GDP Calculation cont’d
Published by Ravikiran Rao February 11th, 2004 in EconomicsI am glad that I waited for a day before coming up with the answers. The wrong answers provide ample support to my hypothesis. To clarify, what I am trying to prove here is that:
- Economics is not that difficult to understand if you try to understand it the way physicists and engineers understand and explain their fields, i.e. by building simplified models to make sense of reality and gradually refining them to gain a better understanding.
It is not true that the messiness of the real world ensures that Economics cannot be understood that way.
It is the economists’ fault that Economics is not explained that way.
The weird way in which Economics is learnt ensures that even educated and intelligent laymen lack a conceptual understanding of Economics in a way that would never be possible with educated and intelligent laymen vis-a-vis basic Physics. This lack of understanding shows up in a lot of debates and decisions.
200 “rupees” is the “right” answer and here is why.
I am buying hundred bucks worth of wheat from Yazad, so I am getting 100 rupees worth of value. Yazad too is getting the same amount of wheat, and we are assuming that he is getting 100 rupees worth.
To clarify why we are doing this, suppose that instead of working for Yazad, I were working for Yazad Inc, with Yazad as its manager-cum-only shareholder. So Yazad gets a dividend-cum-salary of 100 bucks from his company which he uses to buy wheat. Although nothing has changed, the ostensible GDP of our economy would have doubled. To avoid this, we need to try to measure this transaction too.
This example is trivial, but it already illustrates many issues in Economics.
GDP is not a measure of goods produced. It is not a measure of money spent. It is a measure of value added. We use the 100 rupees I pay as a proxy for “the value I get from (say) 100 kg of wheat”. Yazad may (notionally or in reality) pay the same amount for the same amount of wheat, but is he getting the same quantity of wheat? Can the value I get and the value Yazad gets really be added? This problem is already kind-of covered, but the GDP does not measure non-monetary value. For example the value I get from wheat is that I can convert them into chappatis and eat them. As long as I am the one grinding the grain for myself and making the chappatis, the activity does not enter into the GDP. If I outsource the making of chappatis, obviously I am doing so because I have better uses of my time, but the increase in GDP is nonetheless overstated because we weren’t measuring the value-added earlier. Rather than state the third point, I will pose another problem. What will be the GDP be in the following cases? They cases are mutually exclusive.
Because we get bored in the evenings, I and Yazad hire a dancer to entertain us. (Just assume that she materialised out of thin air, like an Apsara.) I pay her 30 bucks which she uses to buy wheat and Yazad pays her 30% of his share of wheat (which of course translates to 30 bucks worth of wheat).
We hire a security guard to defend us (he too materialises out of thin air). I pay him 30 bucks which he uses to buy wheat and Yazad pays him 30 bucks worth of wheat.
A gangster turns up and extorts 30 bucks from me (which he uses to buy wheat from Yazad) and 30 bucks worth of wheat from Yazad. The gangster promises not to kill us, and also protect us from other gangsters. He keeps his promise.
A gangster turns up and extorts 30 bucks from me. He asks Yazad to grow rice on 30% of the land. He uses my 30 rupees to buy half of Yazad’s rice and gives it to me.(The other half of rice, Yazad consumes) I don’t like rice as much as I do wheat.
I didn’t quite get what you meant by “..but is he getting the same quantity of wheat?” in #1
3.1) 260?
3.2) 200 if you count the gaurd as part of the production activity.
3.3) not any different from (3.2) from an ‘economics’ perpective.
3.4) 0.7*200+60 –making the necessary assumptions.
by the way, is the gangster a veiled allusion to the government?
No its an open allusion to the government.
Sorry I meant: “Is he getting the same value out of the wheat?”
what about the answers ravi?….not as sure about them as I was the last time..hehehe..atleast lemme know how many I got right!
Incidentally Ravi, the way you claim Engineers or Physicists would see the economy, is exactly the way that most economists see the economy, and your model is overly simplistic, which is its virtue when trying to get a clear cut answer, but introduce the complications of multiple sectors, consumer spending, investment, government taxation and spending(The leaky bucket), infaltion, trade in goods and services, entreport services, foriegn exchange, and you just begin to complicate the macro model without even trying to introduce the micro issues which help determine these macro indicators. Yazad ofcourse will at this point say “Bah.. you are all Keynesians!!” and storm out of the room :-). Arbitrarily confusing Economists who do say exactly all these things with Policy makers who ignore all the caveats of the economists, is a common sin, for which absolution is easily obtained :-).
A question for the quiz master, if engineers know how to understand the economy and resolve its problems how come despite their methedological takeover of economics, they have not been able to resolve the problems faced by economies?
The Answers:
3.1 Ravi was paid 100Rs. he spent 30 on Apsara, and was now left with 70, which he used to buy wheat worth 70 Rs. from Yazad who now only had 170Rs. worth of it left. so the final accounts are
Ravi: 70 Rs. in wheat
Yazad: 100 Rs. in wheat
Yazad: 70 Rs. in Rs.
Apsara: 30 Rs. in wheat
Apsara 30 Rs. in Rs.
National Income: 300Rs.
Assuming ofcourse that Apsara continues to exist in the economy.
3.2 Same as above, except Apsara turns into Security Guard (KLPD) :-P.
3.3 If the Gangster remains in the economy then he has no effect on the economy except that he has reduced the choice that ravi and yazad can exercise with their money, in the previous case they could have fired the security guard, but they can’t fire the gangster, and as such they are worse off. but Income has not been affected provided the gangster continues to exist in the economy and does not take the loot out of it.
3.4 Here is where your analysis gets complicated, till now you have just had one unit of value and one commodity, but with the introduction of rice you now need to have a relative price of rice and wheat(well there was also Ravi’s Labour and we have received information that it is the equivalent of Rs. 100 in wheat). Since rice is scarcer than wheat it should be more expensive, but if it is perfectly substitutable by wheat, then the price of both will be the same. Here we introduce an important factor that cannot be addressed in the calculus induced euphoria of neoclassical economics (though of late Consumer Choice theory has grown more liberal) - Instituitions, tastes and habits. If Ravi is a wheat eater and Yazad is a rice eater, then both will value the respective commodities, and Ravi maybe willing to spend more on buying wheat while Yazad may increase the reservation price for rice. The more products you add, and the more people and choices the complications of the model grow concomitantly.
All this is before we introduce the Gangster. Here the accounts go like this assuming 1kg rice=1kg wheat
Ravi: 70 +30 = 100Rs.
Yazad: 140+30+30-100 = 100Rs.
National Income = 200Rs.
I maybe wrong on all counts but I don’t think there should be any mistake.
Answers from this novice…
1. 260
2. 260
3. 200
4. Unable to say anything concrete.