If I get it right, GDP means value that is produced in some territory over some time. This value is measured in money. But how exactly should I understand that “value”? Is it relative value, in relation to other markets, or is it real value? For example Holywood produces a film. Production would cost 5 million dollars, but it will generate 55 million dollars, so the gain is 50 million. Does this increase GDP by 50 million? (consider that the film is aired in isolated market i.e. no money comes from foreign countries… in other words it is filmed in the USA, aired only in the USA, and only relates to the USA GDP) If that is true, where do the 50 million come from? Is that money somehow generated out of the thin air and put into circulation, and thus increase life standard in the country?
In your example, the movie contributes 55 million dollars to GDP, i.e., the total price of sales to consumers. The $5 million that the movie cost to make is included in that, but not counted twice. So, for example, the cost of supplying food to the cast and crew while making the movie is not counted in GDP, but the price of the soda and popcorn sold in cinemas is included in GDP.
Actually, my understanding is that GDP counts all $60 million (provided that it is all “domestic” as the OP specifies). GDP counts up all expenditures, so $5 million of production costs is just as much an expenditure as $55 million of ticket sales.
No, GDP is total value of all final goods and services produced in a country within a time period. The production expenses are intermediate goods, and so their value is assumed to be counted in the value of the ticket sales.
The important thing to remember is that GDP measures what is produced. What was added to GDP was not $55M, but one movie, valued at $55M. For example, the value of living in a house is counted into GDP even if the house is owner-occupied and no rent is being paid to anyone. Other non-financial transactions are excluded simply because they are so hard to see/assign a value to: if we could count them, we would. Since we can’t, we just hope they remain fairly steady as a percentage from year to year, so as not to screw our comparisons.
This is why when someone buys stock, it’s not counted in GDP: nothing new was produced, ownership simply changed. But when their broker buys the stock, we do count that service–and we value it at whatever they paid the broker. But it’s the service, not the payment, that we are tracking.
So does that mean that new $55M are somehow introduced into the system?
Also, are there factors that decrease GDP? For example if I buy a bag of potato chips and eat it, is the value somehow lost from the market?
If the house burns down, is the value of living in it lost and result in negative contribution to GDP?
Apparently, it’s not a simple question. But the BEA (Bureau of Economic Analysis) - more or less the recognized authority on such things - has thoughtfully provided a fairly short primer on the subject. Measuring the Economy: A Primer on GDP and the National Income and Product Accounts.
That depends on what you mean. If you mean “value” is introduced, that’s fine. If I can make a movie for 5 million, and sell 55 million worth of tickets, then that is a helluva lot of value added.
If you mean money, then no, not necessarily. No new “money” necessarily has to be introduced into the system. When we’re measuring GDP, we’re measuring how much existing money is being passed back and forth.
Imagine the system like a bunch of plastic soda pop bottles, connected to each other with a series of tubes. Each plastic bottle can represent how much money a person holds. There’s a bottle with my name on it, and a bottle with yours. I go to the grocery store and buy something – money flows from me to the grocery store. In this plastic tube system,* you can see the water being pumped out of my individual plastic bottle (my own money holdings), and into the plastic bottle of the grocery store. There are many such places where I make purchases, so there are many small streams of water out of my personal bottle.
There is in addition a tube where a whole lotta water flows into my plastic bottle. This is the income I receive from my job.
There is no absolute need at this point for us to “introduce” new money into the system. (Important in real life, but not necessary for visualizing this particular process.) Water is being pumped from bottle to bottle based on the choices that individuals make. A company somehow raises enough money to spend 5 million on a movie – that means they convinced people to give them the money to start their enterprise: 5 million flowed into their bottle from investors with a lot of cash on hand for such things, and then that same 5 million flowed back out again to pay for actors, cameras, film, screenwriter, director, lighting, set design, etc. And then? The movie was successful. It sold 55 million worth of tickets.
GDP, as Manda JO has already mentioned, is a measure of the flow of money for final goods and services. Notice: it’s not a measure of how much water is in the bottles. Instead, it’s a measure of how much water flowed from bottle to bottle for the specific purpose of purchasing final goods and services.
The total amount of water is not a restriction on the flow. We could have half the water in the system, but if the flow of the water was twice as fast, then there would be no change whatsoever in GDP. We want to have enough water to facilitate the flow of transactions at any given time, but ultimately it’s the real production of stuff we care about, not how much water exists in the system.
*If you’re familiar with the Discworld series, there’s an object called the Glooper that is basically this idea. And the Glooper itself was based on Bill Phillips’s analog computer from 1949.
There are no factors that decrease GDP.
GDP is gross, not net. We don’t subtract anything. It’s right there in the name.
Again, no. Look at the words behind the acronym: Gross Domestic Production. GDP is an attempt to measure production, that is, how much stuff we make. It’s a measure of domestic production, which is, stuff that we make inside our country’s borders. And it’s a gross measure of production, not a net measure.
