PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
Measuring the
Economy’s Output
7
LEARNING OBJECTIVES
LO7.1
LO7.2
LO7.3
LO7.4
LO7.5
Explain how gross domestic product (GDP) is defined and measured.
Describe how expenditures on goods and services can be summed to determine
GDP.
Explain how GDP can be determined by summing all of the incomes that were
derived from producing the economy’s output of goods and services.
Discuss the nature and function of a GDP price index, and describe the difference
between nominal GDP and real GDP.
List and explain the shortcomings of GDP as a measure of domestic output and
well-being.
© 2016 McGraw‐Hill Education Limited
7-2
7.1
Measuring the Economy’s
Performance: GDP
National Income Accounting
measures economy’s overall performance
• Statistics Canada compiles National Income and
Product Accounts
• Assess health of economy
• Track the long-run course of the economy
• Formulate policies
LO1
© 2016 McGraw‐Hill Education Limited
7-3
7.1
Measuring the Economy’s
Performance: GDP
Gross Domestic Product
The main measure of the economy’s performance
• The total (aggregate) market value of all final goods
and services produced within the borders of a
country during a specific period of time
A Monetary Measure
LO1
© 2016 McGraw‐Hill Education Limited
7-4
TABLE 7-1
Year
Comparing Heterogeneous Outputs by Using
Money Prices
Annual output
Market value
1
3 sofas and 2 computers
3($500) + 2($2000) = $5500
2
2 sofas and 3 computers
2($500) + 3($2000) = $7000
Society is willing to pay $1500 more for the combination
of goods produced in year 2 than for the combination of
goods produced in year 1.
LO1
© 2016 McGraw‐Hill Education Limited
7-5
7.1
Measuring the Economy’s
Performance: GDP
Avoiding Multiple Counting
• To avoid multiple counting, only final goods and
services are counted
• Final goods: Goods and services purchased for final
use and not for resale or further processing or
manufacturing
• Intermediate goods: Products purchased for resale
or further processing or manufacturing
• Value added
LO1
© 2016 McGraw‐Hill Education Limited
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TABLE 7-2
Value Added in a Five-Stage Production
Process
(1)
Stage of production
(2)
Sales value of
materials or product
(3)
Value added
0
Firm A, sheep ranch
$ 120
Firm B, wool processor
180
60 (= 180 – 120)
Firm C, suit manufacturer
220
40 (= 220 – 180)
Firm D, clothing wholesaler
270
50 (= 270 – 220)
Firm E, retail clothier
350
80 (= 350 – 270)
Total sales value
$1140
Value added (total income)
LO1
$120 (= $120 – $0)
$350
© 2016 McGraw‐Hill Education Limited
7-7
7.1
Measuring the Economy’s
Performance: GDP
GDP Excludes Nonproduction Transactions
Two types of nonproduction transactions:
• FINANCIAL TRANSACTIONS
•
•
•
Public Transfer Payments
Private Transfer Payments
Stock-Market Transactions
• SECOND-HAND SALES
LO1
© 2016 McGraw‐Hill Education Limited
7-8
7.1
Measuring the Economy’s
Performance: GDP
Two Ways of Calculating GDP: Expenditures and Income
• The Expenditures Approach:
• The sum of all the money spent in buying final goods and services
• By households, businesses, government, and buyers abroad
• The Income Approach
• The income derived or created from producing final goods and
services
• Payments to the suppliers of factors of production as wages, rent,
interest, and profit
LO1
© 2016 McGraw‐Hill Education Limited
7-9
7.2
The Expenditure Approach
•The Expenditures Approach: adds up all the
expenditures made for final goods and services.
• The Expenditures Approach adds up
• personal consumption expenditures (C)
• gross investment (Ig)
• government purchases (G)
• net exports (Xn) = exports (X) – imports (M)
LO2
© 2016 McGraw‐Hill Education Limited
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TABLE 7-3
Value Added in a Five-Stage Production
Process
GDP
Percent of GDP
Personal consumption expenditures (C)
1073
54.3
Gross investment (Ig )
467
23.6
Government current purchases of goods and
services (G)
417
21.1
Net exports (Xn)
+18
+1.0
Gross domestic product at market prices*
1975
100.0
*Includes adjustments and statistical discrepancy.
