Module One – GDP Lecture 2 Part 1

Hello and welcome to our second lecture.
In this lecture, we’re going to focus exclusively on topic of gross domestic
product. I can remember one of my
former professors once telling us that macroeconomics is
pretty much the study of gross domestic product.
I remember thinking at the time, well, that doesn’t sound particularly
interesting, if this discipline is just all about this, this one thing.
But in fact, eventually I realised that he was right.
Gross domestic product is such an important part of the macroeconomy.
And there are moreover such an important part of the way macroeconomists think
about the economy that there is hardly a topic in macroeconomics that doesn’t in
one way or another involve the analysis of gross domestic product.
It is absolutely front and centre to our discipline and understanding
this concept – What it is, what it measures,
how it the role it plays in the economy is going to be important for us in pretty
much every single lecture and every single topic.
What I want to do in this lecture is talk to you about what gross domestic
product actually is. But moreover, I want to demonstrate for
you why it’s important. And why it’s important in the sense that,
if you have a really good, fundamental understanding of what gross
domestic product is and what underlies the measurement of
gross domestic product, you can actually start saying some pretty important
profound things about some very key macroeconomic issues.
For example, have a look at this chart. This chart shows data for the United
States on exports and imports. And it shows something that there’s a lot
of public debate about in the in the US. And indeed, in lots of countries which
also experiencing something very similar to this.
You can see from this chart that imports into the United States are invariably
higher than exports and that’s true for many countries.
There are many other countries in which the opposite is true, let’s just focus on
this case. What you can also see from the chart is
that in recent times, the gap between imports and exports has widened
considerably. And there’s a lot of debate about this,
and what it actually means and where it’s coming from.
You hear some commentators say, well, this shows how inefficient
US industries are. They’re no longer capable of sending
their products into the global market. Or you might hear that this tells us
something about workers in the United States that workers and work practices in
the United States are somehow deficient relative to the rest of the world.
And that explains why there the gap between imports and
exports is widened. And there are lots of other similar
explanations or stories that are told. But in fact, there are some profound
macroeconomic reasons that go way beyond that sort of superficial argument that
can explain this. And indeed, by having a good
understanding of gross domestic product, we can see exactly what those important
fundamental macroeconomic forces responsible for this gap between imports
and exports might be. In other words, if you can understand
gross domestic product, you’re already a long way down the road towards
understanding some very important key fundamental aspects of the macroeconomy.
So, we’ll come back to this chart in a little while, after we’ve explored gross
domestic product and you will have to see exactly why it
is that there is a gap between imports and exports and what the fundamental
reason is for that gap and why it might have widened in recent years.
Let’s begin with a definition of gross domestic product.
This is a very standard definition you see here.
It measures the flow of economic activity in a geographic region, usually a
country, over a particular period of time.
Now, we usually think of GDP in terms of a country or a nation,
but we don’t have to. It is possible to think of measuring
economic activity in a state or a province. But for macroeconomic level,
it’s usually a country, a nation that
we are of thinking of. Now, this is a very broad
definition of GDP. And in a moment, we’re going to refine
this definition and making it much, much more precise.
But I want to draw your attention to this word, flow, because this is a word we’re
going to encounter at various points during our course.
In macroeconomics, we’re going to deal with a large number of
economic variables. GDP, being one of the most
important of those. Economic variables can be of two broad
different types. The first is a flow and GDP is indeed,
one such variable. A flow is a variable that is defined and
indeed only makes sense if we think of it existing over a period of time.
In your own experience, the income that you earn per week is an
example of a flow. We define that variable in terms of a
distinct period of time, income earned per week.
And quite a few of the economic variables we’ll be looking at are flows.
That is they only make sense if we think about them as occurring over
a period of time. But there’s a second classification of
economical variables which is also going to be important for us, these are
variables known as stocks. An economic variable that’s a stock is
defined not over time, but at a particular period of time, like a
particular point in time. In your own experience, an example of a
stock might be the amount of savings deposits you have in a bank account on a
particular day. Let’s say, January the 30th.
So, stock is not defined over time, it’s defined at a point in time.
Now, there is a relationship, often, between flows and stocks.
Indeed, at several points in the course, we’re going to explore that relationship
because it is often the case that the flows we’re interested in
actually have the effect of building up your stocks.
So, in this case, it’s the flow of income that enables you to increase the amount
of saving that you have in your bank account.
The flow is contributing to the stock. And we’re going to see this interaction
between flows and stocks at lots of points during the course.
But we will come to that in due course. Right now, I just want to focus on this
particular flow, gross domestic product. Now, the other key part of this
definition, and this is actually going to be the focus for the for the rest of the
lecture, is that it’s a measure of economic activity.
Now this is a tricky concept because what exactly do we mean by economic activity?
How can we actually give that phrase a concrete meaning?
And this is not at all a straight forward question to answer because there are at
least three distinct ways of thinking about economic activity.
First, we can think about economic activity in terms of production.
Here, we’d be looking at the flow of goods and services that are produced in
an economy over a particular time period. So, how much is being produced over the
last 12 months? And that’s a very legitimate and way of
thinking about economic activity that has obviously going to be very important.
But we don’t have to think about economic activity as being a flow of production.
We can also think about it as a flow of expenditure.
How much spending was being undertaken in the economy over a particular time
period? And there’s a third way of thinking about
economic activity. Over a particular time period in an
economy, how much income has been earned? So, there are three ways of thinking
about economic activity. And it’s not at all obvious which of
those three ways is the most appropriate from the viewpoint of understanding the
macroeconomy? It turns out, however, that the
distinction between production, expenditure and income as measures of
economic activity, is not going to be as important as you might think.
What I’m going to explain for you is that whilst, in some sense, these are quite
distinct ways of thinking about economic activity,
over any particular time period, it turns out that these are going to be equivalent
ways of thinking about economic activity. That is over a year, let’s say, if we try
to measure economic activity, thinking about it as a flow of production, and we
then set down and measured economic activity as a flow of expenditure.
And to complete this exercise, we then calculated economic activity, thinking
about it as a flow of income that’s being earned.
You will, in fact, get the exact same answer.
In other words, economic activity can equivalently be measured as a flow of
production, expenditure and income. And it often doesn’t matter which
approach you take, you get the same result.
It’s going to take a little bit of work to demonstrate that, but if you think
about it logically as we go through this, you’ll see that this must be true.

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