Two weeks ago, the U.S. Government’s Commerce Department reported that the country’s 2nd quarter (April-June 2015) Gross Domestic Product or GDP grew at a 3.9% annualized rate over the first quarter (January-March 2015). This was great news as the U.S. historical rate of annualized GDP growth is 3.2%.
GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy's goods and services supply has grown, or recessed, compared to the prior three calendar months. GDP is considered the most important macroeconomic measurement to most economists as it measures the goods & services produced for its citizens.
GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy's goods and services supply has grown, or recessed, compared to the prior three calendar months. GDP is considered the most important macroeconomic measurement to most economists as it measures the goods & services produced for its citizens.
Let me try to make the measurement of GDP easy to understand and learn why it is considered the most important macroeconomic measurement of any nation.
GDP is simply a calculation that measures the market value (final price) of all the final goods and services produced within the borders of our country, whether or not those goods and services were produced by an American or a foreign company. Thus, U.S. GDP includes Toyotas produced in Alabama. but the calculation excludes Cadillac’s made in Canada. GDP includes all U.S. exports (goods sold to other nations) since they were produced in the U.S. but the GDP calculation excludes all U.S. imports since imports, by definition, are produced in another country.
If you think about it, ultimately our country's economic satisfaction is best measured by the goods and services that are produced and that we, as citizens, have access to, which is why GDP is the measurement that is synonymous with “economic growth” or growth in goods and services for its citizens. In addition, rising GDP (more goods and services) is the ultimate economic goal of any economy, which can best be accomplished through the means of two other key macroeconomic measurements of employment and productivity, which are not the subject of this particular blog.
Let’s describe how the GDP calculation is made. Each quarter, the Government (Commerce Department) compares the final value of the domestic goods produced and services rendered in the current quarter to the final value of the goods produced and services rendered in the previous quarter. The calculation then takes the quarter-over-quarter percentage gain and annualizes the percentage by essentially multiplying by 4. The percentage growth comparison is always restated for inflation so that the production figures are comparable from one period to the next and are not impacted by changing price levels. For economic purists, we call this “real GDP” which is the only GDP reported by the media, even though the word “real” is almost always dropped to avoid confusion with the average citizen. For example, the second quarter 2015 U.S. GDP report included a 3.9% estimated GDP annualized growth rate. This means that the second quarter final value of goods and services produced was approximately .9% higher than the first quarter value. If we annualize the quarter over quarter growth that would mean we are growing at a 3.9% annual growth.
Now let me get to my favorite point on GDP, which most citizens do not understand. GDP growth in goods and services value is precisely the same as income growth! For example, in the second quarter of 2015 we can also say that incomes for Americans grew by 3.9% on an annualized basis, restated for inflation. Said another way, our country’s purchasing power grew by 3.9%, which represents the income growth to purchase the increasing 3.9% increase in goods and services. You probably never thought about it this way but every time you purchase something, every dollar you spend is going to someone as income, whether it is to the workers as wages, the landlords as rent, a bank that has made a loan as interest income, or to the owners of the business as profits. In short, Real GDP = Real Income and the only question is how that real income is dispersed among owners (profits), workers (employee wages), lenders (interest), and lessors (rent). Many citizens are unaware that the Government calculates GDP both in terms of the final market value of the goods and services PRODUCED under the “expenditure method”, which is the version that the media uses which focuses on what goods and services are produced and purchased, as well as a GDP calculation version called the “income method”, which focuses on the REAL INCOME (gains in purchasing power) earned from that same production.
I find the preceding paragraph, GDP = Income, to be a breakthrough moment for a citizen, or a first time economic student, in truly understanding the value of the GDP measurement. It is easier for most to think in terms of percentage growth in income in lieu of a fuzzier wording like GDP percentage growth.
The final point of caution is that the real GDP or income growth rate is a collective U.S. average, thus the growth in GDP or incomes does not indicate how those real income gains are accruing to the various socioeconomic classes or professions. Over the past 15 years, most of the gains in GDP or real income is accruing to the educated resulting in higher income inequality. Said another way, and using the 3.9% real GDP report, most of the 3.9% increase in incomes is going to the educated and skilled workers and to the owners (entrepreneurs)! As discussed in my last blog posting, over the last 15 years the real income gains of the middle class have stalled and have even slightly declined as global labor competition and technology have combined to "put a lid" on their real income growth.
The final point of caution is that the real GDP or income growth rate is a collective U.S. average, thus the growth in GDP or incomes does not indicate how those real income gains are accruing to the various socioeconomic classes or professions. Over the past 15 years, most of the gains in GDP or real income is accruing to the educated resulting in higher income inequality. Said another way, and using the 3.9% real GDP report, most of the 3.9% increase in incomes is going to the educated and skilled workers and to the owners (entrepreneurs)! As discussed in my last blog posting, over the last 15 years the real income gains of the middle class have stalled and have even slightly declined as global labor competition and technology have combined to "put a lid" on their real income growth.
Discussion Questions:
1. What is real GDP?
1. What is real GDP?
2. Why does Real GDP = Real Income?
3. Which four groups earn the income generated by the production of goods and services?
4. Many analyses show that our nation's middle class have made virtually no real income gains over the last 15 years. How could this be so if GDP = Income and our real GDP has been growing over the last 15 years?
6. Describe three things you would try to do as President to increase Real GDP (economic growth).
