Nominal GDP is the sum of this year's output valued at this year's prices. The problem is that nominal GDP changes when prices change and when the quantity of output changes. We want to separate the desirable increase in the quantity of output from the undesirable increase in prices.
Real GDP is the sum of this year's output valued at base year prices. Prices from the base year are used to calculate real GDP for all years.
One way of measuring the improvement in living standards is to look at how much our productivity in making the goods consumed in the past has improved. How long do we have to work to earn enough to purchase the goods and services we consume.
Multiplication of Productivity 1895-2000
Time Needed for an Average Worker to Earn the Purchase Price of Various Commodities
|Commodity||Time-to-Earn in 1895 (Hours)||Time-to-Earn in 2000 (Hours)||Productivity Multiple|
|Horatio Alger (6 vols.)||21||0.6||35.0|
|Cushioned office chair||24||2.0||12.0|
|100-piece dinner set||44||3.6||12.2|
|Cane rocking chair||8||1.6||5.0|
|Solid gold locket||28||6.0||4.7|
|Sterling silver teaspoon||26||34.0||0.8|
Source: 1895 Montgomery Ward Catalogue
The contribution to improved living standards depends on what goods you value and what set of weights you use. If you do not read books, for example, then you would attach very little importance to any productivity gains in book production. Also, some 1895 goods are not equivalent to their 2000 counterparts. For example, in 1895 if you wanted music in the home you needed to own a piano. Now, a cheap transistor radio can provide music in the home. So, if the good is not "Steinway piano" but "music in the home" instead, then our productivity in providing that good has increased dramatically. And, suppose "sterling silver teaspoon" is really "flatware that will not rust". Then, our standard of living in terms of rust-proof spoons has risen a lot.
Let's use measured real GDP per capita. In 2000 dollars:
1900 $4,360 2000 $34,992
Real GDP per capita increased by a factor of 8 over the 20th Century. That's a growth rate of 2.1 percent a year.
However, that is surely an underestimate of the improvement in living standards.
If we use the Boskin Commission estimate that unmeasured improvements in quality and the invention of new goods and new types of goods have led standard measures to understate true economic growth by 1 percent a year, then (in 2000 dollars):
1900 $1,643 2000 $34,992
Living standards have improved 21 times during the 20th century. Living standards grew 3.1 percent a year on average. That's still without adjusting for the decline in the working year.
Real GDP per capita measures total output divided by population.
output output workers ------------ = --------- X ----------- population workers population
Output per capita depends on the (1) productivity of labor and (2) the labor force participation rate. Labor force participation rose over the 20th century as women entered the labor force in large numbers following World War II. More critical for living standards has been at least a 10-fold increase GDP per worker.
Productivity growth was especially rapid in the years following World War II through the 1960's.
|average annual growth|
rate of productivity
Computers may be responsible for the productivity improvement of the late 1990's. However, there is no single convincing explanation for the productivity slowdown of the 1970's, 80's, and early 90's.