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Consumption and GDP

 
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PostPosted: Thu Sep 23, 2021 9:05 am    Post subject: Consumption and GDP Reply with quote

https://www.econlib.org/consumption-is-not-a-part-of-gdp/

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Aug 14 2020

CONSUMPTION, GDP, JEROME POWELL, NGDP
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Consumption is not a part of GDP
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By Scott Sumner
Consumption is not a part of GDP
Categories: Fiscal Policy Macroeconomics Monetary Policy
By Scott Sumner, Aug 14 2020
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I used to teach my students that consumption was roughly 2/3rds of GDP. Actually, consumption is not a part of GDP.

Consider this analogy. You have an annual income of $100,000. You might say:

1. Income = wages + capital income

You might also say:

2. Income = consumption + saving + taxes

And you can make the second equation more complex by breaking consumption down into spending on clothes, haircuts, restaurant meals, etc.

It makes sense to say wages and capital income are both a part of income. On the other hand, to me it doesn’t make much sense to say spending on haircuts is “a part of” income.

Of course that’s a question of semantics. So let’s look at some statements with real implications:

1. My decision to earn more wages will cause my income to rise.
2. My decision to get more frequent haircuts will cause my income to rise.

The first claim is obviously plausible (assuming I find employment), while the second claim would require some pretty fancy footwork to justify.

In the textbooks, GDP = C + I + G + (X-M)

That makes it look like consumption (C) is a part of GDP. But it isn’t—consuming adds to C and subtracts from I (inventories). GDP measures aggregate production, and consumption is obviously not production. If I go and spend $100 on a new product, it doesn’t cause GDP to rise by $100, even if the good is domestically built. Rather investment falls by the value of the good, as inventories fall. (GDP may rise slightly, as my decision to buy the good boosts retailing services.)

The decision to consume more only causes GDP to rise if it causes production to rise.

Now it’s certainly possible that my decision to get up off the couch and go buy something does in fact cause GDP to rise. But if GDP does rise, it is for reasons that are completely unrelated to the myth that consumption is a part of GDP. Consider the following analogy. Getting a haircut might make my income go up because I look more presentable and find it easier to get a job. But in that case the reason my income goes up has nothing to do with the claim that my consumption of haircuts is “a part of my income”. It’s a use of my income. There has to be some other indirect effect, which needs to be explained.

In order for consumption to boost GDP, we need two assumptions to be met. First, more consumption must boost nominal GDP. Second, more NGDP must boost real GDP.

The first assumption requires an incompetent central bank. The Fed is supposed to keep NGDP growing at rate that best allows it to meet the dual mandate. Even if the optimal NGDP growth rate is not constant, it surely doesn’t depend on whether you decide to go get a haircut. There’s some growth rate in NGDP that best meets the Fed’s mandate. For your decision to get a haircut to boost NGDP, the Fed must respond incompetently, allowing aggregate demand to go off course. That might happen, but in that case NGDP is not rising because “C is part of GDP”. Perhaps velocity rises by more than M falls—they screw up.

Even if NGDP does increase, there’s no necessary increase in RGDP. If more NGDP always did cause RGDP to rise, then Zimbabwe would be the world’s richest country. For an increase in NGDP to boost RGDP you also need the assumption of sticky wages.

So it’s just possible that consumption does boost GDP, but not for the reason you were taught in school. If we were honest with students we’d say, “Spending more might cause Jay Powell to screw up while doing his job at the Fed. This causes the total dollar value of spending (NGDP) to rise. And because people have money illusion, they are fooled into thinking that work has become more lucrative, and so they decide to work more. Output (RGDP) also rises.

I think you see why we don’t teach students this way. It’s confusing. So we make up a fairy tale. But the fact that students are taught the wrong explanation means that they never really learn macro, even if they are absolutely straight A students, the best in their university. How can they learn what actually happens if they are taught that consumption is part of GDP, so spending more causes GDP to rise?

You might argue that Jay Powell doesn’t know when I go out to buy something, so the lack of monetary offset is a plausible assumption. But the consumption shocks that matter are not the whims of individuals (which balance out due to the law of large numbers), they are the collective decision of millions of people to spend more, perhaps due to a federal tax rebate. In 2008, the tax rebate did boost GDP a bit in the second quarter, but the Fed responded with tighter money and it led to lower GDP in the 3rd and 4th quarters. For the year as a whole, the tax rebate added nothing to GDP. Students wouldn’t know that based on the models they are taught in macro. It seems like a policy that gets people out shopping should boost GDP. It doesn’t.

