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Video transcript

in the last video we took a look at what is probably the simplest possible economy and it's not even clear that this economy is even possible this one-person economy but to make it more analogous to the real world where we have households and we have firms in this one island this guy set up a firm and he essentially leashed out all of the factors of production to that firm including his own labour he leased it out the rent on his Labor's essentially his wages and then he bought all of the goods and services he needed from that same firm so his payments would his expenditures would be the revenue of that firm and then the revenue of that firm would be turned into the expenses and the profit of the firm so whatever the revenue wasn't using expenses would ended up being profit and then all of that went back to that one household as income and when we talked about how would we measure the economic activity in this island right over here how would we measure its gross domestic product we said well look we could measure in multiple different ways we could when is as its leaving his hands the dollars and it's going to the firm you could view it as the total expenditures or as its approaching the firm that's the same thing as the total the total revenue for this firm total revenue for this simplified one one firm economy and that total revenue is the same thing as the total expenses plus the profit for that firm and that's the same thing as this one households income and so let me write this down the way we looked at in the last meeting that very simple example GDP is was equal to household household expenditures which was equal to firm firm revenues which was equal to firm expenses expenses plus profit which is equal to household income household income household I'll just write Inc for income household household income and of course household income is then at least in this case right over here it ended up being equal to household expenses what I want to do in this video now is think about it in more general terms let's extend it to a more calm flex economy to the world we live in and with that I want to look at the more formal definition for GDP so this is the more formal definition of GDP or I could say the definition of GDP and it's the market value of all final goods and services and we're going to talk about with each of these things mean of all of all final goods and services all underline all separately all final goods and services let me do that in a different color all final goods and services produced within a country produced within a country in a given period so you can have a GDP for a month you could have a GDP for a quarter of a year which would be three months or you could have the GDP in a given and a given year and I guess you could even have GDP over a ten-year period but it tends to be we always think of GDP in terms of annual GDP or quarterly GDP or sometimes even so there's some estimates of even monthly GDP but it tends to be annually or quarterly but let's parse it a little bit more because these little terms can be interesting so the first one I like to parse is the idea of market value market value what this is saying is well we need some way to measure what we've produced and the best way we can do it is say well how much benefit are people getting it and what they're willing to pay for it in the market is the best way that we can measure how much benefit they're actually getting out of it so for example if if some1 if in the in the year in the year I don't know a if someone if an avocado was produced if an avocado is produced in some farm and also a an orange is produced in an orange is produced we won't say that for each of these you won't say Oh GDP is increased by one fruit we look at the market value for it so if the market value of this avocado is $1 and the market value of this orange is 50 cents is 50 cents then by producing this fruit the market the GDP has increased by 50 cents by producing this avocado it's per Dubin its gdp has increased by $1 now in the next year maybe there's maybe there's whatever demand for avocados goes down or whatever and people pay less for it and the market value of this of an incremental avocado is $0.50 then in the next year even though the actual number of fruit that was produced is the same as the previous year now of a sudden the contribution from avocados might be the same as a contribution from oranges so it really depends on the market value and then we can focus on this all the market value of all goods and services all goods and services so we would do all the different avocados and oranges but we would do computers we would do cars we would do tires and we're doing services so if you have a if you have help at home if you go to the doctor the market value of all of those things are going to be put into GDP now this won't include some things so this does not include this does not include illegal things if someone sells someone else drugs we're not keeping track of it some would argue that maybe it should be kept track of in some way that you have kind of this black market in in things but you're not keeping track of illegal illegal activity and you're also not keeping track of goods and services that are produced within the household and consumed within the household so for example if if well if if you hire an outside person to babysit your children your child that would be considered part of GDP that is a service that you are paying for but if you yourself is are babysitting your children that is not going to be considered in GDP if I start a lawn mowing business and I go mow other people's lawns or late maybe before my wife and I were were dating she used to pay me to mow my lawn then it would be included in GDP but maybe once we get married