therefore, the GDP of a country can be measured by calculating the
total value of expenditures on final goods and services purchased by
each parties.
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Components of GDP
• Using the expenditure approach, the GDP can be categorized into 4
main categories:
1. Personal Consumption Expenditures (C - ‘Consumption’)
- Spending by households on goods and services
- Includes durable goods and nondurable goods dfeg.tl
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U - Includes: 住宅
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domestic households;
(b) Total expenditure on investment by firms operating in the country:
i. Business fixed investment (e.g. factories, machines etc…)
ii. Changes in business inventory (inventory refers to goods that have been produced but
not yet sold)
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Components of GDP
3. Government Consumption and Gross Investment (G - ‘Government Purchases’)
- Spending on goods and services by the government.
- Transfer payments is0not included since it does not result in the production of new
goods and services, e.g. Comprehensive Social Security Assistance Scheme
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4. Net Exports of Goods and Services (NX = EX – IM - ‘Net Exports’)
- Defined as the value of exports minus the value of Imports
- Includes goods and services produced domestically but sold to other countries and
excludes those that are produced in foreign countries but consumed locally
The GDP defined by the expenditure-approach is therefore given by:
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Y = C + I + G + NX
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Measuring GDP Using the Value-Added
method
• An Alternative method to compute GDP is to measure the value
added: the market value a firm adds to a product.
• The final selling price of a product must equal the sum of the values
added to the product at each stage of production
Firm Value of Product Value Added
Cotton farmer Value of raw cotton = $1 Value added by cotton farmer = 1
Textile mill Value of raw cotton woven Value added by cotton textile = 2
into cotton fabric = $3 mill = ($3 − $1)
Shirt company Value of cotton fabric made Value added by shirt = 12
into a shirt = $15 manufacturer = ($15 − $3)
L.L.Bean Value of shirt for sale on Value added by L.L.Bean = 20
L.L.Bean’s Web site = $35 = ($35 − $15)
Total Value Added = $35
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Components of GDP in the US (2012)
Source: Hubbard & O’Brien, Macroeconomics, Pearson, 5th Edition, 2015, p. 244 15
Components of GDP in HK
Components of GDP in HK (2019 & 2020) (billions of HK$) 69%
2,019 2,000
2020 67%
Private Consumption 1,973 1,788
Expenditure
Investment 518 510 1,500
Billions of HK$
Gross domestic fixed 521 460
capital formation
Changes in inventories -3 49 1,000
Government Consumption 309 342
Expenditure
18% 19%
Net Exports 44 49 500
4,255 4,245 11% 13%
Exports of goods
Exports of services 799 507
2% 2%
Imports of goods 4,376 4,287 0
Imports of services 634 416 Private Investment Government Net Exports
Consumption Consumption
Expenditure Expenditure
Total GDP 2,845 2,688
2019 2020
16
Source: Census and Statistics Department, The Government of the Hong Kong Special Administrative Region
Nominal GDP - China vs. US (2001 to 2020)
25,000
20,000
15,000
Billions US$
10,000
5,000
0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
China US
Source: World Development Indicator, The World Bank Group 17
Nominal GDP - Hong Kong (2001 to 2020)
400
350
300
Billions US$
250
200
150
100
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Source: World Development Indicator, The World Bank Group 18
Comparison of GDP across countries in the
world
Nominal GDP by country (2019)
USA
CHN
JPN
DEU
IND
GBR
FRA
ITA
BRA
CAN
RUS
KOR
AUS
ESP
HKG
0 5000 10000 15000 20000 25000
Billions US$ 19
Source: World Development Indicator, The World Bank Group
What’s wrong with the graphs?...
• The GDP measure we considered in the previous graphs are the
Nominal GDP at current prices
• 2 main problems:
1. Population is not adjusted for…
- i.e. the larger the population, the higher the nominal GDP
- It can be converted into per capita terms
2. Inflation over time is not adjusted for…
- we are not sure if the increase in nominal GDP is due to increase in prices over time or
due to increase in production…
- i.e. Real vs. Nominal GDP…
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Real vs. Nominal GDP
• Since GDP is measured in “value” terms, we might have problems
interpreting changes over time if prices change. Is an increase in GDP
due to production increasing, or due to prices increasing?