The only even halfway plausible argument that consumption boosts GDP occurs at the zero bound, where there is some debate as to whether the Fed offsets consumption shocks.






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Steve
Aug 14 2020 at 2:30pm
This feels somewhat related to the claim people make that “consumer spending is 70% of GDP and drives the economy”, which they then use to justify mailing out checks for people to spend. If you dig too deep you get the idea that people really think the economy is some kind of perpetual motion machine, and they don’t actually understand what creates wealth.

I’m not an economist. Is there a good succinct rebuttal to the notion that we need people out there spending money to drive the economy? Or does it out of necessity require a deep dive into theory, the “paradox of thrift”, etc.

Or am I wrong and that is actually important, and I’ve misinterpreted this post?

Scott Sumner
Aug 14 2020 at 6:55pm
I do think that we need people out spending money, but it doesn’t need to be mostly on consumer goods–investment goods will do just as well.

Joe K
Aug 14 2020 at 2:34pm
Scott, do you mean to say Investment instead of Inventories in your discussion? Thanks for all your efforts in this area.

Elijah
Aug 14 2020 at 2:51pm
Simple, yet profoundly relevant. If you make a mistake in the initial framing of the problem (or in your understanding of the frame), the conclusions that follow will always be skewed towards the wrong.

Art Carden
Aug 14 2020 at 3:56pm
This is a good way to put it. I usually teach this by emphasizing that it’s an accounting identity and explaining C, I, G, and NX as “what we do with what we produce” rather than “where production comes from.”

Ed Zimmer
Aug 14 2020 at 4:31pm
With the lack of understanding of double-entry accounting you show in this post, it’s clear that you’ve never run a business. Nor are you showing any understanding of GDP. Forget you textbook equations – they’re relevant only if you understand what the letters mean (which you clearly don’t). So back to elementary:
GDP (specifically NGDP) is the measure of our productive (ie, production-and-consumption) economy. GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because all spending is another’s income), Our economy depends on household spending (about 2/3 of GDP). That spending is limited by household income (which comes only from those sectors). Business provides that income to the extent demand (ie., business opportunity) exists, and government provides the rest. All that’s important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends only on currency-users perception), there are no limits other than that perception.
So consumption (by households, as well as the other sectors) IS included in GDP (even in RGDP as that’s simply NGDP deflated by inflation).
To emphasize, the dollars (U.S.) we pass back and forth are simply tokens that have value (ie., purchasing power) only because we believe they have. They’re accepted by our landlord, grocer, auto dealer, … only because the owners of those businesses believe that their employees and the businesses they patronize will accept them.
And… the household spending in GDP includes everything that the public buys to consume — food, clothing, housing, transportation, healthcare, entertainment, etc. However, looking at the income side of GDP, you’ll find that neither Federal borrowing nor personal or corporate income taxes are part of that income — so they do not (and never have) paid for (or funded) that spending. So there really is a <a href=”http://TENonline.org/magic-money-tree.html”>Magic Money Tree</a>.

Scott Sumner
Aug 14 2020 at 7:12pm
You said:

“And… the household spending in GDP includes everything that the public buys to consume — food, clothing, housing, transportation, healthcare, entertainment, etc.”

This is very much mistaken. GDP measures production, not consumption. I might consume something previously held in inventory. I might consume an imported good. I might consume something purchased at a garage sale. Those activities are consumption, not (domestic) production. They are not a part of GDP. Again, consumption is not a part of GDP, which only includes production. The P in GDP stands for production.





Ed Zimmer
Aug 15 2020 at 10:22am
Scott,
No, I do not believe I am mistaken (although semantics may be the problem here). BEA measures production by measuring consumption. The primary GDP account is what BEA calls “Personal consumption expenditures”. The account is a compilation of all household spending on final goods and services during the preceding 12 months. The data that is compiled into this account comes from retailers and service providers – not manufacturers. BEA uses the spending data to compile GDP because that data is the most accessible and accurate, available from the multitude of monthly and annual financial reports businesses and government agencies are required by law to submit. You’ll find links to the applicable BEA literature at .Magic Money Tree

Scott Sumner
Aug 15 2020 at 12:26pm
Again, that’s flat out wrong. GDP does not include “consumption”, it includes the production of consumer goods that are built within the US and during this calendar year (or quarter). That’s is, it includes the production of consumer goods and the production of investment goods.