Source: Statistics Canada Gross Domestic Product, expenditure-based.
LO2
© 2016 McGraw‐Hill Education Limited
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7.2
The Expenditure Approach
• Gross investment (Ig) includes
• All final purchases of machinery, equipment, and tools by
firms
• All construction
• Changes in inventories
• Intellectual property products (R&D)
• Net investment =
Gross investment - depreciation
LO2
© 2016 McGraw‐Hill Education Limited
7-12
FIGURE 7-1
Gross Investment, Depreciation, Net Investment,
and the Stock of Capital
Gross
Investment
Stock of
capital
Net investment
Stock
Depreciation
of
capital
January 1
LO2
December 31
© 2016 McGraw‐Hill Education Limited
7-13
7.2
The Expenditure Approach
• GDP as the sum of all the money spent in buying
final goods and services.
GDP = C + Ig + G + Xn
• For Canada in 2014 (in billions, from Table 7-3):
GDP = $1073 + $467 + $417 + $18 = $1975
LO2
© 2016 McGraw‐Hill Education Limited
7-14
7.1 GLOBAL PERSPECTIVE
Comparative GDPs of Selected Nations, 2013 (trillions of dollars)
LO2
© 2016 McGraw‐Hill Education Limited
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7.3
The Income Approach
• The Income Approach: adds up expenditures that
are allocated as income to those producing the
output
• Wages, salaries, and supplementary labour income
• Profits of corporations and government enterprises
before taxes
• Interest and investment income
• Net income of farm and unincorporated businesses
• Indirect taxes less subsidies on products
• Depreciation: Capital consumption allowances
LO3
© 2016 McGraw‐Hill Education Limited
7-16
7.3
The Income Approach
• Net domestic income at factor cost
• All the income earned by Canadian-supplied factors of production
as wages, interest, rent, and profit.
• 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.
LO3
© 2016 McGraw‐Hill Education Limited
7-17
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
7.4
Nominal GDP versus Real GDP
•Nominal GDP
• GDP measured in terms of the price level at the
time of measurement (unadjusted for inflation)
•Real GDP
• Nominal GDP adjusted for inflation.
LO4
© 2016 McGraw‐Hill Education Limited
7-19
TABLE 7-5
LO4
Calculating Real GDP (base year = year 1)
(2)
Price of
pizza
per unit (P)
(3)
Price index
(year 1 = 100)
Year
(1)
Units of
output
(Q)
(4)
Unadjusted,
or
nominal, GDP
(Q) x (P)
(5)
Adjusted,
or
real, GDP
1
5
$10
100
$50
$50
2
7
20
200
140
70
3
8
25
250
200
80
4
10
30
?
?
?
5
11
28
?
?
?
© 2016 McGraw‐Hill Education Limited
7-20
7.4
Nominal GDP versus Real GDP
PRICE INDEX
• A measure of the price of a specified collection of
goods and services, called a “market basket,” in a
specific year as compared to the price of an
identical (or highly similar) collection of goods and
services in a reference year
LO4
© 2016 McGraw‐Hill Education Limited
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7.4
Nominal GDP versus Real GDP
PRICE INDEX
Price index in specific year =
price of market basket in specific year
x 100
price of same market basket in base year
For example, if in year 2, price of basket is $20
Price of same basket in base year is $10, then
price index, year 2 = ($20/$10) x 100 = 200.
LO4
© 2016 McGraw‐Hill Education Limited
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7.4
Nominal GDP versus Real GDP
DIVIDING NOMINAL GDP BY THE PRICE INDEX
Nominal GDP
Real GDP 
100
Price Index
For example, if in year 2, nominal GDP is $140
and price index is 200, then Real GDP =
($140/200) x 100 = $70.
