McConnell Economics, Chapter 7

[Jin+Guice]

Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 7.

[Jin+Guice]

Chapter 7 discusses national accounting. The ultimate measure of national accounting is GDP, which considers is a measure of a nation's total domestic output.

GDP counts only finished goods produced in the current period.

There are two ways of measuring GDP, which are expenditures and income. These two measures should theoretically be equal. 
Computing GDP through income entails adding up consumer expenditures, investments, government expenditures and net exports.
Computing GDP through expenditures sums employee compensation, rent, interest, small business and corporate profits, indirect business taxes, depreciation of capital assets and foreign factor income. 

Indirect business taxes include sales and excise taxes, business property taxes, license fees and custom duties. The foreign income factor adds the amount of income earned by foreigners supplying resources to the United States and subtracts the income earned by Americans supplying resources to the rest of the world. This moves us from GDP to GNP. Personally I find this confusing, but unless you're talking about a problem where the distinction is important, it's not a critical detail in understanding the full framework.

GDP seeks to measure output, but the dollar amount of GDP could be increased by an increase in output or inflation. To handle this problem and obtain "real GDP" as opposed to "nominal GDP" GDP must be inflation adjusted.To do this a price index is established, which compares the price of goods and services in one year to the same "market basket" in another year. Nominal GDP is then divided by this price index to make GDP comparable across years. More details and examples on this process can be found in section 7.3 of the text.

GDP has several shortcomings including: ignoring non-market transactions (aka household production), lack of data from criminal (including tax evading) activites, difficulty dealing with increased product quality or changing technology and a lack of accounting for the environmental destruction. GDP is taken as a measure in well being, but, increasing GDP (or more precisely increasing GDP per capita) doesn't always guarantee an increase in the happiness or satisfaction of citizens. As is customary in economics, these problems are acknowledged in the introduction to the topic and then ignored in all future discussion.

[white belt]

It was good to understand all the pieces that go into GDP, because nearly all government policies related to the economy are looking maximize GDP growth over the long term.

I did a little research into alternative measurements of well-being, but it seems like there hasn't been much consensus on an ideal replacement. I think it makes sense for a developing country to focus on increasing GDP per capita because it will increase well-being to a certain level. However, I think once an a certain level of GDP per capita is reached (maybe above the global poverty level?), then an alternative measurement of well-being would be more useful.

[ertyu]

GDP per capita has limitations for developing countries, because often they suffer from the greatest income inequality. There would be very few extremely rich, almost no middle class, and masses and masses of destitute poor. So the average doesn't really give you much info.

Also, GDP just measures market value of goods and services you made in your country in a year. But in developing countries those "goods and services" are really resource extraction/mining. So you can have all of the middle east that has very high GDP per capita because of all the oil, but very low standard of living for large swaths of the population.

tl;dr: GDP per capita isn't even that good for developing countries, but it's all we can actually quantify. there's human development index and the like for better estimates of standard of living.

[7Wannabe5]

There’s also all the “broken window” and nth degree efficiency/bureaucracy spending which contributes to GDP, but not standard of living/quality of life.

[Jin+Guice]

GDP/ capita is a bullshit metric that's not worth focusing on as a nation.

ERE: Free yourself from the economic so you can focus on what's really important (not different at the national level).

@Ertyu's point: Average income says nothing about distribution, without which is worthless. A certain level of inequality is a convenient way to own a lot of slaves without the stigma or they responsibility to feed them.

@7w5's point: GDP is gameable and highly imperfect.

[mathiverse]

If I had an income statement from a business and I wanted to calculate value add (one of the ways to measure productive output), would the appropriate calculation be to take the operating profit and subtract interest payments? Does that calculation map exactly onto the value add concept?

The definition from the book is "Value added is the market value of a firm's output less the value of the inputs the firm has bought from others."

Another question: When we calculate gross private domestic investment, one component is the change in inventories. Is it true to say that the change in inventories number only considers inventories of final goods?

[jacob]

My key takeaway was that investors are free to quantify available data and try to figure out what performs best. Investing is not science rooted in objective reality. Rather it's some combination of intersubjective and interobjective realities.

I think this is also why there are different definitions of profit.

Immediate variables that are useful to calculate an answer to your first question is ROE and EBITDA. But that's just one form of valuation. An older school was P/B but if you read Graham bookvalue may well only belong to another era. What's the book value of an idea after all?

Im' not quite sure what you're asking when it comes to the second question. The problem here is likely in terms of evaluation what the inventory is actually worth. Mark to market, original cost, ... Corporations tend to pick whatever benefits them. In fact, a change in standards pretty much caused the March 2009 recovery.

PS: I'm thrilled to see someone trying to translate theory into practice. It's been all too rare so far.

[mathiverse]

Thank you! I appreciate the explanations!

Im' not quite sure what you're asking when it comes to the second question. The problem here is likely in terms of evaluation what the inventory is actually worth. Mark to market, original cost, ... Corporations tend to pick whatever benefits them. In fact, a change in standards pretty much caused the March 2009 recovery.