Consumption is not a part of GDP, only production counts.

Ed Zimmer
Aug 15 2020 at 3:34pm
I still see that as over- (and misleading-) simplification. For example, a durable good does go into GDP when it’s made, but it goes into GDP’s “Gross private domestic investment” (GPDI) account (ie, GDP’s business-spending account), but when it’s sold, the sale is credited to the “Personal consumption expenditures” (PCE) account and debited from the GPDI account. So when one’s interest is GDP’s effect on public livelihood, it’s only the PCE account that is of interest. The GPDI account is only a transitory, buffer account that can rise or fall without consequence so long as government spending does the opposite.

Jon Murphy
Aug 14 2020 at 4:53pm
I am having some trouble following you. I understand this part:

That makes it look like consumption (C) is a part of GDP. But it isn’t—consuming adds to C and subtracts from I (inventories). GDP measures aggregate production, and consumption is obviously not production. If I go and spend $100 on a new product, it doesn’t cause GDP to rise by $100, even if the good is domestically built.

That, it seems to me, is akin to the “imports are not included in GDP” discussion. Imports are netted out because they show up elsewhere, so an increase in imports does not reduce GDP.

What I am confused about is the haircuts example:

It makes sense to say wages and capital income are both a part of income. On the other hand, to me it doesn’t make much sense to say spending on haircuts is “a part of” income.

Doesn’t it matter to ask “part of whose income?” The only reason GDP is discussed as “national income” is because one person’s spending is another person’s income, no? If your barber is added in, then your consumption of haircuts would raise income.

Scott Sumner
Aug 14 2020 at 7:06pm
Just as “an increase in imports does not reduce GDP”, an increase in consumption does not increase GDP. GDP measures production, not consumption.

Producing something and consuming something are two very different activities.

Ed Zimmer
Aug 14 2020 at 5:40pm
With the lack of understanding of double-entry accounting you show in this post, it’s clear that you’ve never run a business. Nor are you showing any understanding of GDP. Forget you textbook equations – they’re relevant only if you understand what the letters mean (which you clearly don’t). So back to elementary:

GDP (specifically NGDP) is the measure of our productive (ie, production-and-consumption) economy. GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because all spending is another’s income), Our economy depends on household spending (about 2/3 of GDP). That spending is limited by household income (which comes only from those sectors). Business provides that income to the extent demand (ie., business opportunity) exists, and government provides the rest. All that’s important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends only on currency-users perception), there are no limits other than that perception.

So consumption (by households, as well as the other sectors) IS included in GDP (even in RGDP as that’s simply NGDP deflated by inflation).

To emphasize, the dollars (U.S.) we pass back and forth are simply tokens that have value (ie., purchasing power) only because we believe they have. They’re accepted by our landlord, grocer, auto dealer, … only because the owners of those businesses believe that their employees and the businesses they patronize will accept them.

And… the household spending in GDP includes everything that the public buys to consume — food, clothing, housing, transportation, healthcare, entertainment, etc. However, looking at the income side of GDP, you’ll find that neither Federal borrowing nor personal or corporate income taxes are part of that income — so they do not (and never have) paid for (or funded) that spending. So there really is a magic money tree.

Mal
Aug 14 2020 at 10:05pm
This is rather misguided. There is no production without consumption. No business will operate for long without paying customers. No business will invest in expansion without paying customers consuming the output of the business.

Production is not important. It is increasingly automated or sent overseas for cheap labor. Wages are not important either – they have been flat for majority of Americans and play limited role in GDP growth.

Only two things matter – debt (money stock), and consumption (money flow). Those two things make GDP. When you take out home equity loan to pay for extra haircuts, that debt becomes income for the hairstylist when you consume the haircut. When corporations issue debt to buy back stocks, CEOs use windfalls to buy super yachts. Consumption of yachts becomes income for yacht makers.

What is wealth? An income generating asset. What is income? Debt being converted into consumption. Without debt, no income, without income, no wealth.

Scott Sumner
Aug 15 2020 at 12:31pm
You said:

“This is rather misguided. There is no production without consumption.”

This is faulty logic. I could say “there is no production without livers”. After all, if humans didn’t have livers we’d be all dead and could not produce goods. That’s true, but it doesn’t make livers a part of GDP.

