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The meaning, the measurement, and the use of GDP

April 21, 2020

In this eighth lecture of Economics for Everyone, we begin our discussion of macroeconomics, the study of the overall level of economic activity.

The lecture offers some background and motivation by examining the sharp increase and sluggish fall of the unemployment rate during the 1930s, the Great Depression. This led to a crisis in economic thinking, and to the publication of John Maynard Keynes’s “General Theory”. Thus macro-economics was born.

Our first challenge involves a host of measurement issues, and in this lecture we examine the meaning, the measurement and the use of Gross Domestic Product. This statistic is nicely presented, reviewed, and evaluated in Diane Coyle’s book, GDP: A Brief but Affectionate History, and it is the major reading on your list for this lecture.

 

Download the presentation for Lecture 8, “The Meaning and Measurement of Macroeconomic Activity” as a pdf, and if you like listen to narrated version.

 

7 Comments
  1. Thanks for this talk– very illuminating. I was struck that the US unemployment rate of 10% in 2009/10 is considered a serious crisis, but had not reached the 25% rate reached in the 1930’s. Do commentators on the recent rate consider it to be comparable to the earlier one?

    I wonder whether the dips and peaks of US unemployment are leveling out over generations as governments become more experienced in managing economic crises, and what is considered a historic low today would not have been seen as comparably serious in previous centuries. It strikes me that this might also relate to labor force participation: if women make up a greater share of the measured labor force now than in 1930, then more of human labor is accounted for in GDP figures.

    We might fairly presume that in 1930 a high rate of women were “employed” informally in care roles for their family, whereas now a greater share of that labor can be accounted for with more widely available services such as kindergartens, nannies and nursing homes. Would we then have higher standards today for employment rates given that a greater share of US citizens are providing value that is captured in national accounting figures?

    • Thank you Sam for these very insightful reflections. There are a number of very good points raised with respect to the meaning and significance of the unemployment rate, how it relates to broader demographic changes in society, and also how its cyclical movements relate to government policy. A fair response on these issues would have to be lengthy, and I would like to incorporate your questions into next week’s lecture, which will explicitly discuss the unemployment rates, its meaning and measurement. I hope you don’t mind picking up the conversation again at that point.

      But you also raise an excellent concern on the meaning of GDP, and the distinction between market and non-market work. My Tweet announcing the lecture received a replay from a former Assistant Chief Statistician responsible for the National Accounts in Canada on this very theme. He explains it, eloquently and briefly, here: https://twitter.com/PhilSmith26/status/1252790750821199874?s=20 .

      Hope this helps to keep you and your fellow students thinking about the topic.

  2. Robert permalink

    Hello Professor & Everyone,

    I think I’m going to like macro-economics. Although, we’ll have to see how it goes. As a history major, it feels connected to ways of viewing the world that make sense to me.

    I am going to respond to part of your lecture, but then maybe leap out into the economic stratosphere, so I’ll hope you forgive me!

    In your discussion of the circular flow diagram, you mentioned the fact that income must equal expenditure. This makes sense. In any system, one cannot lay out more than one takes in.

    But, I wonder about the example of work that isn’t included in GDP, such as household labor. It is interesting to wonder, if we have a massive quantity of work creating value that isn’t included in the GDP – left off the books, as it were – it might be that we have an uncounted surplus which throws off the accounting between income and expenditure.

    It’s as if we have a huge number of inputs coming into our system that aren’t being entered into the double-bookkeeping of the circular flow diagram. Similar to Adam Smith leaving services out of his equations?

    This occurred to me, I think, because I heard an interview on the radio the other evening with an economist who teaches at SUNY, Stephanie Kelton.

    It seems questions concerning the necessity of income to equal expenditure might become increasingly relevant in the near term, as a result of our shutting down our economies as a result of the coronavirus. Professor Kelton raised a concern that some will soon be calling for massive cuts to social programs or education to pay for the costs involved in responding to the coronavirus.

    Out of all this comes two questions:

    1. Is this a correct understanding of the necessity for income to equal expenditure?

    2. In the same way that Keynesian economics was a response to the Great Depression, do you think that a similar revolution in economic orthodoxy might arise out of the current circumstances?

    Thank you so much,
    Robert

    • Good points, all, Robert. Thanks for this. First, yes total income received from all sources must equal total expenditures on all goods and services, and a corollary of this is that savings must equal investment. This is double-entry book-keeping. And to stress, once again, the definition of GDP … the reference is to valuations of market activities, using (to the extent possible) the observed market prices.

      I think the questions you raise don’t relate so much to this accounting identity but rather to a whole host of issues associated with the boundary between market and non market activities, and this in turn can take us into a discussion about the relevance of GDP as a broader measure of well being. If I understand correctly, public policy discussion may well need broader measures of well being than GDP, and using GDP alone may bias our policy decisions. That is the way I’m interpreting the question.

