Measuring Economic

Performance

Readings

• Lequiller François and Derek Blades, 2006, Under standing NATIONAL ACCOUNTS, Organization for Economic Cooperation and Development, Chapter 1 and 2. Link

• Bureau of Economic Analysis “Introduction to the National Income and Product Accounts” Link

Measuring the Economy

• National accounts are the core statistical measure of the economy.

• Accounts cover many features of the economy but organizing concept is

Gross Domestic Product (GDP)

Gross Domestic Product (GDP)• “GDP combines in a single figure, and with no double

counting, all the output (or production) carried out by all the firms, non-profit institutions, government bodies and households in a given country during a given period, regardless of the type of goods and services produced, provided that the production takes place within the country’s economic territory.” L & B p. 15

All goods sold in an economy share a common unit of measure: the price at which they are sold.

Sum up the value of goods

GDP is a measure of production

• Value added at production establishment i

• GDP is the sum of VA across establishments.

iValue Added =Sales + inventories -raw materials, semi-processed inputs and energy costs.

i iGDP Value Added

Economic Concept

• Value Added is production at firm level due to the combination of capital equipment and workers.

• Value added is not equal to profits because the costs of worker and capital are not deducted.

• Accounts are created by national statistical agencies

• UN System of National Accounts is the “internationally agreed standard set of recommendations” used by most countries.

• Annual data for many countries available at the UN

Link

Link

Production ApproachSub-aggregates

• Divide production establishments into sectors usually along the line of – Agriculture: Natural Resources (Agriculture, Forestry,

Fishing) – Industry: Goods production (Mining, Manufacturing,

Utilities, Construction)– Services: Trade, Transport, Communication, Services

Agr

icul

ture

, hun

ting,

fore

stry

,fis

hing

(IS

IC A

-B)

Min

ing

& U

tiliti

es

Man

ufac

turin

g (IS

IC D

)

Con

stru

ctio

n (IS

IC F

)

Who

lesa

le, r

etai

l tra

de,

rest

aura

nts

and

hote

ls (I

SIC

G-H

)

Tran

spor

t, st

orag

e an

dco

mm

unic

atio

n (IS

IC I)

Oth

er A

ctiv

ities

(IS

IC J

-P)

19702010

0

10

20

30

40

50

60

Hong Kong: Value Added by Sector

UN Main Aggregates Link

Dynamics of Industrial Structure

Industry, value added

15

20

25

30

35

40

45

High income Upper middle income Lower middle income Low income

Services, value added

15

25

35

45

55

65

75

85

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

High income Upper middle income Lower middle income Low income

Demand

• If we add up the value added at all stages of production we derive the value to the end user.

• Sum of Final Demand Aggregates equals Sum of Value Added

Expenditure Approach

• Purchase of Final goods by end users are divided into two categories:

1. Consumption: Household expenditure (durables, nondurables & services); government (nondurables & services) expenditure; nonprofit expenditures

2. Investment: Inventories, Fixed Investment (equipment, structures)

Some Asian Expenditure Shares: 2010

Source: United Nations Main Aggregates Database Source: United Nations Main Aggregates Database

1 2 3

123

-10

0

10

20

30

40

50

60

70

80

90

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Household consumption expenditure General government final consumption expenditureGross fixed capital formation Changes in inventoriesSeries5

People’s Republic of China

Reconciliation

• Some demand for domestically produced value added comes from abroad, some domestic demand is satisfied by overseas goods.

GDP = Consumption + Investment + Exports – Imports

Exports – Imports = External Balance = Trade Balance = Net Exports <> 0

HK Exports & Imports

197019721974197619781980198219841986198819901992199419961998200020022004200620082010

0

50

100

150

200

250

Exports of goods and services Imports of goods and services

% of GDP

UN Main Aggregates Link

Value Added and Income

• Production establishments are where income is generated. Funds raised can be paid for labor and finance costs, left over money is profit income.

• Sum of domestic value added (GDP) is equal to wage payments plus financial and profit income referred to as “operating surplus and mixed income.”