I certainly agree that consumption is a motivation for production, but it’s not literally production.

I was tempted to say “this is Malformed logic” 🙂

You said:

“Production is not important.”

Tell that to people in Zimbabwe, a country that has had the fastest growth in demand in the entire world during the 21st century.





Mal
Aug 15 2020 at 2:43pm
“This is faulty logic. I could say “there is no production without livers”. After all, if humans didn’t have livers we’d be all dead and could not produce goods. That’s true, but it doesn’t make livers a part of GDP.”

If we didn’t have livers and were dead, GDP would be zero. While quantity of livers is not explicitly defined in the GDP, it is one of the key metrics driving GDP growth. Only debt is more important, but number of livers is the second most important quantity that creates GDP. No livers = no GDP.

“Tell that to people in Zimbabwe, a country that has had the fastest growth in demand in the entire world during the 21st century.”

While Zimbabwe has population growth (or liver count growth if you will), they do not have the debt growth needed to sustain their production. Their total national debt is only $11 billion. For comparison, United States generates this much debt in an afternoon. If you gave Zimbabwe free $26 trillion (just the portion of the debt that US government injected into the economy as incomes), Zimbabwe economy would materially improve.

Even if you scaled for the population (Zimbabwe – 14 million, US – 320 mllion), this would work out to $1.1 trillion injected into Zimbabwe economy as income. This would have an impact on Zimbabwe GDP, wouldn’t you agree?



art andreassen
Aug 14 2020 at 11:46pm
Scott: There seems to be a misunderstanding of what GDP measures and how it is calculated. GDP is an accounting procedure to further allocate industry shipments. Yes it starts as a measure of the economy’s total production of goods and services but those goods and services are then distributed to who purchases them: consumers, business, government and export. The haircut is measured as a product in GDP when produced and the product is allocated to who purchases it. It is classified as consumption because people consume it, not business or government or exports. Whether the consumer uses wages, savings, borrows from his mother or steals the money, the haircut goes into GDP and is shown as part of personal consumption. Garage sales, unless the seller is a business and declares an income and profit, does not get into GDP. The products sold got into GDP when they were produced and were classified in PCE. The seller did not produce the product he sells.

Imports are excluded from the total “GDP” but are confusidly hidden by the notation (X-M), obviously, not every dollar of imports is exported. Imports are imbedded in PCE, Inv, Gvt and Exports, in both their final sales and in the inputs that go into their production process. It is possible to estimate what portion of each demand component is imports by using input/output analysis.

See: Chentrens, Andreassen: “Induced Consumption: Its Impact on GDP and Employment”, Federal Forecasters Conference, 2009. It also gives a quick and dirty way of using I/O to approximate the Keynesian consumption multiplier

Scott Sumner
Aug 15 2020 at 12:33pm
Most economists understand how GDP is calculated. It’s explained in principles textbooks.

foosion
Aug 19 2020 at 7:15am
Here’s an excerpt from Mankiw’s Principles of Macroeconomics, 3rd Editon:



GDP (which we denote as Y) is divided into four components: consumption (C), investment (I), government purchases (G), and net exports (NX):

Y = C + I + G + NX.

This equation is an identity—an equation that must be true by the way the variables in the equation are defined. In this case, because each dollar of expenditure included in GDP is placed into one of the four components of GDP, the total of the four components must be equal to GDP.

We have just seen an example of each component. Consumption is spending
by households on goods and services, such as the Smiths’ lunch at Burger King.

foosion
Aug 19 2020 at 7:18am
Mankiw also writes: “Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time.”

However, you can see how his statement that consumption is spending by households might be interpreted.

James
Aug 15 2020 at 12:51am
Scott,

Your getting a haircut certainly does cause a rise in GDP if you did not pay for a haircut in the previous accounting period. As you point out, GDP is a measure of production. If your haircut gets produced, it absolutely should be counted in GDP.

Your inventory story is entirely at odds with reality. Anyone can verify this by looking at the data here: https://apps.bea.gov/scb/2020/05-may/pdf/0520-selected-nipa-tables.pdf Page 5 in the pdf is a great starting point. Consumption is orders of magnitude large than changes in inventories. There is simply no way that consumption and inventories offset in the way your post suggests.

