Measuring the Economy’s
Output
Chapter 7
Catherine Boulatoff
Introduction
• When you graduate and start looking for a fulltime job, your experience will, to a large extent,
be shaped by prevailing economic conditions.
– If firms throughout the system are expanding their
production of g&s, employment is rising, and jobs are easy
to find. Better to enter the labor force in a year of
expansion.
• Because the health of the overall economy
profoundly affects all of us, changes in economic
conditions are closely monitored and widely
reported in the media.
– National Income Accounting measures the economy’s
overall performance (typically done by Statistics
Canada)
Gross Domestic Product (GDP)
• It measures the total income of a nation.
– It is the most closely watched economic statistic
because it is thought to be the nbest single
measure of a society’s economic well-being.
• GDP is the Total Market Value of All Final
Goods and Services produced within a
Country in a given Period of Time.
Let’s consider each phrase in this
definition more closely
• “GDP is the Market Value…”
– To add together many different kinds of products into a single
measure of the value of economic activity,
• “… of All…”
– It includes all items produced in the economy and sold legally.
• “… Final…”
– When International Paper makes paper, which Hallmark then uses to
make a greeting card, the paper is called an intermediate good, and
the card is called a final good.
• “… Goods and Services…”
– Both tangible (food, clothing, cars) and intangible services (haircuts,
housecleaning, doctor visits).
• “… Produced…”
.
– Currently produced. It does not include transactions involving items
produced in the past. When GM produces and sells a car, the value of
the car is included in GDP. When one person sells a used car to
another person, the value of the used car is not included in GDP
• “… Within a Country…”
– Within the geographic confines of a country, regardless of the
nationality of producer. When a Canadian citizen works temporarily in
the United States, her production is part of U.S. GDP. When an
American citixen owns a factory in Haiti, the production at his factory
is not part of U.S. GDP (part of Haiti’s GDP)
• “… In a Given Period of Time.”
– Usually, that interval of time is a year or a quarter (3 months)1.
A map of world economies by size of
GDP in USD, World Bank, 2014
GDP at market prices (current US$)
(World Bank)
Avoiding Multiple Counting
• To measure aggregate output accurately, all
goods and services produced in a particular year
must be counted only once.
– Hence the measuring the final products only.
• Alternatively, we could avoid multiple counting by
measuring and cumulating only the value added
at each stage.
– Value Added is the market value of a firm’s product or
service minus the cost of inputs purchased from
others.
Example: Value Added in Bread
Production
Video
Statistics Canada
(2015)https://www.youtube.com/watc
h?v=DB1jGHc8LXA (4.11mn)
GDP does not value…
GDP excludes Nonproduction
Transactions
• There are typically of two types:
• Purely financial transactions, such as
– Public Transfer Payments that the government makes directly
to households (social insurance payments (welfare and
employment insurance)
– Private Transfer Payments (money given by paretns to their
children, cash gifts given during the holidays.
– Stock Market Transactions. The buying and selling of stocks and
bonds. Payments for the services provided by a stockbroker are
included in GDP calculations however.
• Second-hand sales
.
Two Ways of calculating GDP
For the economy as a whole,
income equals expenditure
because every dollar a buyer spends
is a dollar of income for the seller.
.
.
The Expenditure approach
Adding up the amount spent on final goods
during the period
There are Four categories of spending in the economy:
– Personal Consumption Expenditures (C): Includes all household
spending on consumer goods and services (durable and non-durable goods)
Durable goods that have expected lives of three years or more. About 60% of (C)
are on services.
– Gross Investment (Ig): (1) All final purchases of machinery, equipment, and
tools by firms, (2) All constructio, (3) Changes in inventories, and (4) Intellectual
property products (R&D)2
Net investment = Gross investment – Depreciation (or capital consumption
allowance)
– Government Purchases (G): All spending on the g&s purchased by govt
at the federal, state, and local levels. It excludes transfer payments, such as Social Security or
unemployment insurance benefits, pension plan.
– Net Exports (Xn): Spending by foreigners on our exports minus spending by Canadians on our
imports
.
.
A few notes on Gross Investment (Ig)
• Recall that Investment in Economics means
the purchase of capital.
– It does NOT mean purchase of the financial assets like stocks
and bonds.
• All new output that is not consumed is, by
definition, capital.
– Suppose inventories increased by $10M between Dec 31, 2014
and Dec 31, 2015. Thus the economy produced $10M more
output than was purchased in 2015. We need to count all
output produced in 2015 as part of that year’s GDP, even though
some of it remained unsold.3
All together:
• GDP = C + Ig + G + Xn
• For Canada in 2014 (in billions of dollars):
GDP = $1,073 + $467 + $417 + $18 = $1,975
GDP as income Approach:
• Adding up the income earned by a nation’s
resource suppliers, then adding indirect taxes and
depreciation (capital consumption allowance).
