Home > Economics > Barreling headfirst into confusion over GDP accounting

Barreling headfirst into confusion over GDP accounting

November 11, 2011 Leave a comment Go to comments

And those who were seen dancing were thought to be insane by those who could not hear the music – FW Nietzsche

So, writing a lot on a topic I would be not surprised to find I completely misunderstand, at a time when more people are starting to read my blog, may seem like a foolish thing to do from a marketing perspective. But I really want to get my head around this. In my last post, I made a rather cryptic and ambiguous remark about the problem of distinguishing between ‘investment’ and ‘intermediate’ goods when calculating NGDP. To extend Bob Murphy’s example from the post that reminded me of my confusion, imagine I am a baker who makes bread by mixing flour and yeast in an oven. The flour and yeast are intermediate goods, and how much I paid for them are subtracted from the market value of bread that I sell in order to calculate my contribution to NGDP. Now, my purchase of the oven counts towards NGDP as a final investment good (right?) and because NGDP doesn’t factor in depreciation, by counting the oven as a final investment good rather than an intermediate good the oven’s contribution to my breadmaking does not get subtracted (Because surely otherwise subtracting depreciation to get Net Domestic Product would seem to be double-subtracting the role of capital goods in production…? That’s my rationale for thinking this, anyway).

If the above is correct, then whether or not we count something as a capital or intermediate good affects NGDP. Imagine that instead of raising flour in an oven, there was instead a magic heat powder that you mixed with the flour and yeast to make bread. Magic heat powder sounds like an intermediate good, not a capital good, and would be subtracted from the market value of the bread I sell when calculating NGDP. But if the magic heat powder cost the same and could produce the same amount of bread at the same rate as the oven, I really can’t see what the economic difference is here. If I am right, it seems when I bake bread in an oven NGDP is higher than if I bake bread with magic heat powder.

On this basis NDP (with correctly calculated depreciation, another conceptual minefield*) looks like a more consistent indicator than GDP. But that still doesn’t answer the question I posed yesterday, which is whether it is more relevant for macroeconomic stability when looking at targeting a certain level of nominal expenditure**. There seem to be (at least in my quite possibly confused mind) a number of deep conceptual issues with ‘final goods and services’.

Now, for the sake of my own sanity, would you please tell me whether you can hear the music?

_________________________________________________________________________________________________________

*Seriously, good luck with that one

**If someone who has more patience with government statistics than I do (occupational hazard) fancied charting up NNDP vs. NGDP over the last ten years, and note how depreciation was calculated, then that would be seriously awesome. As would looking at any past revisions made.

Categories: Economics
  1. November 12, 2011 at 2:20 pm

    Suppose a new oven costs $500, and lasts for 10 years of baking. Suppose a new batch of magic heat powder also costs $500 and is a big enough batch for 10 years of baking. GDP would be the same in both cases, if you treat both as an investment expenditure. And if you use straight line depreciation, so that one tenth of the oven and one tenth of the magic heat powder gets used up each year, you will get the same result in both cases for NDP. You subtract $50 depreciation of the oven, and $50 depreciation on the heat powder, from GDP to get NDP.

    Another way of looking at it: at the end of the first year, the $450 of unused magic heat powder in your stock of inventory is treated the same way as a slightly-used oven worth $450. Both are included in the stock of capital.

    But if both goods get used up *within the year* (the oven or magic powder are useless at the end of the year), then both would be treated as intermediate goods, I think. So GDP=NDP in both cases.

    What this suggests is that it seems to matter whether you calculate GDP by the year, by the decade, or by the month. Hmmmm. You get the same number for NDP in all cases, but different numbers for GDP.

    Here’s a simpler example:

    Assume a baker with 10 ovens, and he replaces one per year. GDP will be $500 higher than NDP every year. But now he only needs to buy one $500 batch of magic heat powder per year, which all gets used within the year, so GDP=NDP. Yet the two economies (the oven economy and the heat powder economy) look exactly the same in all economically relevant respects, as long as the baker keeps everything the same year after year.

    Hmmmm. I think you might be onto something. (But don’t trust me on this, because I’m not very good at this sort of thing).

    • November 12, 2011 at 3:36 pm

      Nick,

      I know, it’s very confusing! Glad to know I’m not the only one who’s a bit stumped. Also, as you will be able to tell if you read what else I’ve written, I am a huge fan.

      Cheers,
      Richard

  1. November 13, 2011 at 9:20 am
  2. November 13, 2011 at 11:41 pm
  3. November 14, 2011 at 9:36 pm
  4. April 12, 2012 at 10:35 am

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