Abuse of language

3:10 AM at this writing, and already the day's not a total waste. Good omen!

I searched FRED the other day for UK real gdp and sorted the results by "Obs Start" to see the ones that go way back in time. That's how I found the "Hodrick-Prescott (HP) Filtered Log of Real Gross Domestic Product at Factor Cost in the United Kingdom" graph we were looking at yesterday, the one with alternating periods of moderation and hyperactivity. That's the graph that made me say "I don't know what the hell this graph is."

That was the first item in the sorted search results. (The "Obs Start" is 1270.) The next two items  (Obs Start 1700) were these:

• Real Gross Domestic Product at Factor Cost in the United Kingdom, and
• Real Gross Domestic Product at Market Prices in the United Kingdom

What the hell... I thought I knew what Real GDP is. But what's this "factor cost" and "market prices" stuff? And when you figure "real" GDP, don't you start with GDP "at market prices" and then take out the inflation? ???

I've run across those two items before, and they stopped me dead in my tracks. This time I made the bold move and Googled define real gdp at factor cost. The blurb-in-the-box that came up said

Definition of 'Real Gdp At Factor Cost' Definition: Real GDP is the nominal GDP after adjusting for any price changes attributable to either inflation or deflation. ... This measure is called the Real GDP or the GDP at constant price. It does not factor taxes and subsidies.

That, from The Economic Times. Doesn't seem right, though. Their last sentence throws me. At the site, they give a definition:

Real GDP is the nominal GDP after adjusting for any price changes attributable to either inflation or deflation.

Yeah, I know about that. But I never heard that Real GDP "does not factor taxes and subsidies."

Following the definition, they give a description:

Nominal GDP or the GDP at current price can present a distorted picture of the actual growth in GDP owing to price changes. However, if we consider the price of base year as constant and compute the GDP growth rate of the current year using that constant price, the value so arrived at will give a true picture of the actual growth rate in GDP. This measure is called the Real GDP or the GDP at constant price. It does not factor taxes and subsidies.

Again, I know about that. I know that whole paragraph, right up to the last sentence. But then suddenly they tack on that last sentence: "It does not factor taxes and subsidies." First I thought they meant "It does not exclude taxes and subsidies." Now I wonder if they mean "It does not include taxes and subsidies." But either way, I never heard this qualification before, modifying the simple conversion of nominal to real values. It just doesn't seem right.

Under "People also ask" in the Google search results, the first question was "How do you calculate GDP at factor cost?" That might clarify things, I thought.

Yup. The link is Measuring Output Using GDP. First thing they say:

Gross domestic product is the market value of all final goods and services produced within the national borders of a country for a given period of time.

Yeah. So "GDP" is the "market value" measure, as I said. Second thing:

Expenditure Approach

The expenditure approach attempts to calculate GDP by evaluating the sum of all final goods and services purchased in an economy. The components of U.S. GDP identified as “Y” in equation form, include Consumption (C), Investment (I), Government Spending (G) and Net Exports (X – M).

Y = C + I + G + (X − M) is the standard equational (expenditure) representation of GDP.

Yup. And because it measures purchases, the phrase "market prices" is relevant. Third thing:

Income Approach

The income approach looks at the final income in the country, these include the following categories taken from the U.S. “National Income and Expenditure Accounts”: wages, salaries, and supplementary labor income; corporate profits interest and miscellaneous investment income; farmers’ income; and income from non-farm unincorporated businesses. Two non-income adjustments are made to the sum of these categories to arrive at GDP:

• Indirect taxes minus subsidies are added to get from factor cost to market prices.
• Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product.

Now we're talkin! Now it makes sense. You add up the factor costs, Adam Smith's land, labor, and capital costs. The factor costs, seen from the recipient's point of view, are income. But apparently "indirect taxes" add something to the factor cost of output, and "subsidies" reduce that cost. Making those adjustments to the "factor cost" number will get you closer to the "market prices" number.

Then just add depreciation to get from "net" to "gross". This all makes sense. But the income and expenditure approaches are both based on transactions, so inflation is built into the numbers. To get to "real" values, the inflation has to come out. But remember, the two approaches are called "factor cost" and "market prices". So, after they are converted to real values, we have "Real GDP at Factor Cost" and "Real GDP at Market Prices".

And that is how you come to have "real" GDP "at market prices". But here we abuse some language, as Christian Zimmermann might say, as we really mean it's the market price version of Real GDP. And the other one is the factor cost version of Real GDP.

And now I can go back to sleep.