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.

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