All GDP all the time
Published by Ravikiran Rao February 27th, 2004 in EconomicsWe shall now continue our quest to calculate the GDP of our economy consisting of two people, me and Yazad. I shall now answer the four questions that were asked in the previous post.
The GDP here is Rs. 260. This is how:
Ravi: 70 rupees of value-from-wheat + 30 rupees of value-from-dancer = 100
Yazad: 70 rupees of value-from-wheat + 30 rupees of value-from-dancer = 100
Dancer: 60 rupees of value-from-wheat.
totalling up to 260 rupees.
That is one way of calculating the GDP, i.e by looking at the consumption. The other way is looking at the incomes, i.e.
Income earned by Yazad: 100 rupees
Income earned by Ravikiran: 100 rupees
Income earned by Dancer: 60 rupees
The two should match exactly, because all money has to go somewhere.
I think that in practice the GDP is calculated by the second method, i.e. by counting the incomes of people. That is because in a large economy it is difficult to keep track of final consumption. For example, if a purchase of diamonds is made, we don’t know whether it is being bought by an individual to display it in his showcase (in which case it counts as “consumption” and gets added to the GDP) or by a jeweller to be studded in a pendant ( in which case it shouldn’t, because that would be double counting. When a diamond studded necklace is sold, that gets added to the GDP) I am not sure about this.
This case is exactly the same as 1), except the “value-from-dancer” is replaced by “value-from-defence”. Now this is where problems crop up. If we really didn’t want the security provided to us by the gangster, the GDP should be 200 rupees (equal to the amount of wheat produced and consumed) But we don’t know really how much we value the protection, unlike case 2, where we know we together value it at 60 rupees. That’s the problem with the common defence and other functions provided by the government by extorting taxes from us. That’s the limitation with the way economists calculate the GDP. They use economic exchanges as a proxy for the value that people get and then forget the underlying assumption that this makes sense only if the economic transactions are voluntary. Economists calculate the GDP of this case as(And Gautam, no the relative price of rice and wheat don’t matter here because no one is exchanging rice for wheat.)
So now here is the question for today. I and Yazad get into an argument about the dancing girl. No, not the argument you are thinking of. I think that we are wasting our nation of three people is wasting money on frivolous pleasures. Yazad says, “Where is the wastage? From your point of view it might be a waste, but the wheat is going somewhere isn’t it? The dancing girl is getting employment and she is getting paid for it.”
So is there a wastage?
As usual, I am gonna sound off and then later say I stand corrected. But anyways, here goes.
I dont think there is a wastage in the sense that the dancer is doing a service and is getting paid for it, in Kind.
But on the other hand, the dancer isnot involved at all in the production of wheat and paying her wheat might be considered wastage.
But, going by real economic thoughts (i try to) it is not a wastage
I dont consider it ‘wastage’.
But there are some random thoughts floating in my mind.
This means that in an economy of 100 people if the basic needs of all 100 can be taken care of by the work of 10 people - then the remaining 90 can indulge in artistic activities and increase the GDP. In the example that we had - the needs of the three people in the economy (Ravi Yazad and dancer) was just 200 rs worth of wheat. But the increase in GDP was by paying the dancer.
Interesting..
Replacing the dancer by a thief(or some other problem maker) and assuming that Ravi and Yazad pay that problem maker 60 bucks just to ‘remain idle’ - ie - not create any problems, then it would mean that they have created a market for “remaining idle” and thus will increase the GDP by 60 bucks.
Does this sound plausible?
I’m too embarrased by my wrong answers to say anything. :-)
I am a little intrigued by Swami’s comments.
In the economy of 100 people—10 people are farmers. SO the remaining can devote time to artistic pursuits.
How will that increase GDP?
I mean, not all of their artistic efforts will be likeable.
SOme might be amazing failures in their art.
And which might mean that they dont sell. So how will the GDP grow that way?
Or am i putting the cart before the horse?
ravi, wouldn’t the GDP in case 2 be 200 if the guard’s service is considered as part of the production process? well it is 260 if the security service is considered as a ‘final’ service ofcourse!
since the security service is considered as a final service anyway, wouldn’t the GDP in case 3 be 260 too? ’cause GDP concerns itself only with the value of the service however artificial and forced upon it is. Ofcourse this is precisely what you were alluding to too.
In case 4, I thought the amount of wheat produced would be 30% less(30% less land!) than in the other cases which is why I thought the GDP would be 0.7*200+60..was I wrong with the assumption?
Ravi’s model has many errors, among them the way he describes “value” — I shall deal with it in a separate post.
I just want to disassociate with the “Yazad” in the model. Maybe Ravi (and others) can take the Zoroastrian angel Yazad instead of me in the model. He’s known to be the divine problem solver and can perhaps even solve Ravi’s confusion about GDP. :-)
Swami: I am pleased to see that my model is producing results. If you’ve realised that a measure of a country’s prosperity is not whether everyone does *some* work, but when people produce things that other people (or they themselves ) want, then I’ve achieved an objective here.
Ravages: They need not all turn into artists of course. They may do other things. The assumption is that they do things that people want. The best way to measure that is by looking at voluntary transactions.
digdug: Yes if you assume that the security guard is protecting the farm, Yazad is paying him 60 bucks and (and has cut my pay from 100 to 70 bucks) then your answer is correct. In that case, the value of the protection is already built into the price of the wheat. As for case 3, you are right. That’s how economists measure the GDP. I am just pointing out that there is a questionable assumption there.
As for case 4, I did mention that Yazad is growing rice on 30% of the land.
Gautam: Happens to the best of us. You double counted somewhere.
Yazad: What seems to be the problem? I’ve defined “value” as something that a person wantsand is willing to work for. I’ve pointed out that GDP is actually a proxy for measuring value. I’ve almost said that the GDP of a country like the USSR is 0 because there is no way you can find out whether the things that were produced were actually things that anyone wanted. I thought you’d like that.
Ravi - but my question is, do you consider the money paid to the thief as ‘wastage’?
1) Are you giving money to the thief voluntarily?
2) Does giving money to the thief make you happy?
If yes, then no. If no then yes.
My point was that when you aggregate accounts at the national level, it is difficult to find answers to such questions, hence to that extent GDP is deficient as a measure of prosperity.
“…hence to that extent GDP is deficient as a measure of prosperity..”
Good!
I think I am ready for the next lesson, if there is one…
Hmmm. And to think I spent a year studying Economics in college. More up your sleeve?
Ravi, in case 4, the way I saw it, wheat is being produced on 70% of the land and rice on the remaining 30%. The value of the rice produced is 60 Rs. but since wheat is being grown on only 70% of the land, the amount of wheat produced is 30% less than in other cases..so shouldn’t the value of wheat be 0.7*200 rather than 200?
Yes, but my question was related to the GDP not the value of wheat. The same transactions are taking place for rice too, though under duress.
looks like I’m missing your point..can you elaborate, please ravi?..or no…instead explain how you arrived the GDP in case 4 that should clear things up for me!
Sorry!
I just saw that I had mistyped the GDP as 260 there! It should be 200 and you are right :)
And its ages since I did any calculation in my mind. How on earth do you expect me to equate 0.7*200+60 to 200?
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