LO4
© 2016 McGraw‐Hill Education Limited
7-23
TABLE 7-5
LO4
Calculating Real GDP (base year = year 1)
(2)
Price of
pizza
per unit (P)
(3)
Price index
(year 1 = 100)
Year
(1)
Units of
output
(Q)
(4)
Unadjusted,
or
nominal, GDP
(Q) x (P)
(5)
Adjusted,
or
real, GDP
1
5
$10
100
$50
$50
2
7
20
200
140
70
3
8
25
250
200
80
4
10
30
300
300
100
5
11
28
280
308
110
© 2016 McGraw‐Hill Education Limited
7-24
7.4
Nominal GDP versus Real GDP
An Alternative Method
Nominal GDP
GDP Deflator 
100
Real GDP
For example, if in year 2, nominal GDP is $140
and real GDP is $70, then GDP Deflator =
($140/$70) x 100 = 200.
LO4
© 2016 McGraw‐Hill Education Limited
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TABLE 7-6 Steps for Deriving Real GDP from Nominal GDP
Method 1
1. Find nominal GDP for each year.
2. Compute a price index.
3. Divide each year’s nominal GDP by that year’s price index,
then multiply by 100 to determine real GDP.
Method 2
1. Break down nominal GDP into physical quantities of output
and prices for each year.
2. Find real GDP for each year by determining the dollar
amount that each year’s physical output would have sold for if
base-year prices had prevailed.
LO4
© 2016 McGraw‐Hill Education Limited
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7.4
Nominal GDP versus Real GDP
Real-World Considerations and Data
Chain-type annual-weights price index
• Links 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 2011 and 2012 prices to calculate real GDP growth in 2012. Since
the 2011 chain-weighted index was arrived at using both 2010 and
2011 prices, the year 2010 is linked back - as the links of a chain are -
to 2009, 2008 and previous years as well.
LO4
© 2016 McGraw‐Hill Education Limited
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TABLE 7-7
Nominal GDP, Real GDP, and the GDP
Deflator*, Selected Years
(1)
Year
(2)
Nominal GDP
(3)
Real GDP
(4)
GDP deflator 2002 = 100
1981
366.6
778.8
-
1985
495.6
859.0
57.7
1990
690.8
989.5
69.8
1995
826.2
-
76.6
2000
1098.2
-
82.9
2007
1565.9
1565.9
100.0
2010
1662.8
1593.4
-
2014
1974.8
1747.2
113.0
*Chain-type annual-weights price index.
Source: Statistics Canada. Gross GDP.
LO4
© 2016 McGraw‐Hill Education Limited
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7.5
Shortcomings of GDP
Measurement Shortcomings
• NONMARKET ACTIVITIES
• THE UNDERGROUND ECONOMY
• IMPROVED QUALITY
LO5
© 2016 McGraw‐Hill Education Limited
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7.2 GLOBAL PERSPECTIVE
The Underground Economy as a Percentage of GDP, Selected
Nations
LO5
© 2016 McGraw‐Hill Education Limited
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7.5
Shortcomings of GDP
Shortcomings of the Well-Being Measure
• GDP AND THE ENVIRONMENT
• LEISURE
• COMPOSITION AND DISTRIBUTAION OF OUTPUT
• NONMATERIAL SOURCES OF WELL-BEING
LO5
© 2016 McGraw‐Hill Education Limited
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The LAST
WORD
Value Added and GDP
• The value added approach sums up the value of total
output less the value of intermediate goods and
services.
• The expenditure approach sums up the expenditure
on final goods and services.
• The income approach tallies earnings of all factors of
productions.
© 2016 McGraw‐Hill Education Limited
7-32
Chapter Summary
LO7.1 Explain how gross domestic product (GDP) is defined and
measured.
LO7.2 Describe how expenditures on goods and services can be
summed to determine GDP.
LO7.3 Explain how GDP can be determined by summing all of the
incomes that were derived from producing the economy’s
output of goods and services.
LO7.4 Discuss the nature and function of a GDP price index, and
describe the difference between nominal GDP and real GDP.
LO7.5 List and explain the shortcomings of GDP as a measure of
domestic output and well-being.
© 2016 McGraw‐Hill Education Limited
7-33