Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 0
CHAPTER
2
Measuring the Performance of
the Canadian Economy
Learning objectives





Understand what is Gross Domestic Product (GDP).
Understand that we assume that goods are produced
through a production function.
Understand that what is produced must be sold.
Understand that in an economy, total savings is composed
of private savings plus the government budget deficit.
Understand that the dollar value of Gross domestic
product can change if the level of physical production
changes or if the price level changes.
PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa
Copyright 2005 © McGraw-Hill Ryerson Ltd.
CHAPTER
2
Measuring the Performance of
the Canadian Economy
Learning objectives (cont’d)
 Understand that the real interest rate is equal to the
nominal interest rate minus the inflation rate.
 Understand that the unemployment rate can change if the
participation rate changes or if the number of people
employed changes.
PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Measuring Gross Domestic Product
o The measurement of GDP is based on a simple principle:
Whatever is produced in the economy must be sold
(Supply = Demand).
o GDP can be measured by adding the value of final
goods produced (supply) or by adding the final value of
goods purchased.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
o National Income and Expenditure Accounts: A
measure of current activity in the Canadian
economy, published quarterly by Statistics
Canada.
o Gross Domestic Product (GDP): The dollar value
of all final goods and services produced in the
economy over some specified period of time,
usually one year.
Slide 3
Measuring Gross Domestic Product
o Factors of production: inputs such as
labour and capital.
o Factor payments: Payments made to
factors, such as wages and interest
payments.
o Production function: Technological
relation showing how much output can
be produced for a given combination of
inputs.
Chapter 2: Measuring the Economy
Measuring Supply
Y = F(K,N)
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 4
Measuring Gross Domestic Product
o Final goods and services: Goods and services
that are sold to firms, the public, or the
government for any purpose other than use as
an input to production; all goods excluding
intermediate ones.
o Intermediate goods: Goods used to produce
other goods and services.
o Value added: The increase in value of output at
a given stage of production OR the value of
outputs minus value of inputs.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Measuring Supply (cont’d)
Slide 5
BOX
Value Added and the GST
2-1
Farmer
Value of Wheat
Miller
Cost of Wheat
$0.10
Baker
Cost of flour
Less GST rebate
$0.407
-0.007
0.10
Plus GST
0.028
Plus GST
0.007
Value added
0.20
Value added
0.30
Total
Total
$0.407
Final Consumer
Cost of Bread
Less GST rebate
Copyright 2005 © McGraw-Hill Ryerson Ltd.
$0.628
$0.628
-0.028
Plus GST
0.042
Final cost
$0.642
Slide 6
Measuring Gross Domestic Product
o Net domestic product at factor cost: The total
payments to the factors of production.
o Net domestic product at market prices: Indirect
taxes (net of subsidies) are added to net domestic
product at factor cost.
o Gross domestic product: By adding depreciation to
Net domestic product, the result is Gross domestic
product.
o Depreciation: The wearing out of capital as it is being
used to produce output.
Chapter 2: Measuring the Economy
Measuring Supply (cont’d)
o Gross national product: Measure of the value of all
final goods and services produced by domestically
owned factors of production.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 7
Measuring Gross Domestic Product
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Table 2-1: Income Approach to Measuring GDP, 1961 and 2002
Slide 8
Measuring Gross Domestic Product
o Total demand is made up of four components:
o Consumption spending by households (C)
o Investment spending by businesses and
households (I)
o Government purchases of goods and services
(G)
o Foreign demand for our net exports (NX)
Chapter 2: Measuring the Economy
Measuring Demand
o The National Income Identity:
(3) Y = C + I + G + NX
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 9
Measuring Gross Domestic Product
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Table 2-2: Measuring GDP by Components of Demand, 1961 and 2002
Slide 10
Measuring Gross Domestic Product
o Consumption spending: Total current
spending by consumers.
o Investment spending: Additions to the
physical stock of capital.
o Human capital: Knowledge and ability to
produce that is embodied in the labour
force.
