GDP and GDI: Two Sides of the Same Coin (Theoretically)

One of the starting points for understanding macroeconomics is to understand basic measures of the economy and what we call the “circular flow” of goods and services.  The “circular flow” refers to the idea that firms are the economic “agents” who produce and sell all our goods and services for sale, and that households are the folks who consume those goods.  Of course in reality, both groups are made up of the same people, but we divide up the activities into firms and household consumption.  Given this division of activities into two groups, the circular flow is the idea that the groups both buy and sell to each other.  Households buy the products sold by firms, but households also sell their labor to the firms.  This is all good and it shows how interdependent firms and households are.  Firms can’t hire and pay if they don’t sell products, but households can’t buy those products unless they are able to sell their labor to the firms.

We generally measure the size of an economy by adding up the total value of all the goods and services that are produced and then sold.  This is what we call GDP – Gross Domestic Product.  GDP is the accepted way to measure the size of an economy.  The GDP number as observed and estimated each period is what should technically be called Nominal GDP.  It’s the starting point for estimating Real GDP.  Real GDP is GDP adjusted for changes in the overall level of prices – it takes the inflation/deflation out of the GDP numbers so we can compare GDP from different time periods.

The GDP numbers as reported by the government agencies is generally computed by observing and at times estimating how much spending happened.  In other words, it’s an attempt to add up the value of all final sales by firms of the products they produced.  A “final” sale means the product has been sold to someone who intends to use it up or consume it as opposed to reselling it or making it into an even better product.

There is however another way to estimate GDP.  Since the total value of what firms produce is the money the firms receive, then we could look at how that money is disposed of by those firms.  Put in other words, instead of looking at what households spend to buy goods and services, we can look at the income households received.  We could look at the other side of the circular flow.  When calculated this way, we give it a slightly different name: Gross Domestic Income or GDI.  Because of the circular flow, the two sides shoudl be the same.  In other words, in theory GDP should equal GDI.  In general and over the long haul they do.

Of course theory and practice sometimes differ.  On a quarter-by-quarter basis, GDI and GDP differ slightly because of difficulties in measuring precisely – what we call statistical discrepancy.  Occasionally the discrepancy is bigger than other times for reasons economists don’t fully understand.  The first half of 2011 was one of those periods.  So was 2007.  But as you can see from this graph (thanks to James Hamilton at Econbrowser), in general GDP does equal GDI.

 

Congressional – FAIL economics

In a previous post I noted that members of Congress usually don’t understand economics at a level to even pass a Principles Econ 201 or 202 course.  More proof from Pat Garafalo of Think Progress.  Apparently Rep. Shadegg of Arizona, a Republican representative for at least 5 years doesn’t understand that consumer spending is essential to the creation of jobs.  He believes that maintaining spending by unemployed people doesn’t have any positive effect on the economy.  Instead he believes in some kind of mythic “job creators” in our economy who apparently create jobs without any consideration of being able to sell what is produced by the workers!  Of course maybe the Congressman is simply a little behind in his reading.  I mean we only figured out this concept of a circular flow and the need for consumer spending to exist for there to be jobs recently, as in, oh, 1829 at the latest.

Rep. Shadegg Scoffs At The Fact That Jobless Benefits Are A Benefit To The Economy: ‘No, They’re Not!’

Unless Congress acts today, unemployment benefits will expire for 2.5 million Americans, with unemployment above nine percent and five unemployed workers competing for every available job opening. If Congress, as expected, does nothing, this will be first time in the last forty years that benefits have expired with unemployment so high.

According to calculations by the Congressional Budget OfficeMoody’s Economy, and myriad other economists, unemployment benefits are the single best way to pump money into the economy and generate economic activity, as the unemployed are very likely to spend all of the benefits they receive (thus moving money into local businesses). But during an interview with MSNBC’s Mike Barnicle today, Rep. John Shadegg (R-AZ) scoffed at the notion that unemployment benefits help the economy. “Unemployed people hire people? Really? I didn’t know that,” Shadegg jeered:

BARNICLE: What about the fact that unemployment benefits pumped into the economy are an immediate benefit to the economy? Immediate…

SHADEGG: No, they’re not! Unemployed people hire people? Really? I didn’t know that.

BARNICLE: Unemployed people spend money Congressman, ’cause they have no money.

SHADEGG: Aha! So your answer is it’s the spending of money that drives the economy and I don’t think that’s right. It’s the creation of jobs that drives the economy…Actually, the truth is the unemployed will spend as little of that money as they possibly can. Job creators create jobs.

BARNICLE: Have you ever been unemployed? Have you ever been unemployed?

SHADEGG: Yes, I have.

BARNICLE: What did you do with the money? Save it?

Watch it:

At the same time that he was dumping on the unemployed, Shadegg called for extending all of the Bush tax cuts without paying for them, joining a slew of Republican lawmakerswho care more about tax cuts for the very wealthy than unemployed Americans about to lose the last strand of safety net that they have available.

Shadegg never managed to explain why all of the job creators he cites would create any jobs if households aren’t spending money. In that vein, MarketPlace noted today that “when unemployment checks stop, it’s felt right away by businesses like gas stations, apartment operators, and grocery stores.” And as the Center for American Progress’ Heather Boushey and Jordan Eizenga found, “the workers losing benefits have an average weekly benefit of a little over $290 per week, which translates into a total loss of about $2.5 billion dollars in benefits over December. This is equal to about one in seven dollars of the gain in retail sales seen between December 2008 and December 2009.”

Multiplier in Action – The Circular Flow

As principles students learn early on, the economy is made of a circular flow of goods, services, and labor. Total spending becomes the $ firms can use to pay workers, which becomes income for those households, which in turn becomes more spending that supports more jobs.  The economy grows (and employment grows) when something injects an increase somewhere in the circular flow.  Then as the money flows around, it has  a multiplier effect.

Locally, if we focus on the mid-Michigan area, we can see that effect. Since GM added another shift some weeks ago to it’s Lansing Delta Township plant, it moved 400-500 jobs to Michigan from Tennessee (where is closed a different plant).  For Michigan, this is good news.  It’s not only more jobs here, but the people employed spend their income creating jobs for even more locals in stores, suppliers, restaurants, etc.  Most estimates put this multiplier effect from manufacturing jobs at around 1.5-2.0.  So, for every 10 new jobs in manufacturing the local economy will actually grow by 15-20 new jobs.