Like many Principles of Macroeconomics courses, mine begins with an introduction to GDP. We motivate RGDP as a measure of economic activity and NGDP as an indicator of income or total expenditures. But how does more RGDP imply that we are better off, even materially? One entirely appropriate answer is that the quantities of output are greater. Given some population, greater output means more final goods and services per person. So, our real income increases. But what else can we say?
First, after adjusting for price changes, we can say that GDP underestimates the value that people place on goods and services that are transacted in markets. Given that 1) demand slopes down and 2) transactions are consensual, it stands to reason that everyone pays no more than their maximum value for things. This implies that people’s willingness to pay for goods surpasses their actual expenditures. Therefore, RGDP is a lower bound to the economic benefits that people enjoy. Without knowing the marginal value that people place on all quantities less than those that they actually buy, we have no idea how much more value is actually provided in our economy.
Second, consider some more micro fundamentals. Maybe you know what happens to price and quantity when supply and demand change. But do you know what happens to the ‘areas’, such as consumer surplus, producer surplus, willingness to pay, total expenditure, and total variable cost? How well-off people are is reflected by the size of total welfare, or the sum of consumer and producer surplus. If either supply or demand increases, then the quantity transacted increases. But it’s also true that *both* consumer and producer surplus rise. This is a really robust outcome. It’s true so long as demand slopes down and as supply slopes up. Even if either of these bedrocks are violated, it merely limits the gains to demanders or suppliers rather than both. Therefore, greater quantity transacted is always associated with greater welfare. It’s not that macroeconomists are just obsessed with producing more stuff. Rather, more goods and services imply more social welfare.
Third and final, as we know, consumption isn’t everything. People enjoy leisure too. Each moment, people decide how they want to spend each additional increment of time. If people spend more time consuming goods and services, or working, then it must be the case that they prefer that over leisuring – on the margin anyway. Therefor, a higher RGDP implies that people are compensated more for their leisure when they choose to work. The implication is that, if leisure hours remain constant, then people value their leisure more now than ever before. So, higher RGDP implies not only that people obtain greater value of consumption, but also that they enjoy their leisure more too. It’s pretty hard to measure the entire demand curve for leisure. So, we’re again left knowing that there are unobservables whose existence implies that RGDP underestimates the value that people enjoy.
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