o Gross investment: Depreciation is not
deduced.
o Net investment: Gross investment minus
depreciation.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Measuring Demand (cont’d)
Slide 11
Measuring Gross Domestic Product
o Government purchases: Government
purchases of goods and services.
o Government expenditure: Government
purchases plus transfers.
o Transfer payments: Payments that are made
to people without their providing a current
service in exchange.
o Net exports: The difference between
exports and imports.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Measuring Demand (cont’d)
Slide 12
BOX
Problems in Measurement of GDP
2-2
o Not all output is produced in the market
(e.g. domestic production and
government services).
o Activities that represent the use of
resources to prevent certain “bads” (e.g.
crime prevention and national security).
o New and improved products (e.g.
computers and cars).
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 13
Allocation of Income and Savings
(4) Y = C + I
Y
C
I
: National income
: Consumption spending
: Investment spending
(5) S = Y - C
S
: Savings
4) into 5):
Chapter 2: Measuring the Economy
In an economy with… … no government or foreign trade:
(6) S = I
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 14
Allocation of Income and Savings
(3) Y = C + I + G + NX
G
NX
: Government purchases
: Net exports
(7)YD = Y + YNR + TR - TA
YD
YNR
TR
TA
: Disposable income
: Income from non-residents
: Transfer payments
: Taxes
Chapter 2: Measuring the Economy
In an economy with… … government and foreign trade:
(8)SP = YD - C
SP : Private savings
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 15
Allocation of Income and Savings
7) into 8):
(9)SP = (Y + YNR + TR - TA) - C
3) into 9):
(10) SP = C + I + G + NX + YNR + TR - TA - C
= (G + TR - TA) + (NX + YNR) + I
Government budget deficit
Current account balance
- SG
CA
Chapter 2: Measuring the Economy
In an economy with… … government and foreign trade (cont’d):
(11) S = SP + SG = I + CA
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 16
Measuring Gross Domestic Product
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Figure 2-1: Investment, Savings, and the Current Account 1961 and 2002
Slide 17
Policy in Action
Federal Government Fiscal Balance
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 18
Real and Nominal GDP and Inflation
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
o Current dollar (or nominal) GDP:
Measuring GDP between two periods
while allowing the price level to change
between the two periods.
o Constant dollar (or real) GDP: Measuring
GDP between two periods holding the
price level constant.
o Chain weighted GDP: Calculated by
averaging the base over two years, the
current and the preceding year, and so
the averaging moves over time as the
current year moves over time.
Slide 19
Calculating Real GDP: Different Base years
Table 2-4
1. Real GDP Calculated Using 1995 Base Year Prices
Year
1995
Price
Quantity
$1,000 per report
10 reports
$10,000
$1,000 per computer
5 computers
$5,000
1995 GDP measured in 1995 Dollars
2002
Value in
1995 Dollars
$15,000
$1,000 per report
15 reports
$15,000
$1,000 per computer
10 computers
$10,000
2002 GDP measured in 1995 Dollars
$25,000
Growth rate of real GDP = ($25,000/$15,000) = 66.67%
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 20
Calculating Real GDP: Different Base years
Table 2-4 (cont’d)
2. Real GDP Calculated Using 2002 Base Year Prices
Year
1995
Price
Quantity
$1,100 per report
10 reports
$11,000
$500 per computer
5 computers
$2,500
1995 GDP measured in 2002 Dollars
2002
Value in
1995 Dollars
$13,500
$1,100 per report
15 reports
$16,500
$500 per computer
10 computers
$5,000
2002 GDP measured in 2002 Dollars
$21,500
Growth rate of real GDP = ($21,500/$13,500) = 59.2%
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 21
Price Indexes and Inflation
P
P
  P
t
t1
t
Chapter 2: Measuring the Economy
o Price index: A measure of prices in any
one year compared to the level of the
same prices in some base year (base
value = 100).
o Inflation: The rate of change in prices.
o If Pt represents the price index in period t
and Pt-1 represents the price index In the
previous year, the the annual rate of
inflation, t is:
(13)
t1
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 22
Price Indexes and Inflation
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
o GDP deflator: The price index that pertains
to the goods produced in GDP. It is the
ratio of nominal GDP in a given year to
real GDP of that year.
