Wednesday, July 16, 2014

GDS vs GDP: Crude, but you get the idea

The snowplow hit our mailbox last winter. Broke the post. I went out and got a 2x4 and made a new mailbox post. The work was easier than I expected.

The other day I was looking for something in the garage. I found a 3-foot length of 2x4 left over from the mailbox repair. I kept it because... because you never know.

It occurs to me that the 2x4 I bought is a model of Gross Domestic Spending. The part of the 2x4 I used to make the post, well, that's the output, that's GDP, final spending. And the 3-foot difference, that's sort of like non-final spending.

If I had a customer that paid me for the mailbox job, my little metaphor would be more accurate. But as it is, I was the final customer. Mine was the final spending. My work was for my own satisfaction (according to the IRS) so I got no tax deductions for my spending. And my 3-foot leftover piece is just post-consumption detritus. Guess I could pay somebody to haul it to the dump, and that would add a little more to GDP.

What seems to bother most people about GDP is that it doesn't measure happiness. I think that's weird. What bothers me about GDP is that it ignores trillions of dollars of spending just because we get to subtract those trillions from our taxable income. So I invented Gross Domestic Spending (GDS).


The Arthurian said...

If I had a customer that paid me for the mailbox job, the whole 2x4 would have been non-final spending for me, part of GDS but no part of GDP.

Greg said...


Doesn't the guy who takes the cut up tree and produce a 2x4 get to count that 2x4 in GDP? So in that sense your payment for the 2x4 was a part of GDP......... no?

Greg said...

to continue form last comment;

your payment for the 2x4 was a part of GDP regardless of whether you used it to produce a mailbox or not.

Correct me if Im wrong

The Arthurian said...

Hey, Greg.

There are different ways of looking at it. You can figure GDP as income, or as spending, or as the value of output created, something like that.

Maybe the guy who cuts down the tree gets a dollar. And the guy who brings the tree to the sawmill gets a dollar. And the guy who cuts it into a 2x4 gets a dollar. And the warehouseman gets a dollar. And the retailer gets a dollar. So there are in total five steps, with one dollar added at each step.

This $5 of value added, or output, matches the $5 of income received by the several supply-side magnates. And the $5 also match the price paid by the final customer. If the customer pays $5, everything comes out even.

But if the customer pays $6, there is an extra dollar to be accounted. Perhaps the retailer keeps it. That's okay, but then four guys made $1 each and one guy made $2, so the total is $6 income and again it matches the customer's payment. It has to match, one way or the other, because money paid is money received.

So the "value added" method gives the same answer as the "income method".

Now instead of "final" spending, look at *all* the spending that we know about for this 2x4.

The clean and tidy way to think of GDP is to think of "final" spending: the last customer to pay for the thing.

The trucker pays the lumberjack $1, then takes the tree to the sawmill. When the trucker sells the tree he recoups the $1 he paid for the tree, plus he gets $1 for the value he adds to the process, or $2. So, so far $1 spent by the trucker and $2 spent by the sawmill. Total spending so far = $3.

The sawyer gets $1 for the value he adds to the product. Plus he has to get back the $2 he spent to buy the thing from the trucker. So he sells the thing (which now does look like a 2x4) to the warehouseman for $3. Total spending so far = $6.

The warehouseman paid $3 for the 2x4, and adds $1 value to the product for warehousing the product. So he sells it to the retailer for $4. Total spending so far = $10.

The retailer paid $4 for it and sells it to the final customer for $5. (The value added by the retailer was $1.) Total spending so far = $15.

So there was $15 of spending to produce the 2x4 that sold for $5. The $5 (the final price to the customer) represents the total value added. The $5 is the "final spending". The other $10 of spending was "non-final" or "preliminary" or "intermediate" spending. This non-final spending is the spending that is taken as income tax deductions.

One of the major costs that gets deducted is "cost of goods sold". In our case, the $1 paid by the trucker, plus the $2 paid by the sawmill, plus the $3 paid by the warehouse, plus the $4 paid by the retailer is all non-final spending.

1+2+3+4 = $10 of non-final spending.

That said, yes: my payment for the 2x4 is counted in GDP.

The guy who cut up the tree and made it look like a 2x4... if we are counting GDP by the output method, we can count the 2x4 as the sawyer's output. If we are counting final spending, we count the 2x4 as my final purchase. And if we count it as income, we have the $1 earned by each of five different guys.

So, measured three different ways, the three measures of GDP all have the same value.

But we cannot take my purchase of the final product and add it to the sawmill's output of the 2x4, because then the 2x4 would be counted twice. The purpose of the special accounting of GDP is to avoid double-counting.

But now suppose I was repairing the mailbox for a customer. I buy the 2x4 for $5 but now it is NOT FINAL SPENDING!!!. I do a little work, and my customer pays me $6. Of the $6, $1 pays for the value I added, and the other $5 is my cost that I get to write off.

Sorry, too many words.