      Coyle’s book has a great deal more to say about this, sometime in a subtle way and sometimes very directly. There are a whole host of non market activities that have a bearing on well-being and also on how we conduct market activities. That was the point of my silly example of the fictitious landscaping company I claimed to have ran as a younger man, something valued in the market that was then not valued once it was brought into the confines of the household. But take child care as the most obvious real life example. We may well want to value these activities in understanding our society, but we don’t have a price for them. National accountants struggle with this in a whole host of ways, sometimes, for example, using prices that are observed in the market for equivalent services. (But this is not always satisfactory because it assumes that prices would be constant if all non-market activities were brought into the market. Demands and supplies would likely change, and so would prices).

      Your second question is a very good one, and relates to how the subject is evolving. It is hard to say what impact COVID-19 will have on economic thinking in the longer term, but the Great Recession beginning in 2008 certainly did bring about that kind of rethinking, in some ways resurrecting the relevance of Keynes, who had in some strong measure been displaced from discourse beginning in the late 1970s, and making macro-economists much more aware of the need to incorporate the financial side of the economy into models of the real economy. Keynes was very much concerned about the interaction between financial markets and the production of goods and services, and pointed why monetary policy (the control of the money supply and its influence on interest rates) was an important public policy tool, but also explaining the circumstances under which it was ineffective and hence the need for fiscal policy. These are issues very much debated now that were on the back burner before the Great Recession. We will touch on them in more detail as we move to the last two lectures of the course, so I hope you can bring this question up again.

  3. Thank you for the introduction to this concept. Though I grasp the concept, how it is actually measured boggles my mind.

    I, too, am curious to know more about what we don’t include in GDP and how that affects the way we look at the overall economy. This is an interesting piece from the IMF last year about how women’s work is undervalued, https://blogs.imf.org/2019/10/15/the-economic-cost-of-devaluing-womens-work/, and not just work that we consider domestic in the west, but also heavy labor: “UNICEF estimates that women spend 200 million hours per day worldwide simply fetching water. In India, women spend more than an hour every day collecting firewood.” All, presumably, not included in GDP. The gender gap of unpaid work appears to be most narrow in the Nordic countries.

    I’d also be curious to know how Universal Basic Income would affect GDP.

    I just started reading the Coyle book, and I’m sure she will address these further on.

    • Vince, keep reading Coyle! You’ll love it. Also see my brief response to Sam’s point, and the Tweet I link to.

      These are issues that deserve a lot more discussion, and that is why I put the entire book by Coyle on the reading list. One theme that emerges is that since GDP historically was the only game in town as an overall measure, it came to be used as an indicator of well-being and welfare of a society, not simply as a measure of market activity. And this may well have skewed our perceptions of what is of value and who produces it. This direction in policy discussion is also the impetus for the development of broader indicators, and why I ended the lecture with some open-ended questions to motivate your thinking and reading.

      Universal Basic Income is often discussed in micro-economic terms: how well it is targeted on those with need, the incentives for labour market engagement, impacts on family structure. But there could be a macro-economic story to be told. This would rely on a concept that Keynes introduced, “the marginal propensity to consume”, which we will address in the lecture after the next one. Briefly, in the Keynesian model saving in some sense is not a virtue. The overall level of economic activity is determined by the autonomous level of spending in conjunction with the fraction of an extra dollar that is spent on consumption, the marginal propensity to consume. So if a Universal Basic Income gave money to people who are more likely to spend all of it, rather than it going to others with a higher propensity to save some of it, then it would raise overall economic activity. That is how the Keynesian model would look at it. But more to come on this!

  4. Hi professor,

    The first question I wanted to ask is about the necessity of Macroeconomics that arose during the ’30s. You’ve mentioned that the great depression was one of the reasons. I guess that would be related mostly to fiscal policy needs and reforms to rebuild the economy. But, in terms of monetary policy, is it correct to assume that the geopolitical changes in Europe and its colonies in forthcoming years made macroeconomics even more important?

    My second question is in regards to the shares in GDP. You’ve mentioned that consumer purchases/expenditures account for 2/3 of the US economy. In the equation, there are also shares of investments and government expenditure. Can we talk about different types of economies based on the shares of these three economic actors? Another question would be if there is a ‘golden standard’ in these shares. I understand that the variation across both rich and poor countries will be huge in the division of shares between these three, but is there a ‘healthy’ division seen from a macroeconomic perspective as the most optimal, or efficient? I know there will be a lot of opinions on the government expenditure shares in the GDP, but are there such ideas regarding consumer purchases and investments?

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