Income Approach to Measuring GDP

Value Added distributed as income to Employees, Owner/Creditors, & Gov’t1. Compensation of employees (Wages, Benefits)2. Net operating surplus (Profits, Net Interest, Rental

Income)3. Taxes on Production

17

52%47%

2%

Value Added 2010 1.58 Trillion HK$Compensation of employees Gross operating surplus Taxes on production

Value Added 1,606,092Compensation of employees 828,139Gross operating surplus 753,171Taxes on production 24,782

Using GDP to Measure Economic Performance

•

• Measuring stick of value is prices of goods in terms of money, but arbitrary changes in the stock of money arbitrarily change prices/the measure of value over time.

• Comparing value across time requires abstracting from those arbitrary changes in value.

What is Economic Growth in a world of many goods?

• We need to combine the many goods produced or consumed in an economy into one measure.

++

++

=?

Value vs. Volume• Consider the sales of a hypothetical single good

k (for example, k = apples). • Dollar Value of sales (called vk) is the product of

the volume of goods sold (called qk) measured in the goods natural units (i.e. bushels of apples) and the dollar price per good (called pk)

vk = pk*qk

• Growth of value can be decomposed into growth of volume and growth in prices.

Share of Value• We could measure total value for the economy. • Divide our economy into K categories of goods

indexed by k = 1,…, K.

• Value of sales of good k, vk. GDP is represented as the sum of value across goods

1 2 3... K

t t t t t tGDP V v v v v

Value weignts and Inflation Vectors• The weight of k in the economy could be

defined as which add up to 1 across sectors.

• For every type of good at time t, an inflation vector representing the growth rate of prices.

ktv

11

kkpt

k tt

p gp

kk vw V

Real GDP Growth

• Growth of value can be decomposed into growth of volume and growth in prices.

• Instead we could construct a weighted average

1 2 31 2 31 1 1 1...

K

REALGDPt

q q q K qt t t t t t t t

g

w g w g w g w g

1 1

(1 ) (1 ) (1 )

(1 )(1 )(1 )

k k k

kk

k

v p qt t t

v k kq t t t

k kt pt tt

g g g

g v p g v pg

Notes on Price Indices: New Goods

• Weights change as production structure of the economy changes

• Market baskets used to construct don’t need to stay the same over long-periods.

• K categories of goods don’t need to stay the same over long periods.

• New goods can be introduced as long as matched goods are compared in every t and t-1 period.

1

kt

kt

pp

1971-1975 1976-1980 1981-1985 1986-1990] 1991-1995 1996-2000 2001-2005 2006-20100

2

4

6

8

10

12

14

GDP Growth

Hong Kong USA World

Average % Growth

Inflation• We also decompose the growth of the aggregates

into growth in prices (inflation) and growth in volume (output). (1 ) (1 )(1 )V P Q

t t tg g g

(1 )(1 ) (1 )V

P tQtt

gg g

Midterm Exam

• Thursday, October 24th, 2013– When: 1:30-2:50 p.m. – Where: TBA

• Bring writing materials and calculator.• Coverage: Globalization-Human Development• Semi-open book: Bring 1 A4 size piece of

paper with handwritten notes on both sides.

Comparing GDP across Countries

We want to compare output in two countries though those are measured in different currencies.

• Exchange Rate: S - # of domestic currency units purchased for 1 US$.

• An increase in S is a depreciation of domestic currency and a decrease in S is an appreciation.

Exchange Rates

Atlas Conversion Method• Exchange rates are volatile, so convert to US

dollars using SATLAS= 3 year average.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20120

10000

20000

30000

40000

50000

60000

GDP pe Capita, US$

Hong Kong SAR, China Singapore

Axis

Met

hod

• Major project to compare prices internationally implemented by the World Bank with the help of UN and national statistical agencies.

• ICP has been implemented by UN Statistical Office since 1968.