Most consumption is not offset by an equal and opposite change in inventories. You can confirm this by looking at changes in inventories as a percentage of total GDP. It’s in the low single digits. Consumption as a percentage of GDP is in the high double digits. A great deal of consumption includes things that could never be held in inventories. You give an excellent example when you mention a haircut. The same goes for other services as well as other electronically delivered goods.



Mark Z
Aug 15 2020 at 4:51am
I think you’re misunderstanding the inventory story. If we take the total stock of goods produced for the year as given, then by definition, if we consume more, we leave less in inventory, and if we consume less, the goods we don’t consume get counted as inventory. I think when Scott says inventory declines as we consume more, he’s saying if we hypothetically consumed more in a given period, inventory would have to be less. This does not at all predict that an increase in consumption over time will be offset by a decline in inventory over the same time period, because GDP itself can increase over time. A change in consumption over time would only require an offsetting change in inventory over the same period if GDP (and all other components of GDP other than consumption and inventory) were fixed.

Dylan
Aug 15 2020 at 7:07am
I’m also confused by this, particularly in the haircut example. The haircut doesn’t sit in inventory somewhere it exists only in the act of being consumed. So, how does me deciding to get a haircut not raise GDP. This seems true for most any services where production=consumption, no? As mark W points out, there’s also a measurement problem with production, or at least a valuation problem. Producing something doesn’t give it a value, that only happens when someone purchases it.

How does the purchase of say a collectible factor into GDP. If I buy a Honus Wagner baseball card for $2m and sell it 6 months later for $2.5m, are those transactions invisible to GDP?

Ed Zimmer
Aug 15 2020 at 12:25pm
Dylan,
No,those kind of transactions are not included in GDP. Just as Fed borrowings and personal/corporate income taxes are not included in GDP, neither are profits. GDP is a measure of the production-and-consumption economy (which is the essential economy, because it provides our livelihood). The P&C economy can be accurately measured because it deals only in currency flow (ie, with income and expenses). But not all currency goes to consumption – some goes into savings, investments, donations, gifts, holding and speculative gains, etc. Those transactions constitute the rest of the economy – the FIRE (Financial, Insurance, Real Estate) economy. The FIRE economy is much more difficult to measure (bordering on impossible), because its transactions involve not just income and expenses, but also assets and liabilities (ie., accumulated income and expenses).

Scott Sumner
Aug 15 2020 at 12:44pm
I was using the haircut analogy with an individual’s personal income. I certainly agree that the production of a haircut is a part of GDP, but that does not logically imply that my decision to get a haircut causes GDP to rise. For that claim you need a model, and as I explained in this post the Keynesian model is highly flawed.

I agree that people with higher incomes (more production) will tend to consume more. But you can’t reverse that and assume that the decision to consume more causes higher income.

Phil H
Aug 15 2020 at 1:10am
This is all a bit over my head, but I’m gradually thinking through it… I think I’ve understood the first half, and I wonder if there’s something fishy about this sentence:

“consuming adds to C and subtracts from I (inventories).”

I see what you mean, that consuming adds to C by shifting some material asset out of inventory and (effectively) using it up. But wouldn’t it be right to say that I in the equation must be the difference in inventory; whereas the act of consumption takes something out of the absolute inventory stock? I suppose if it takes something out of inventory stock, it must affect the inventory flow… I may have not got this clear in my head!

The other thing was the “fancy footwork”. Again, I see what you mean, but isn’t this exactly the kind of “fancy footwork” that gets assumed in, for example the process of supply and demand balancing out? Clearly there is a lot that has to go on behind the scenes, but the economic theory is an abstraction over all of that. That’s how I’d rationalised it.

Scott Sumner
Aug 15 2020 at 12:46pm
Yes, C affects the inventory flow.

On your last point, this discussion is unrelated to the S&D model.

MarkW
Aug 15 2020 at 6:44am
In the textbooks, GDP = C + I + G + (X-M)

That makes it look like consumption (C) is a part of GDP. But it isn’t—consuming adds to C and subtracts from I (inventories). GDP measures aggregate production, and consumption is obviously not production.

It seems to me that the confusion lies in the difference between what GDP *is* vs how GDP is measured. So GDP is the domestic production of goods and services — simple enough. But how to measure it? When goods and services are produced there isn’t a good way of measuring all the quantities and value of production directly. So as I understand it C + I + G + (X-M) is just an attempt to measure — indirectly — what cannot be measured directly. None of C, I, G, X, or M are actually components of GDP — they’re just a way to try to estimate what production must have been. And using this method, we know we’re missing lots of valuable things. If somebody paints their own house that is part of the GDP, but is not captured. If somebody hires an off-the-books house painter, that is part of the GDP, too, but is also not captured. Collectively, people prepare themselves hundreds of millions of meals every day–highly valuable activity–that is not included in GDP. And there are plenty of more examples like this.