• Items making up National income:
1) Wages, salaries and supplementary labour income
2) Profits of Corporations and Government Enterprises
Before Taxes4
3) Interest and investment income (interest paid by
private businesses to the suppliers of capital (ex:
interest on bonds and loans of capital)
4) Net farm and small business income (includes most
rental income)
TABLE 7-4
Calculating GDP in 2014: 1: The Income
Approach (billions of dollars)
GDP
Percent of GDP
Wages, salaries, and supplementary labour income
$994
50.3
Profits of corporations and government enterprises
before taxes
278
14.0
Interest and investment income
169
8.5
Net income of farm and unincorporated businesses
55
2.8
Taxes less subsidies on factors of production
77
3.9
Indirect taxes less subsidies on products*
121
6.1
Capital consumption allowances
280
14.1
1
0.3
1975
100
Statistical discrepancy
Gross domestic product at market prices
*Includes inventory valuation adjustment.
Source: Statistics Canada Gross Domestic Product, expenditure-based.
LO3
© 2016 McGraw‐Hill Education Limited
7-18
Adding up Domestic income
• Net Domestic Income at Factor cost (sum of (1) to (4) =
All the income earned by Canadian-supplied factors of
production as wages, interest, rent, and profit.
+ indirect taxes, less subsidies, which include general
sales taxes (including GST), business property taxes, and
customs duties. I.e. portion of expenditures diverted to the
government.
+ depreciation (The useful life of capital equipment
(ex: forklift) extends far beyond the year in which it was
produced. To avoid understating profit and income in the
year of purchase, and to avoid overstating profit and
income in succeeding years, the cost of such capital must be
allocated over its lifetime. The amount allocated is an
estimate of the capital being used up each year in
production, called depreciation).
The Three Faces of GDP
Consumption
Labour Income
Market value of
final goods and
services
=
=
Private sector
Investment
Government
Purchases
Capital Income
Net Exports
Production
.
Expenditure
.
Income
.
Theoretically and in Practice
• Using either method, we should get same
results. In reality, many difficulties arise that
prevent this from getting a set of calculations
with total precision
• People misreporting their incomes on tax returns,
difficulty to estimate depreciation…
• Statistical Discrepancy is therefore added to
calculations to make both measures equal.
Example: Measuring GDP by
production or by expenditure
1 million automobiles
($15,000 each)
700,000
consumer
200,000
business
50,000
government
25,000
exported
Unsold
Inventory
We can measure GDP by total production or by expenditure.
© 2012 McGraw-Hill Ryerson
Limited
Ch5 - 22
LO2: The Expenditure Method
for Measuring GDP
Two additional national income
accounts concepts (useful in later
chapters):
• Personal income (PI) = The earned and unearned
income available to resource suppliers and others
before the payment of personal income taxes.
• Disposable income (DI) = Personal income less
personal taxes.
– Also main determinant of consumer spending (chapter 9)
Nominal versus Real GDP
• Nominal GDP
– Current production at current prices
• Real GDP
– Current production at constant prices
• Adjusted for inflation
• Base year prices
EXAMPLE:
1) Compute the nominal GDP in each year:
2) Compute the real GDP in each year (2005 base year):
3) What is the percentage change in nominal GDP between
2005 and 2006?
4) What is the percentage percentage change in realGDP
between 2005 and 2006?
.
.
Our first price index: The GDP Deflator
• The GDP deflator is a measure of the overall
level of prices.
GDP deflator2015 = (Nominal GDP2015/Real GDP2015) x 100
.
Example (base Year 2012)
(1)
Units of
pizzas
(Qp)
(2)
Price of
pizza
per unit
(Pp)
(3)
Units of
calzones
(Qc)
(4)
Price of
Calzone
per unit
(Pc)
(5)
(6)
nominal real GDP
GDP
2012
10
$10
3
$10
$130
$130
_______
2013
12
12
7
11
$221
_____
116.32
2014
13
15
9
12
____
$220
137.73
2015
15
12
12
13
______
______
_____
Year
(7)
Price
index
One way to measure the economy’s inflation rate is to compute
the percentage increase in the GDP deflator from one year to the
next.
Real-World Considerations and Data
Statistics Canada uses a new method (adopted in 2001)
to determine real GDP: The Chain Fisher Real GDP
Method.
• Chain-type annual-weights price index link each year to the previous
year through the use of both the prior-year prices and current-year
prices.
• For example, the calculation of the chain-weighted index would use both
2012 and 2013 prices to calculate real GDP growth in 2013. Since the
2012 chain-weighted index was arrived at using both 2011 and 2012
prices, the year 2011 is linked back - as the links of a chain are - to 2010,
2009 and previous years as well.
• It Makes real GDP less sensitive to base year chosen.
Additional problem
GDP and its components:
In each of the following cases, determine how much GDP
and each of its components is affected (if at all).
A. Debbie spends $200 to buy her husband dinner
at the finest restaurant in Boston.
B. Sarah spends $1800 on a new laptop to use in her
publishing business. The laptop was built in China.
C. Jane spends $1200 on a computer to use in her editing
business. She got last year’s model on sale for a great
price from a local manufacturer.
D. General Motors builds $500 million worth of cars,
but consumers only buy $470 million worth of them.