E XERCISES FOR C HAPTER 3
4. Economic activity & performance
4.6 Per capita real GDP
requires explanations of changes in unit labour costs, of producer output and pricing decisions and information on the net indirect tax rate. Those explanations are parts of an economic model of the supply side of the economy.
To show the empirical importance of the distinction between real and nominal GDP, Table4.5gives Canadian data over the period 2004 to 2016. Nominal GDP rose from $1,331 billion in 2004 to
$2,027 billion in 2016. Without knowing what happened to prices of goods and services in general, we cannot judge what happened to the quantity of output over that period. To answer this question we use the GDP deflator to convert nominal GDP to real GDP in the prices of the base year 2007 as follows:
Real GDPyear t= GDPyear t
GDP deflator× 100 (4.9)
Table 4.5: Canadian nominal and real GDP 2004–2016
2004 2008 2012 2016
Nominal GDP (billions $) 1,331 1,653 1,823 2,027
GDP deflator (2007=100) 91.4 104.0 109.2 112.9
Real GDP (billions 2007 $) 1,456 1,589 1,669 1,796
Source:Statistics Canada, CANSIM Tables 380-0064 and 380-0066
For example, in 2016, nominal GDP was $2,027 billion and the GDP deflator (2007= 100) was 112.9. Real GDP measured in constant 2007 dollars was then:
Real GDP2016= 2027
112.9× 100 = 1795.4 in 2007 dollars
When converted to constant dollars, the change in real GDP is much smaller than the change in nominal GDP. Over the 2004–2016 period shown in the table, real GDP increased by 23.4 percent compared to a 52.3 percent increase in nominal GDP. On average, prices in 2016 were 23.5 percent higher than in 2004. Clearly, it is important to distinguish between nominal and real GDP.
4.6. Per capita real GDP 95
standards of living depends also on what is happening to the size of the population. To find per capita real GDP for a country, which is real GDP per person, we simply divide real GDP by population.
Per capita real GDP: real GDP per person.
Per capita real GDP= Real GDP
Population (4.10)
The study of short-run macroeconomics is strongly motivated by the negative effects of recessions on national standards of living. Figure4.6 shows the negative effects of recessions on per capita GDP in 1982, 1991, and 2009.
Figure 4.6: Quarterly Rates of Growth in Per Capita Real GDP in Canada, 1982–2016
1982Q1 1984Q1 1986Q1 1988Q1 1990Q1 1992Q1 1994Q1 1996Q1 1998Q1 2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1 2014Q1 2016Q1
−6
−4
−2 0 2 4 6
0
Year and Quarter
%
Source: Statistics Canada, CANSIM Table 380-0064 and Series V1
Macroeconomic models are built to help us understand the causes of fluctuations in real GDP, employment, and the price level. Understanding the workings of the economy is essential for the design and implementation of monetary and fiscal policies that contribute to economic stability and protect standards of living.
In longer time horizons macroeconomics seeks to understand and explain the growth of real GDP that is essential to protect and improve standards of living as population grows. Growth also
increases the capacity of the economy to direct its resources to a wider range of activities that may include improvements in the quality of goods and services produced or reductions in the effects of growth on social and environmental conditions.
Limitations of real GDP
Because we use GDP to measure the output and income of an economy, the coverage should be as comprehensive as possible. We should also recognize that the composition of GDP and the distribution of income are important to a country’s standard of living.
In practice, we encounter several problems when including all production in GDP. First, some production causes noise, pollution, and congestion, which do not contribute to economic welfare.
Current national and international concern about greenhouse gases and climate change is a clear and obvious example of the issues involved. We should adjust GDP for these costs to evaluate standards of living more accurately. This is sensible but difficult to do. Recent policy changes by governments to impose carbon taxes on fuels and fuel efficiency targets for automobiles aim to reduce some greenhouse gases. But most such nuisance goods are not traded through markets, so it is hard to quantify their output or decide how to value their costs to society.
Similarly, many valuable goods and services are excluded from GDP because they are not marketed and therefore are hard to measure. These include the home cleaning, maintenance, and improve-ments households carry out for themselves, and any unreported jobs and incomes in the economy.