I just mow her lawn out of because it's my well we're the same family now then it will not be included in GDP but all does include pretty much everything that can be tracked anything where someone is is is there's an exchange of money there's some payment between two parties for that good or service now a really interesting thing this is something that I used to find confusing when I first got exposed to GDP is a whole notion of final goods and services and to understand this let's think about let's think about how genes might be produced so you have you have a cotton farmer a cotton farmer and there's some service that needs to be performed so whatever you know some farming some labor that needs to be performed and let's say that that is five dollars of labor and let's say that some land has to be rented so let's say that that is five dollars of well I'll just make it a different number four dollars of land four dollars of land and there are other inputs but we don't have to go into all the details and with that and there's going to be some electricity and things like that but we won't count all of it you can produce some cotton just to plant cotton you can produce you can produce some cotton some raw cotton and that raw cotton is worth the market value of that raw cotton is worth let's say it's worth ten dollars so it's ten dollars worth of raw cotton and then you could take that raw cotton you could take that raw cotton and you could combine it with some more labor with some more labor so let's say you combine that with another I don't know six dollars of labor six dollars of labor and it would also probably require some machinery and electricity and things like that but I won't factor all of those things in just now we don't need them to kind of get the point across and if I do that if I combine the $10 this kind of intermediate good with the $6 of labor then all of a sudden I can produce cotton thread I can produce I can produce cotton thread and that cotton and the worth of the market value of that cotton thread let's say is now twenty dollars is now twenty dollars and maybe there's another intermediate good there maybe it's some dye let's say it's well we'll put the dye in later let's do the dye in later so I have a twenty dollar thread and let's say I could take that $20 thread I could take that $20 thread I'll make it well let me keep stay with white just cuz I started there I could take that $20 thread and I could throw put in some more labor maybe I could take ten dollars of labor ten dollars of labor and then I can essentially create it'll essentially create $30 worth of $30 worth of cotton fabric $30 worth of cotton fabric and then I could take that $30 worth of cotton frappe Rick $30 worth of cotton fabric plus some more labor so let's say another five dollars of labor five dollars of labor and let's say we also are going to put in $1 of dye $1 of dye right over here and in the process I can create I can create the market value let's say this is $50 worth of blue jeans $50 worth worth of blue jeans blue jeans and I do this and I do this all over the course of the year so the period in question so the period for this one I'll assume it's the period as a year so it's all happening over the course of the period in question so maybe it's happening we're talking about the GDP in 2012 this is all happening in 2012 so what would be the contribution to GDP if we didn't have the word final here we just said the market value of all goods and services then we would add this $5 to this $4 to this $10 to this $6 and we would because of the production of this jeans we would get a very very large number a very very large contribution to GDP but that would be not even double counting that would be triple or quadrupling or quintuple counting the value that's actually being created because all of this values essentially being accounted for in this end $50 so the actual contribution to GDP you would only put the final good so you wouldn't include all of these other intermediary goods and services you would just say this whole chain of event results in a $50 a $50 increase in GDP and in another video we'll talk about well what happens if they don't get to this point during the course of the year if we just if we kind of stop at one of the intermediary goods but assuming you get to this point you just include the final good in GDP now this last part of it is produced within a country produced within a country and this is you know you might have heard GNP gross national product and that's the main difference GDP says if we talk about let's say we're talking about the United States so that's my best attempt at drawing the United States GDP says look if it was produced inside the country if it was produced inside the country we don't care who it was produced by it could have produced been produced by someone from Mexico it could have been produced by someone from Canada it could have been a factory that's owned by the Chinese but if it was produced on within the borders of the United States it gets counted as GDP it gets kind of as GDP if an American if an American who's an American national goes overseas and produces something that is not counted as GDP if an American owns a firm in another country and that other that firm the other country produces something that is not the GDP when you focus on people's nationality that is GNP so not to confuse things but if you're if you want to focus on GNP then you do care about the earnings of American nationals and so you wouldn't count the Canadian but you would include the American who's making money overseas so GDP fairly simple idea you say what's being produced within these boundaries we don't care who's doing the producing and what their actual nationality is and we're going to ignore production by that nationality outside of these borders