Components of Real GDP, Depreciation and Net Output

Components of Real GDP:

How does the ‘Commerce Department's Bureau of Economic Analysis’ [BEA] build its measure of real GDP? The Bureau includes in its measure of real GDP, which we will always denote by a Y in the equations and the diagrams, the values of:

a) Merchandise and services which are finally purchased and used by families (except for newly constructed buildings); these merchandise and services are known as consumption spending (denoted C).

b) Merchandise and services (including newly constructed buildings) which become part of society's business or residential capital stock; these merchandise and services are known as investment spending (denoted I). Gross investment spending is splited in two parts: First, the capital consumption allowance, or we can say the depreciation of worn-out or obsolete capital; and second, net investment that raises the whole capital stock. Investment can too be splited into 4 components: apartments and houses (residential structures), other buildings and infrastructure (which are non-residential structures), machines (producers' durable equipment), and as we noted above the modification in business inventories.

c) Government purchases (denoted by G); Note that, government purchases do not contain any payments the government makes which aren’t payment for merchandise or services provided to the government.

d) Lastly, net exports (denoted NX) are balancing item comprised in GDP; the GDP total is required to be adjusted for the difference between imports and exports to make the Countrywide Income and Product Accounts consistent.

Accountants add up all of these elements to calculate GDP (see Table below). This description of GDP, the National income identity, is one of the major fundamental bases of Macroeconomics:

Y = C + I + G + NX    

This is the equation that you will write down more than any other equation, during any macroeconomics course.

What is and is Not in GDP:

Depreciation and Net Output

GDP counts all investment including replacement investment in its measure of total economic activity, for the measure of investment included in the Real GDP is, gross investment.

Why is the replacement investment included in real GDP? Why is it seen not as a price of doing business but in its place as the near equivalent of constructing a new factory to extend the business's productive capacity? Depreciation spending is counted in real GDP since the statisticians who compile the NIPA haven’t any confidence in their estimates of economy-wide depreciation. An enhanced measure of economic activity is NDP, which is, Net domestic product. It includes just net investment and excludes depreciation. However, the national income accountants have a preference to focus attention on measures which they think are reasonably correct, and so downplay the (poorly measured) NDP and emphasize the GDP estimate.

Government Purchases

Government purchases of merchandise and services are as well counted in GDP. The government uses the merchandise and services it buys : it constructs roads, provides police protection and courts, issues weather reports, maintains the national parks, runs school, at the time of the Cold War it maintained armies in West Germany to prevent a Russian attack on Europe, and so on.

A lot of these services, if they were offered by private businesses, would be counted as intermediary merchandise, things which aren’t of final value themselves but as a substitute are aids to private sector production. As such, they will be excluded from GDP.

Consider about it. Assume two companies signed a contract that a specific arbitrator would be the judge of any disputes that arose between them, and suppose they paid the arbitrator a fee. The services of the private judge that they hired would be classified the NIPA as an intermediate good, and not incorporated in the final merchandise and services added up to calculate GDP.

However, all government purchases of merchandise and services are counted as part of GDP, as well as the money government collects in taxes and then pays to its personal judges, bailiffs, and clerks etc, many of whom decide business to business disputes. A large chunk of government purchases fall into this category. They are counted as part of the GDP, but would not be counted if they had been made for similar substantive purposes by private industries.

What Isn't in GDP But Should Be:

Moreover, many expensess excluded from NIPA, and so from GDP, possibly should not be. Production which occurs within the household is excluded from the GDP. That’s, the work family members do to keep their personal households going, for which they aren’t paid, is excluded from the GDP.

This exclusion wraps our image of the United States economy. In 2000 some 129 million Americans, both male and female, worked a total of about 206 billion paid hours (and around 7 million Americans spent a total of 5 billion hours looking for jobs). However many Americans (most of them adult women) will also spend no less than 100 billion hours performing services like chauffeuring, shopping, cleaning, and cooking--which would count as employment and would count in the GDP if they were receiving pay for them rather than doing them for their own families. Within the household production has never been counted as part of GDP. Back when NIPA system was set up, economists supposed that it would be difficult or even impossible to acquire reasonable, credible, and defensible estimates of the economic value of within the household production.

Depletion, Pollution, and "Bads”:

Lastly, NIPA system does not make any allowance for the depletion of scarce natural resources. To the degree that an economy produces a high income by using up important natural resources, that income is not true GDP at all but the depletion of natural resources. Qatar, Kuwait, and Saudi Arabia have high levels of measured real GDP for each worker, but much of their revenue arises not out of sustainable production rather the sale of limited and depletable natural resources. A better system would have a category for depletion of the natural resources.

Furthermore, the NIPA contains no category for production of “bads" things which you would rather not have. Producing more smog doesn’t reduce GDP. The extra cases of lung cancer caused by cigarette smoking don’t diminish GDP (As a matter of fact, they raise the medical care sector's contribution to GDP). If demand for locks and alarm systems rises since crime increases, GDP increases. As we noted before, GDP is a measure of the economy's level of productive effort only, not of well-being.

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