Deducting nuisance outputs and adding the value of unreported and non-marketed incomes would make GDP a more accurate measure of the economy’s production of goods and services.
Furthermore, high GDP and even high per capita GDP are not necessarily good measures of eco-nomic well-being. The composition of that output also affects standards of living. Health care services are likely to have different effects than military expenditures. The United Nations pre-pares an annual Human Development Index (HDI) to provide a more comprehensive measure of a country’s achievements. The HDI provides a summary measure based on life expectancy, adult literacy, and real GDP per capita.
Table 4.6 shows HDIs for the top ten countries in 2015, according to the Human Development Report, 2016. The second last and last columns in the table are of particular interest. The second last column shows the HDI adjusted for national per capita GNP. The underlying argument is that ranking national economic wellbeing simply by using per capita GNP would miss the importance of life expectancy and education as indicators of standards of living. For example, Singapore and the United States would rank highest by per capita GNP alone, but that ranking is reduced by lower life expectancy and years of schooling. The last two columns in the table compare HDI rankings in 2015 compared to 2014.
Conclusion 97
Table 4.6: Top ten countries based on the United Nations human development index
HDI Country HDI Life Expected Mean GNP/pop1 GNP/pop HDI
Rank Expectancy yrs yrs − HDI rank
(years) schooling schooling rank2
2015 2015 2015 2015 2015 2015 2014
1 Norway 0.949 81.7 17.7 12.7 67614 5 1
2 Australia 0.939 82.5 20.4 13.2 42822 19 3
2 Switzerland 0.939 83.1 16 13.4 56364 7 2
4 Germany 0.926 81.1 17.1 13.2 45000 13 4
5 Denmark 0.925 80.4 19.2 12.7 44519 13 6
5 Singapore 0.925 83.2 15.4 11.6 78162 -3 4
7 Netherlands 0.924 81.7 18.1 11.9 46326 8 6
8 Ireland 0.923 81.1 18.6 12.3 37065 11 8
9 Iceland 0.921 82.7 19 12.2 43798 20 9
10 Canada 0.920 82.2 16.3 13.1 42582 12 9
10 United States
0.920 79.2 16.5 13.2 53245 1 11
Source: United Nations Human Development Reports: 2016 HDR Report.
http://hdr.undp.org/en/composite/HDI Note1: GNP in PPP international dollars.
Note2: Difference between rank by GNP per capita and by HDI value.
A negative value means the country is better ranked by GDP than HDI.
Do the limitations of GDP matter for our study of macroeconomics? Probably not. We will be examining changes in real GDP from year to year, for the most part. As long as the importance of nuisance and non-marketed outputs, life expectancy, literacy and inequalities do not change dramatically in that time frame, changes in measured real GDP will provide good measures of changes in economic activity and performance. Changes in per capita real GDP will also provide measures of changes in standards of living.
C ONCLUSION
In this chapter we have looked at indicators of macroeconomic activity and performance, and the measurement of macroeconomic activity using the national accounts. We have not examined the conditions that determine the level of economic activity and fluctuations in that level. An economic model is required for that work. In the next chapter we introduce the framework of a basic macroeconomic model.
K EY C ONCEPTS
Macroeconomics studies the whole national economy as a system. It examines expenditure decisions by households, businesses, and governments, and the total flows of goods and ser-vices produced and incomes earned.
Real Gross Domestic Product (GDP), prices and inflation rates, and employment and un-employment rates are indicators of macroeconomic activity and performance.
Fluctuations in the growth rate of real GDP, in inflation rates, and in unemployment rates are important aspects of recent economic performance in Canada.
The expenditures by households, production of goods and services by business, and the in-comes that result are illustrated by the circular flow of real resources and money payments.
The National Accounts provide a framework for the measurement of the output of the econ-omy and the incomes earned in the econecon-omy.
Nominal GDP measures the output of final goods and services at market prices in the econ-omy, and the money incomes earned by the factors of production.
Real GDP measures the output of final goods and services produced, and incomes earned at constant prices.
The GDP deflator is a measure of the price level for all final goods and services in the econ-omy.
Real GDP and per capita real GDP are crude measures of national and individual welfare.
They ignore non-market activities, the composition of output, and the distribution of income among industries and households.