It seems to me that students should know that GDP = C + I + G + (X-M) is NOT an identity. It’s not what GDP is. It’s only an (imperfect, incomplete) attempt to measure GDP.

Ed Zimmer
Aug 15 2020 at 12:39pm
MarkW
The transactions you see as “missing” are missing only because you’re thinking of GDP as measuring productive activity. But that’s not its intent. It simply measures the flow of currency through the production-and-consumption economy.

MarkW
Aug 16 2020 at 2:49pm
“…you’re thinking of GDP as measuring productive activity. But that’s not its intent.”

Well, Scott certainly believes measuring production is the intent (see his followup).







Jon Murphy
Aug 16 2020 at 5:01pm
The transactions you see as “missing” are missing only because you’re thinking of GDP as measuring productive activity. But that’s not its intent.

Uh…that is the explicit intent of GDP

Jon Murphy
Aug 15 2020 at 10:48am
I was thinking more about this last night and again this morning. I was still confused to your point, but at breakfast, it clicked. I see what you’re saying now, and you’re absolutely correct!

Stefano Cirolini
Aug 15 2020 at 12:33pm
Does my by buying an haircut increase GDP? In my view, it depends on the alternative use of the money I would pay for the haircut. If I don’t buy the haircut, but instead I buy something other, including investment of some sort, then it doesn’t make any difference. If I keep the money in a jar in my cupboard, then the GDP should decrease, but, as explained, the Fed would intervene by changing the quantity of money, so that the value (not quantity) of production remains the same.

Jose Pablo
Aug 15 2020 at 1:35pm
Very interesting, Scott! thank you.

Kind of reminds me of Adam Smith:

By not confining his expense within his income, he encroaches upon his
capital…he pays the wages of idleness….diminishing the funds destined
for the employment of productive labour, he necessarily diminishes…the
real wealth and revenue of [his country’s] inhabitants. If the prodigality
of some was not compensated by the frugality of others, the conduct of
every prodigal, by feeding the idle with the bread of the industrious,
tends not only to beggar himself, but to impoverish his country. (WN
339.20)

Digging deeper on this, does every “wage” increase “income”?

1.- When we pay for the lavish offices of “tax advisors” and their inflated “wages”, are we increasing the “nation wealth” in any manner?

2.- The works (so to speak) in the more than 200 congress committees and the wages associated with them, do increase the “nation wealth”?

3.- When we spend X% in military equipment that will be scrapped without being used (or even worse, will be used to destroy “capital goods”) are we increasing the “nation wealth”?

What should we be teaching students regarding the concept of “productive labor”? or even, if your fellow blogger Caplan is right about the education system (and he may be), should we be teaching them anything at all?

James
Aug 15 2020 at 8:30pm
Who said consumption is part of GDP?

The consumption is just a means of accounting for what was produced. It’s not the production (GDP) itself. Never was.

Say you produce 1 trillion in goods and services–thats GDP. You can measure it by summing total production or measure it by summing consumption and change in inventories. Either way it’s still 1 trillion in goods and services. (simplying matters by ignoring T, G and X-M but it’s still the same). You can consume 700 billion of your 1 trillion GDP and inventories rise by 300 billion. 700 plus 300 = 1 trillion. You can consume 1.1 trillion and it’s still 1 trillion. 1.1 trillion consumption plus negative 100 billion change in inventories is still 1 trillion.

You can consume 0 of it and inventories rise 1 trillion. No one ever said consumption was production.

Same goes for haircuts. Produce 1 trillion in haircuts and nothing else, consume only 1 trillion in haircuts and nothing else, and GDP is 1 trillion. The consumption is just a means of accounting for what was produced. It’s not the production (GDP) itself. Never was.

MICHAEL PETTENGILL
Aug 17 2020 at 10:48am
It’s like saying you don’t need the left hand of consumption to the right hand of production to clap.

Scott is the beat economist who merely snaps his fingers of production because he rejects the jokes about economists:

Harry Truman had a famous quip about economists. He said:

Give me a one-handed economist! All my economists say, ‘on one hand … on the other.’