(14) GDP deflator = Nominal GDP/Real GDP
o Deflator based inflation rate:
(15) t = % nominal GDP - % real GDP
o Consumer Price Index (CPI): Measures the
cost of a fixed bundle of goods that is
representative of the purchases of the
average consumer.
Slide 23
BOX
GDP deflator, the CPI, and Inflation
2-3
Inflation as measured by the GDP deflator and the Consumer Price
Index, 1962-2002
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 24
Inflation and Nominal and Real Interest Rates
P t 1  P t
B
i
t

P
B
B
(16)
t
o Nominal interest rate: Measures how much
money you received above the amount that you
initially invested, expressed as a percentage.
o Real interest rate: Nominal interest rate minus
the inflation rate.
r i
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
o Bond: Contract between a lender and a
borrower. If PBt is the current price of the bond
and PBt +1 is the price of the bond at t + 1, then
the nominal interest rate is:
(17)
Slide 25
Inflation and Nominal and Real Interest Rates
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Figure 2-2: Nominal and real interest rates and inflation, 1961 and 2002
Slide 26
The Unemployed and the Unemployment Rate
o Labour force: The total number of individuals
who are employed, plus the number of individuals
who are actively seeking employment but who do
not have jobs.
o Unemployment rate: The percentage of the labour
force that is unemployed.
Unemployment rate =
Number of unemployed persons
X 100
Chapter 2: Measuring the Economy
Measuring the unemployment rate
Total labour force
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 27
The Unemployed and the Unemployment Rate
o Labour force participation rate: Number of
persons in the labour force as a percentage of the
adult population.
Participation rate =
Labour force
X 100
Adult population
o Natural rate of unemployment: Rate of
unemployment at which the flows into and out of
the unemployment pool balance; also, the point
on the augmented Phillips curve at which
expected inflation equals actual inflation.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Measuring the unemployment rate (cont’d)
Slide 28
The Unemployed and the Unemployment Rate
o Frictional unemployment: The unemployment
that exists when the economy is at full
employment.
o Structural unemployment: Long-term
unemployment that arises because of a lack of
matching between the skills of workers and the
needs of employers.
o Discouraged workers: Individuals who have been
in the labour force, could not find employment
and have now given up looking for a job. They are
not in the labour force and therefore are not
counted among the unemployed.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Measuring the unemployment rate (cont’d)
Slide 29
The Unemployed and the Unemployment Rate
o Okun’s law: The hypothesized relationship
between changes in the unemployment
rate and changes in real GDP.
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Okun’s law
Slide 30
The Unemployed and the Unemployment Rate
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
Figure 2-3: Okun’s law, 1962 and 2002
Slide 31
Chapter Summary
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
• GDP is the value of all final goods and services
produced in an economy within a given period.
• GDP can be measured from the supply side as
payments to factors of production or on the
demand side as components of spending.
• Total savings in an economy is composed of
private savings plus government savings.
• Nominal GDP is also called current dollar GDP.
• Real GDP is also called constant dollar GDP.
• Chain weighted GDP is an alternative measure
of real GDP.
Slide 32
Chapter Summary (cont’d)
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Chapter 2: Measuring the Economy
• A price index is a measure of prices in any one
year compared to the level of the same prices
in some base year.
• Inflation is the rate of change in prices.
• Nominal interest rates give the return on bonds
in current dollars and real interest rates give
the return in constant dollars.
• The unemployment rate is defined as a
percentage of the labour force that is
unemployed.
• The labour force participation rate is defined
as a percentage of the adult population that is
in the labour force.
Slide 33
The End
Chapter 2: Measuring the Economy
Copyright 2005 © McGraw-Hill Ryerson Ltd.
Slide 34