Link

PPP’s1. Divide expenditures into k = 1,..,K categories

of goods.2. All j = 1,..J countries (in 2005, J = 146) report

total expenditure in domestic currency of all categories

.3. Sample prices of representative goods from

each category in each country. 4. Construct average of those prices (relative to

“anchor” economy) for each country j basic heading type of good k .

kjv

k kj ANCp p

PPP XrateClassification Name 20051101 Food and non-alcoholic beverages 8.81547906 7.781102 Alcoholic beverages and tobacco 10.1680743 7.781103 Clothing and footwear 6.11435997 7.781104 Housing, water, electricity, gas and other fuels 9.09847987 7.781105 Furnishings, household equipment and household maintenance 7.61334163 7.781106 Health 2.9312812 7.781107 Transport 9.40016616 7.781108 Communication 6.83789147 7.781109 Recreation and culture 5.24897067 7.781110 Education 3.25951882 7.781111 Restaurants and hotels 8.98215569 7.781112 Miscellaneous goods and services 5.61784877 7.781501 Machinery and equipment 7.5934365 7.781502 Construction 4.15019416 7.78

Hong Kong PPP per Category

WDI provides PPP data for many countries using US$ as anchor currency

PPP Conversion Factor

• PPP is a value weighted average of relative prices of all K goods.

1 2$ 1 2

1 2 ...

,......,

Kj j jAC K

j j j j KANC ANC ANC

nn jj

j

p p pPPP w w w

p p p

v w V

PPP 2010

PPP PPP/XR XRChina 3.94638098 0.582922 6.770269Hong Kong 5.34545752 0.688032 7.769167Korea 827.345987 0.71566 1156.061Japan 111.389068 1.268959 87.77988Singapore 1.04012836 0.762831 1.363508

One benchmark for thinking about whether a currency is undervalued or overvalued. If PPP < XR, then domestic goods are relatively cheap, currency is undervalued.

GDP in Intl$• PPP’s are used to construct comparable

measures of GDP for multiple countries by converting them into international dollars.

$[ $] jINTLjj

GDPGDP Intl PPP

GDP per capita, PPP (current international $)2005

Hong Kong SAR, China $35,677.92China $4,114.57India $2,299.76Indonesia $3,216.81Malaysia $11,754.53Korea, Rep. $22,783.27Thailand $6,750.94Singapore $45,374.24

Per capita GDP in international dollars is headline way of comparing living standards.

• Use real GDP growth rates to construct path of constant price International $GDP for comparisons of production levels across time and space.

GDP per Capita, PPP

0.00

10,000.00

20,000.00

30,000.00

40,000.00

50,000.00

60,000.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Const

ant 20

05 In

ternat

ional $

Singapore Hong Kong

• Developing countries tend to be relatively cheap with PPP’s being lower than exchange rates.

• OECD countries tend to have more similar price structures, though they tend to be relatively more expensive.

• High income, non-OECD countries tend to be relatively cheap.

• Compare values measured in different currencies using the PPP and exchange rate method.

Is China the Biggest Economy in the World?

• Discuss Subramanian Link

Country NameIndicator Name 2005 2006 2007 2008 2009 2010 2011 2012China GDP (current LCU) 18493.7369 21631.4426 26581.0306 31404.5427 34090.2813 40281.65 47261.92 52760.77China PPP conversion factor, GDP (LCU per international $)3.447589843 3.46627859 3.6247 3.82281305 3.76702264 3.97864056 4.18192048 4.23068287United States GDP (current LCU) 12564.3 13314.5 13961.8 14219.3 13898.3 14419.4 14991.3 15684.8

5364.250895 6240.53782 7333.305 8215.03492 9049.66191 10124.4758 11301.487 12470.982

Exchange Rate Method • Exchange Rate Method can be a useful measure if you

are going to convert income in one area and spend it in another. – Ex. Your Swiss food company projects that it can at most get

a 20% share of the market for Mexican processed foodstuffs. Converting the size of Mexico’s processed food expenditures from Pesos to Swiss Francs is useful info for estimating profits. .

• But macro aggregates are often used to give an idea of living standards, here exchange rates are not as useful because they are highly variable and not so representative..

PPP vs. Exchange Rate Conversion

• Exchange rates are easily available so exchange rate is a “quick and dirty” comparison. – Measures how many US dollars someone could buy with

average income. • However, money goes farther in some countries as

many types of goods are relatively cheap (especially in developing countries).– PPP conversion measures how much the goods purchased

by the average person would cost in the US. Better measure of living standards.

GDP in US$ by Conversion Method

2005 GDP per Capita

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

Low income Lower middleincome

Middle income Upper middleincome

US/In

tl$

Exchange Rate PPP

2005 GDP per Capita

0

5000

10000

15000

20000

25000

30000

35000

40000

High income: OECD High income: nonOECD

US/In

tl$

Exchange Rate PPP