exports:

    imports:

As with most Accounting Systems there is an assumed balance.  This "balance" is used in many macro models - so let's discuss it now.  Using the expenditures approach:

Households (individuals) supply the Factors of Production to firms. In doing so they earn corresponding income.

Factors of Production                        Income

1.

2.

3.

4.

The households then use their income to buy what they produced.  Remember that the individuals in the households include owners of the firms, entrepreneurs, etc.

In the circular flow diagram (when everything balances) value of income = value of expenditures = value of output (much is being assumed).

Real Vs. Nominal GDP (very important):

    First let's discuss nominal vs. real income:

    And then nominal vs. real GDP:

Example:

So therefore -

 Nominal GDP:  the value of final goods and services produced in a given year at current prices (that is, changes in prices are NOT taken into account).

Changes in GDP from one year to the next reflect changes in the output of goods and services and changes in their prices. To provide a better understanding of what actually is occurring in the economy, real GDP is also calculated. In fact, these changes are more meaningful, as the changes in real GDP show what has actually happened to the quantities of goods and services, independent of changes in prices.

 Real GDP:  the value of final goods and services produced in a given year when valued at constant prices (takes into consideration inflation or deflation - both of which we will define later).

    Population should also be considered.

Real Per Capita GDP:  Per person GDP (Rank Order of Countries - from CIA World Fact Book)

GDP as a Measure of Well-being

Changes in real GDP are a more accurate representation of meaningful economic growth than changes in nominal GDP, because changes in real GDP represent changes in quantities produced, while prices are held constant. Real GDP per capita is even more relevant because it measures goods and services produced per person and thus approximates the amount of goods and services each person can enjoy. If real GDP grows, but the population grows faster, then each person, on average, is actually worse off than the change in real GDP would indicate.

GDP per capita is not a perfect estimate of well-being. When individuals grow their own food, build their own houses and sew their own clothes, they are not producing goods and services to be sold in a marketplace and therefore GDP does not change. As a result, many countries in South America and Africa have a low GDP per capita that underestimates their well-being, for example.

Some problems with the measurement of GDP (there are others but these are quite obvious):

1.  GDP does not always take into account the destruction of and rebuilding of assets.

Often times after a natural disaster GDP goes up due to the economic activity generated by reconstruction.  Does destroying houses makes good economic sense?  No.   GDP does not take into account whether assets are being increased or decreased and therefore gives an incomplete view of the economy. It doesn't make sense to look at GDP growth without taking a look at what is happening to a nations assets (overall). 

 In other words, GDP might increase, but only because what is being produced and sold is only replacing what we already had before it was destroyed.  It does try to do this with business machinery - but not with other assets.
 

2.  Some things that we value are omitted:

        "do-it-yourself" and household production (child care, laundry, etc.):

        "illegal" or underground production:

        legal activity (trade) that is also underground (not reported)

        unpaid volunteer work for charities:

        leisure time:

        environmental quality considerations:

3.   Some things are counted and maybe should be omitted?

        "regrettable necessities" such as police and fire, national security, etc. (debatable):

Imagine two countries, one with a greater level of honesty such that they can have a smaller police force than the other. The citizens of that country would spend less on fighting crime and have more resources to spend in other ways. That society would have greater well-being but it would not be reflected in GDP. Similar scenarios could be constructed for doctors, soldiers, fire fighters or social workers. Not to say that these aren't valuable and rewarding jobs, just that society would be better off if we didn't need as many of them.

So assuming that individuals would rather use their resources on say, a new car, rather than paying taxes used to hire more police officers, a society that spends less on regrettables will have greater well-being at the same level of GDP.

On the other hand - the reality of life is that fires and crimes happen.  So - instead of basing the analysis on a perfect world without these things -- shouldn't we include them?

What do you think?

Other influences on the quality of life or standard of living (can you think of others?):

        individual political, personal and economic freedom/liberty       

        health and life expectancy

        justice (rule of law)

        personal wealth

        environmental quality, etc.

Why does GDP matter to so many people?  Why does economic growth matter?  Or does it?

GDP, Life Expectancy, and Literacy:  Does there seem to be a correlation?  What does that mean?

This is an empirical question.  Empirical means: 

But if there is a correlation - why?  What's your theory?

    Be careful:  correlation and causation are two very different things!!

DO ICE FOUR