Edward Lotterman: How my lunch contributes to gross domestic product | Edward Lotterman's columns | Idaho Statesman
Most people who follow national news have a general idea of what is meant by gross domestic product, but they don’t understand all the details.
That is as true for many reporters as for the general public. This causes confusion and leads to misunderstandings. Unfortunately, such misunderstandings amid the ongoing financial crisis tend to promote bad policies in the long run.
I saw an example of this on TV recently in an exchange between a business reporter commenting on post-Thanksgiving sales and a network anchor. The reporter had noted that household consumption of goods and services accounts for about 70 percent of total GDP. The anchor inquired about activity in other sectors of the economy like manufacturing and agriculture, where there are positive signs. The reporter answered that yes, growth in these sectors might be good for GDP some day but that for now, consumer shopping was the key driver.
That answer, partially wrong and partially right, missed a key point. Increases in output by manufacturing and agriculture already show up in GDP. But they are incorporated into one of the four categories tabulated: consumption, gross investment, government and net exports. They are not being ignored. If a farm or factory turned something out in the third quarter of 2010, it shows up in the GDP figures for that period.
The confusion stems from the fact that GDP measures the total market value of all final goods and services produced in an economy. The adjective “final” means goods or services in the form in which they ultimately are used.
The objective is to avoid double counting. Take the ham sandwich I am eating for lunch as I type this. Some farmer bought fertilizer, seed, diesel fuel and other inputs to grow wheat. The wheat was trucked to a flour mill. The mill produced flour and other byproducts. Someone transported the flour to a bakery that made rolls that were trucked to a grocery where we bought them. I’m finishing up the last one with a nice slab of ham and some mustard.
GDP just counts the value of the bun that we, the consumers, bought. It does not count the fertilizer, seed and diesel fuel, plus the trucking plus the flour. If one double-counted such production inputs or “intermediate goods” at all stages of the production process, one would drastically overestimate the goods and services that are actually available to meet the needs and wants of people in our society. And that is precisely what GDP is meant to measure.
The preceding few paragraphs give the gist of an early chapter in any introductory macroeconomics textbook. It oversimplifies a bit. Government statisticians don’t measure just the value of the bun. They actually measure the “value added” at each step of the production chain. So they look at the value of wheat minus the value of inputs the farmer purchased, the value of flour minus the cost of wheat and the value of the bun minus the cost of flour and other bakery supplies. All of these “values added” should sum to the amount of money that we paid the grocery store for the final good.
Thus, if a mill produced flour, a baker buns, a refinery diesel fuel or a farmer wheat from July through September 2010, those increases in value show up in third-quarter GDP.
Therefore manufacturing, which is picking up, and farming, which is doing relatively well, already are fully represented in this key economic indicator.
Note other points. GDP measures the “market value” of final goods. So if world demand — or drought — drives up wheat prices and hence prices of flour, buns and fast-food sandwiches, GDP will increase in its most basic, or “nominal” tabulation.
“Nominal” means “not adjusted for inflation.” Adjust for inflation using a price index that covers all items included in GDP — not just the consumer prices covered by the more familiar Consumer Price Index — and you get “real” GDP. It is changes in real GDP that are headlined in news articles from competent media sources.
This does not mean that all price increases are filtered out. If farm product prices increase 10 percent while average prices for all goods average only a 2 percent increase, the value added to real GDP by agriculture will be higher than in the prior period.
A second point is that a given product, such as a hamburger bun, could show up in more than one of the four GDP categories. One tray of buns leaves the bakery and goes to a grocery five blocks up the street from my house. That tray represents “consumption.” The next trays out of the oven go to a public school kitchen three blocks in the other direction and are called “government.” Other trays go out of town, including some delivered across the border to Ontario, Canada. Those trays contribute to “net exports.” And if successive ones end up at the fast-food hamburger joint six blocks south, they are not final goods, even though the value added at the bakery counts. The actual sandwich placed on the customer's tray is a final good.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.
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