Tuesday, June 07, 2005
Here's the basic definition of GDP: Gross Domestic Product (GDP) is the total market value of all the goods and services produced within the borders of a nation for final use during a specified period. Let's unpack it:
- total value -- we are summing up the values of apples and oranges. We can't add apples and oranges directly, so we need a common denominator. Money is a numeraire, and we can add up the exchange value of apples and oranges in terms of money. (Side note: a nice article on the choice of numeraire.) Value represents
- market value -- we assign values based on current prices in the market. This of course causes a problem because inflation can interfere with the signal about the economy we get from GDP.
- within the borders of a nation -- we distinguished between GDP and GNP. For GDP the ownership of the firm does not matter. All goods produced within the U.S. count in GDP. What does not count is the production of, say, Ford in either Mexico or France. The production of Toyota in Tennessee does. The text notes: GDP = performance of domestic economy; GNP (gross national product) = performance of the nation's citizens.
- for final use -- we do not count intermediate goods, for to do so creates double-counting. This allows us as well to say that GDP measures the value added by producers at all stages of the production process. The book makes note of the fact that to make GDP measure within the correct year, we will include "business inventory investment" as part of GDP. (Sidenote: For a contrary argument that says GDP isn't a very good measure of economic activity, see this.)
- during a specified period -- GDP is a flow of current production. A flow occurs during an interval of time. We often speak in terms of a year, but that is the choice of the measurer.
Total output = Total income = Total expenditures = Total value
added at all stages of production
We then turned to employment and unemployment. I used a simpler chart like that below (source), but readers might wish to view this information from the Bureau of Labor Statistics on how the civilian population is divided into the labor force and not the labor force, and how the
former is divided into employed and unemployed workers.
The unemployment rate is defined as U/(U + E) = U/LF, where LF is the size of the labor force. There is a flow each month between all three boxes, and these combine to create an unemployment rate that will be above zero even when workers are satisfied with their present conditions. Workers will be laid off expectedly; others will be engaged in job search to find positions that fit them better. This is often known as voluntary unemployment.
What we need to understand is why we get involuntary unemployment, so that those who would like jobs at current wages are unable to get them. This may be because wages don't adjust to clear the labor market, or workers simply mistake a decline in the value of money for higher real wages. Seen in this light, it becomes more difficult to imagine what government can do to