Let me try to clarify that second question. If I make cars and I only sell cars, I could have an inventory of unsold cars, but also an inventory of unsold wheels and fasteners and other components used in my cars. If GDP is calculated, would it only include the value of my unsold cars? In other words, only the change in finished goods inventory on a balance sheet would be added into GDP, not the change in raw materials inventory?

EDIT: I think the answer to this question comes from these two quotes: "Intermediate goods [aka raw materials in my question] are goods and services that are purchased for resale or for further processing or manufacturing." and "To avoid [multiple] counting [intermediate goods], GDP includes only the market value of final goods [aka finished goods] and ignores intermediate goods altogether."

[mathiverse]

GDP has several shortcomings including: ignoring non-market transactions (aka household production [including carpentry])...

Being a carpenter really helps my outlook with regards to housing. If it's crap, I'll just fix it myself and sell it. Luckily the Danish government already thought of this, so naturally I have to pay taxes off of work I do in my own home...

The US has untapped GDP improvement and tax revenue opportunities!

But, seriously, I thought it was interesting that Denmark taxes for such a thing and I remembered that quote when I read about how the US doesn't include such projects in its GDP.

[ertyu]

Let me try to clarify that second question. If I make cars and I only sell cars, I could have an inventory of unsold cars, but also an inventory of unsold wheels and fasteners and other components used in my cars. If GDP is calculated, would it only include the value of my unsold cars? In other words, only the change in finished goods inventory on a balance sheet would be added into GDP, not the change in raw materials inventory?

EDIT: I think the answer to this question comes from these two quotes: "Intermediate goods [aka raw materials in my question] are goods and services that are purchased for resale or for further processing or manufacturing." and "To avoid [multiple] counting [intermediate goods], GDP includes only the market value of final goods [aka finished goods] and ignores intermediate goods altogether."

correct, the parts would not be included. for questions like these (what counts, what doesn't, how do things get calculated) it's best to refer to the Bureau of Labor Statistics website (bls.gov iirc). A lot of what you'll see in intro undergrad textbooks is oversimplified and might even have minor inaccuracies to make the general principles digestible to an airhead 19 y/old. The culture of the discipline is such: the models might not be correct or accurate, but as long as they illustrate a useful principle in a comprehensible way, they're useful and that's all that matters. In real life, no one uses the graphs from the intro textbook. People get data and they crunch it. The graph is there to lend assumed legitimacy to whatever argument someone wanted to make (e.g. "workers shouldn't ask for minimum wage increases because this causes unemployment" -- though once you crunch the data, it turns out the argument isn't nearly as straightforward because when you pay your minimum wage workers more, they'll turn around and spend it, mostly on local services, and raise the tide for all)

[Ego]

The US has untapped GDP improvement and tax revenue opportunities!

But, seriously, I thought it was interesting that Denmark taxes for such a thing and I remembered that quote when I read about how the US doesn't include such projects in its GDP.

I may be misunderstanding your point but I believe the US taxes this as a capital gain, though there is the loophole.
https://www.irs.gov/businesses/small-bu ... e-tax-tips

[mathiverse]

I may be misunderstanding your point but I believe the US taxes this as a capital gain, though there is the loophole.
https://www.irs.gov/businesses/small-bu ... e-tax-tips

You know what? I may have misunderstood what FBeyer meant. I was thinking he meant that if he did something like build a built-in shelf in his living room, then the government would tax that production based on the imputed cost of the build whether or not it resulted in a capital gain at the point at which he sold his house. (That would align with the nonmarket transaction example in the book: "Certain production transactions do not take place in any market... for example... the labor of carpenters who repair their own homes. Such transactions never show up in GDP.") However, based on the part of the quote where FBeyer says "If it's crap, I'll just fix it myself and sell it," your interpretation seems to be correct. Thanks for pointing that out to me.

[chenda]

This is why a lot of the national GDP rankings are very misleading due to national differences in methodology. Ireland's GDP is massively inflated due to its status as a tax haven , which Paul Krugman famously derided as 'leprechaun economics' (which was rather patronising but was not inaccurate) Whereas Italy's GDP is often said to be artificially deflated due to the large amount of economic activity which is undeclared for tax purposes. California technically has a bigger economy than Germany, but in practice doesn't by a long way.

[mathiverse]

Thanks for the confirmation, ertyu. I appreciate your insights into how practitioners really do the work.

As for the rest, I may be misinterpreting your remarks about economics as a discipline, but, if not, I'll mention that I'm not concerned about the model being simplified for teaching purposes. I believe that's a normal part of pedagogy in most disciplines whether they are more practical disciplines like plumbing, woodworking, or music performance or more theoretical ones like economics, physics, math, etc. That problem is self correcting with more practice and learning.

It will be objected that this sharpness or clarity involves certain distortions or misrepresentations, depending on over-simplifications. But this is the perennial dilemma of the teacher: the teaching of facts and figures vs. the teaching of truth. To convey a model the teacher must reify and diagram and declare clearly what cannot be seen at all. The student must "learn" things in order to realize subsequently that they are not quite the way he learned them. But by that time he will have gotten into the spirit of the matter, and from this he may arrive at some approximation of the truth, an approximation he will continue to revise all his life long.