Mal
Aug 17 2020 at 11:03am
“Say you produce 1 trillion in goods and services–thats GDP.”

There is no such thing as producing 1 trillion in goods and services. The value of goods and services is determined at the point of consumption, not production. Inventories have negative value due to storage and maintenance costs. Best example is oil pricing negative $47 per barrel recently but it is a universal principle. This is why all business tries to minimize inventory and move to just in time delivery.

Why does a pickup truck costs $70,000? Because there is a debt stock worth $70,000 available for consumer to allow him to consume this truck. When consumer takes out the car loan, that debt stock becomes income to the truck dealer. If debt stock available was $20,000, then thats how much the truck would cost. Availability of debt to fund consumption sets the value of goods and services, not production.

“You can consume 0 of it and inventories rise 1 trillion. No one ever said consumption was production.”

And if that truck was not consumed and went into inventories instead, its value would be vastly less next year, and the year after that, and then factory would close due to unsold inventory and GDP would drop to zero.

Zero consumption means zero GDP.

sk
Aug 16 2020 at 1:40pm
If i am to follow your correctly, the reduction in I is offset by the increase in C so your view is no change. Since C has hopefully a profit built in to it, that has to be taken in to account, does it not? If so, there seems to me to be a slight increase in C greater than I (inventory ) if one buys the C +I +G = GDP formulation. So, a small increase in GDP vs. just a pure measurement if I ?

MICHAEL PETTENGILL
Aug 17 2020 at 10:38am
Profit always reduces consumption, and thus production.

Speaking as an economist, not a businessman who calls his compensation and that of investors “profits”.

Profit is the result of scarcity, ie, lack of production to meet demand, the result of not paying workers to produce more. At least in economics in in my 60s youth.

MICHAEL PETTENGILL
Aug 17 2020 at 10:32am
Zero sum. Without consumption, GDP will be zero, because production will not produce without consumption demand.

Of all of economist’s factors of production, only land is relevant without consumption because hunter-gatherers and subsistence farmers do not trade, thus there is no consumption, and thus no production.

GDP can only be measured by consumer spending that pays workers to produce.

If robots replace workers in production, GDP will be zero because consumers will have no money because they are no longer paid to work so they have no money to create demand for anything that isn’t free.

Pierre Lemieux
Aug 17 2020 at 1:22pm
It is very simple. As Scott says, GDP is defined as production. See the BEA’s Measuring the Economy: A Primer on GDP and the National and Product Accounts (p. 2): “GDP measures the market value of the goods, services, and structures produced by the nation’s economy in a particular period.” It’s an internationally-accepted economic definition that is three-quarters-of-a-century old. Whatever analysis and interpretation are added to this, whatever the different means by which GDP is or can be calculated, whatever accounting identities are constructed around that definition, the definition remains–and indeed has to remain for all these addenda to make any sense. For a bit more, see my Regulation article “What You Always Wanted to Know about GDP But Were Afraid to Ask”.

robc
Aug 18 2020 at 8:16am
For example, only the value of a finished loaf of bread is counted; adding the value of the flour that went into the bread would be double counting since it is already accounted for in the price of the bread.

I don’t think this is right. When I buy flour from the grocery store, no one checks to see if I make bread from it, or waffles, or eat it raw (blech). I believe the intermediate good is counted in GDP. Same for eggs and butter and etc. I may be wrong (it happens from time to time) but I don’t think they are estimating the amount of home labor that is going into final goods and adding that into GDP. Maybe they are, maybe there is a multiplication factor for flour based on a average of the final value of the homemade goods, but my understanding was that this wasn’t the case.

I had a post that got eaten, but I made the same point wrt homebrewing. My understanding is that when I make beer, that is not counted in GDP, but the grain, yeast, hops, and water are. If I buy the beer however, that counts in GDP.

robc
Aug 18 2020 at 9:31am
My other reply wasn’t “eaten”, it was on the other thread on this topic! Oops.

Point still stands.



Pierre Lemieux
Aug 17 2020 at 1:48pm
Now, anything else can be defined in terms of, say, consumption, acne, and comets–call that thing “GSmurfy.” Perhaps GSmurfy will be useful to analyze problem X or problem Y: we’ll see and, if true, GSmurfy will become part of our toolbox. But GSmurfy will still not be GDP as defined for 75 years.

Comments are closed.

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