• Nominal GDP = market value of all final goods and services evaluated
at current prices
• Real GDP = the value of final goods and services evaluated at base-
year prices
• The choice of a base-year is arbitrary
21
Calculating Real GDP: Formula
Goods Base year Year 2020
The Nominal GDP at current prices are given by:
Prices Quantities Prices Quantities
Base year =
P1B × Q1B + P2B × Q2B + P3B × Q3B + … + PNB × QNB 1 P1 B Q1 B P12020 Q12020
2 P2 B Q2 B P22020 Q22020
Year 2020 =
P12020 × Q12020 + P22020 × Q22020 + P32020 × Q32020 + 3 P3 B Q3 B P32020 Q32020
… + PN2020 × QN2020
…
N PN B QN B PN2020 QN2020
The Real GDP of year 2020 evaluated at the prices of the base year
= P1B × Q12020 + P2B × Q22020 + P3B × Q32020 + … + PNB × QN2020
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Calculating Real GDP: An Example
The table shows output and prices in 2009 2015
2009 and 2015. Product Quantity Price Quantity Price
• Calculating the total value of output in Eye
examinations 80 $40 100 $50
2009 gives: Pizzas 90 11 80 10
$3200 + $990 + $1350 = $5540. Textbooks 15 90 20 100
• To calculate real GDP in 2015, we use
the prices from 2009. Product
2015
Quantity
2009
Price Value
• This gives real 2015 GDP in 2009 Eye examinations 100 $40 $4,000
dollars of $6680. Pizzas 80 11 880
Textbooks 20 90 1,800
Most prices increased from 2009 to 2015, so using nominal GDP would have
yielded a higher figure: $7800 (> $6680 = Real 2015 GDP in 2009 prices).
• This highlights the need to use real GDP to avoid exaggerating growth
23
Comparing Real GDP and Nominal GDP
• The current base year for
calculating prices is 2009, so real
and nominal GDP are equal in
2009.
• Growth figures reported in the
media are the growth in real
GDP.
• Since prices have generally
increased since 2009, real GDP is
less than nominal GDP, and the
opposite is true before 2009.
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The GDP deflator
• In order to know whether we are achieving price stability, we need to
measure the price level.
• One way to do this is using the GDP deflator: a measure of the price
level, calculated by dividing nominal GDP by real GDP and
multiplying by 100:
Nominal GDP
GDP deflator = real GDP × 100
Since nominal and real GDP will be the same in the base year, the GDP
deflator will be 100 in the base year.
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Calculating the GDP deflator
• Suppose the values of nominal and real GDP for year 2011 and 2012
are as follows: 2011 2012
Nominal GDP $15,534 billion $16,245 billion
Real GDP $15,052 billion $15,471 billion
• Then the GDP deflators for each year can be computed as:
Formula Applied to 2011 Applied to 2012
GDP Nominal GDP $15,534 billion $16,245 billion
100 100 103 100 105
Deflator Real GDP $15,052 billion $15,471 billion
• The change in price level is therefore:
105 − 103 %- GDP dthr
×100 = 1.9%
103 = △
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i.e. Price level rose 1.9% from 2011 to 2012 26
GDP: Issues and Limitations
GDP can be a useful tool to measure total output in an economy. Many
people go further than this, interpreting GDP as a measure of the well-
being of citizens.
• Questions:
1. Is the GDP a good indicator of the total output of an economy?
2. Is the GDP a good indicator of the standards of living/well-being of an
economy?
3. The richer the happier?
27
1. Is the GDP a good indicator of the total
output of an economy?
• Does the GDP include all production in the economy?
A: NO
- Two main types of production are not included in the measurement
of GDP:
i. Household production
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- Services a homemaker provides to the family (since they are not traded in markets)
ii. Underground economy
- Refers to the buying and selling of goods and services that is concealed from the
government to avoid taxes or regulations or because the goods are services are illegal
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2. Is the GDP a good indicator of the
standards of living of an economy?
• GDP measures a country’s total production
• Sometimes the levels of GDP per person:
GDP per capita at time t = GDPt /Populationt
is used as a measure of well-being.
• GDP is not a perfect measure of well-being for various reasons:
i. Value of leisure is not included in GDP
ii. GDP is not adjusted for Pollution or other Negative Effects of Production
iii. GDP is not adjusted for Crime and other Social Problems
iv. GDP does not give information on how the pie is divided up cnn.gl
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Inequality in Hong Kong
Median monthly household income at current 2016 prices by decile group (2016)
10
7
6
Decile
3
2
Median Monthly Household
1 Income = HK$ 25,000
0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000 110,000 120,000 130,000
HK$
Source: Thematic Report: Household Income Distribution in Hong Kong, Census and Statistics Department HKSAR, 2016. 30
Government revenue and expenditure of selected developed
countries and their Gini coefficient
30 60
25 50
20 40
Gini Index
% of GDP
15 30
10 20
5 10
0 0
HK SG US SK CHN AUS UK GER JP CAN FR SW
Tax revenue (% GDP) General government final consumption expenditure (% of GDP) Gini index
Source: World Development Indicator, The World Bank Group 31
3. The Richer the Happier?
Source: The Economist 32
Summary:
• We have introduced in this lecture…
üDefinition of GDP
üCompare Nominal GDP of Hong Kong with various countries
üComponents of GDP
üReal vs. Nominal GDP
üGDP and its limitations
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