NDP, or Net Domestic Product, would be an attempt to measure the flow of all the new stuff created, MINUS the flow of lost value of all the old stuff that is destroyed. Hence “net”, instead of “gross”. Theoretically, this would be superior to GDP, and while there are some half-hearted attempts to measure NDP, nobody really takes them seriously, including the very people who try to do this. It is way way too hard to measure. It’s fantastically easier to measure the value of new goods and services, the gross production. Why? Because every time we make purchases, we provide an easy sticker price. We can value new items at precisely how much people were willing to pay to purchase those items.
If we were trying to measure net production, then we’d need an accurate price tag for all the destruction out there in the world, all the depreciation that has occurred. We know the price of a new factory: it was how much money the company spent purchasing the building and the industrial equipment. We can just look at the flow of the water in the bottles for that: when they bought the equipment, money flowed out of their bottles and into other people’s bottles. Easy to measure.
Although we also know that those robots get old as the years go by, that the value depreciates, we can’t say with anywhere near the same precision about how fast they’re depreciating. We can’t honestly answer that. We can’t look at something simple like water/money flow to answer that question. Even big industrial companies themselves can only make an educated guess. (Add to that the fact that the accountants always want to depreciate the value of the equipment as quickly as possible for tax purposes, and the idea of “depreciation” becomes even more hairy.)
So no. If you buy a new house, we know exactly what the house cost when you purchased it, so that counts as part of GDP. That happens a single time. If the house burns down, it doesn’t show up in GDP since GDP is a gross measure and doesn’t care about destruction. (The “rent” from the house is counted year after year, but the construction of the new house is counted only once.)
We don’t really know for absolute certain if your house is increasing or decreasing in value every year, not until you actually sell it. We could make an educated guess, but we don’t generally bother with that. Yes, it’s true, a house that burns down is huge loss, a genuine loss, but it’s just too difficult to measure all of those losses out there in the world. The loss of a house burning down would be counted in NDP in ideal circumstances, but we don’t live in ideal circumstances and we don’t have the data gathering skills for a truly accurate measure of NDP, so we don’t generally bother doing it. We use GDP instead.
Zapp S, Manda JO did give a very good definition of GDP – “GDP is total value of all final goods and services produced in a country within a time period.” However, I do think the definition of all final goods and services would be helpful in fully understanding this issue. In his book “Introduction to Macroeconomics, fifth edition” Edwin G. Dolan defines Final Goods and Services as “Goods and Services sold to or ready for sale to parties that will use them for consumption, investment, government purchases or exports.” Consumption is spending on goods and services by households for immediate use, except for purchases of private residences; Investment are purchases by businesses of the means of production that are created by people (tools, equipment, structures, software, etc.) plus purchases of private residences, it does not include purchases of stocks and bonds (purchases of stocks and bonds are considered savings in economic theory); Government purchases do not include transfer payments such as unemployment, social security or public assistance benefits; Exports are final goods and services produced in one country, but purchased by people living in another country. Since Consumption, Investment and Government purchases could include Imports (final goods and services produced in another country, but purchased by people living in this country) one way that GDP is calculated by adding Consumption, Investment, Government Purchases and Exports, but subtracting out Imports.
So, what is important is where the movie is made and not where the movie is seen. If the movie is shown in Canada, but was produced in the United States the revenue received by showing the movie in Canada adds to the GDP of the United States. The revenue from the showing of the movie in Canada would be added to the GDP of the United States under Exports.
You also mention relative value and real value. In economics the term “real” is applied to values that are adjusted for the effects of price changes, while the term “nominal” is applied to values that are not adjusted for the effects of price changes. So, an increase in Real GDP means that the economy has produced more final goods and services and so using Real GDP the amount being produced in two different years can be compared.
But, what is the value of a final good or service? In regard to the definition of GDP the value of a final good or service is the price of the final good or service when it was purchased in a market. So, to be included in GDP a final good or service would have to have been purchases in a market. Let’s say that a person owns the residence that she lives in. If she buys paint and paints the house herself then only the price of the paint and not the value of the labor is included in GDP. However, if she hires someone to paint the house then both the price of the paint and the price of the labor is included in GDP. These additions to GDP are only for the year in which the good or service was produced. A house built in 1950 only adds to the GDP for 1950.
Further, Hellestal gives an excellent explanation as to why in your example no new money is involved.
As to value an understanding of producer and consumer surplus can be helpful. Producer surplus is the difference between the price of a good or service and the minimum amount that the seller would be willing to sell the good or service for. Consumer Surplus is the difference between the maximum that a buyer would be willing to pay for the good or service and the price paid.
For example, let’s say that a person wants to sell a TV set and that the minimum they would be willing to sell it for is $10. Also, let’s say that another person wants to buy the TV set and the maximum they would pay for it is $50. In this case a deal for a voluntary exchange can be made, as long as the price is $50 or less, but $10 or more. Let’s say that the price is $25. Then the producer surplus would be $15 and the consumer surplus would be $25. The increase in the value of the TV set (not the same as value added in the case of GDP) just due to the exchange would be $15 plus $25 or $40. This increase in value is equal to the difference between the maximum the buyer would pay and the minimum the sell would take no matter what the price was.
Tom,