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Slide 7 of 28 from CHAPTER 19 - CORRECTION
1 of 22
Potential Output and the Output Gap: Potential national output measures what the economy could produce if all resources were employed at their normal levels of utilization. This is often called full-employment output. The output gap measures the difference between potential output and actual output.
Output Gap = Y-Y* APPLYING ECONOMIC CONCEPTS 19-1 The Terminology of Business Cycles Copyright © 2005 Pearson Education Canada Inc.
2 of 22
Chapter 20 The Measurement of National Income
3 of 22
Learning Objectives 1. Describe the problem of “double counting” and how the concept of value added solves this problem when measuring national income. 2. Explain the income approach and the expenditure approach to measuring national income. 3. Explain the difference between real and nominal GDP, and why GDP per person is a better measure of living standards than just GDP itself. 4. List some of the many things affecting overall well-being that are omitted from official measures of GDP.
Copyright © 2005 Pearson Education Canada Inc.
4 of 22
20.1 National Output and Value Added Production occurs in stages. Many firms produce outputs that are used as inputs by other firms. Intermediate products are outputs of some firms that are used as inputs by other firms. Final products are outputs that are not used as inputs by any other firms. Final products are outputs that are consumed, used as investment goods (inventories), part of government expenditure or exported Practice with Study Guide Chapter 20, Exercises 1 and 2.
Copyright © 2005 Pearson Education Canada Inc.
5 of 22
Each firm’s contribution to total output is its value added, which is the gross value of the firm’s output minus the value of all intermediate goods and services that it uses. Value added = Revenue – Cost of intermediate goods Value added = Income paid to factors of production Example: The baker Note: factor of production vs. intermediate input
6 of 22
The total value added produced in the economy is called Gross Domestic Product (GDP). GDP is a measure of all final output that is produced in the economy. Adding up value added avoids the statistical problem of double counting. If we simply added up each firm’s gross output, we would vastly overestimate GDP. The term final demand refers to the purchase of final goods for consumption, for investment (including inventory accumulation), for use by governments, and for export.
APPLYING ECONOMIC CONCEPTS 20-1 Value Added Through Stages of Production
Copyright © 2005 Pearson Education Canada Inc.
7 of 22
20.2 National Income Accounting: The Basics There are three different ways of measuring national income. • adding up the total value added from domestic production, • adding up the total flow of expenditure on domestic output, and • adding up the total flow of income generated by domestic production. Because of the circular flow of income, these three measures yield the same total, which is called the Gross Domestic Product (GDP).
Copyright © 2005 Pearson Education Canada Inc.
8 of 22
Start with a very simple economy
Domestic Households
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
9 of 22
How does household income actually get used up?
Domestic Households
Imports
Savings Consumption
Taxes
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
10 of 22
Do any other agents buy final G & S from Cdn firms?
Domestic Households Investors Consumption
Governments Foreigners (Exports)
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
11 of 22
Copyright © 2005 Pearson Education Canada Inc.
12 of 22
GDP from the Expenditure Side Consider adding up the expenditures needed to purchase the final output produced in any given year. There are four broad expenditure categories. Actual consumption expenditure, denoted as Ca, includes expenditure on all final goods during the year. For the most recent data on national income, see Statistics Canada’s website: www.statcan.ca.
Copyright © 2005 Pearson Education Canada Inc.
13 of 22
Actual investment expenditure, denoted as Ia, is expenditure on the production of goods not for present consumption, including: • inventories, • plant and equipment, and • residential housing. Actual government purchases of goods and services, denoted as Ga, is the purchase of currently produced goods and services by government and, therefore, does not include transfer payments.
Copyright © 2005 Pearson Education Canada Inc.
14 of 22
Actual net exports, denoted as NXa, is the difference between exports and imports: NXa = (Xa - IMa). Exports are purchases of Canadian-produced goods and services by foreigners. They are part of the total expenditure on Canadian output. Imports are the purchases of foreign-produced goods by Canadians. This does not represent spending on Canadian output, and so it is subtracted from total expenditure. From the circular flow of income, we know that total output equals total expenditure. Calculated from the expenditure side, GDP is therefore given by: GDP = Ca + Ia + Ga + (Xa - IMa) Copyright © 2005 Pearson Education Canada Inc.
15 of 22
Does the expression GDP = Ca + Ia + Ga + (Xa - IMa) imply that everything that firms produce each year is automatically sold to customers?
NO!
INVENTORIES INVENTORIES INVENTORIES
16 of 22
Aggregate Expenditures in 2002 Category $billion $651.2 Consumption 243.4 Government purchases 200.2 Investment (incl. invent. adj.) 47.0 Net exports 0.3 Statistical discrepancy $1142.1 Total
% of GDP 57.0 21.3 17.5 4.1 0.1 100.0
Source: Statistics Canada website: www.statcan.ca. Go to “Canadian Statistics” and click on “Economic Conditions” and then “National accounts.”
GDP measured from the expenditure side gives the major components of aggregate expenditure. Practice with Study Guide Chapter 20, Short-Answer Question 1. Copyright © 2005 Pearson Education Canada Inc.
17 of 22
GDP from the Income Side When calculated from the income side, GDP is the sum of factor incomes and other claims on the value of output. Factor incomes include wages, rent, interest, and profits. These factor incomes are combined to be net domestic income. Other claims on the value of output include: • indirect taxes (net of subsidies), and • depreciation of existing physical capital. GDP from the income side is therefore equal to: GDP = Net domestic income + Indirect taxes + Depreciation
Copyright © 2005 Pearson Education Canada Inc.
18 of 22
Category
Billions of $
% of GDP
Factor Incomes Wages, salaries and supplementary income Interest and miscellaneous investment income Business profits (including net income of farmers and unincorporated businesses)
595.3
52.1
49.7
4.4
210.4
18.4
855.4
74.9
Capital consumption allowance
149.6
13.1
Indirect taxes less subsidies
137.6
12.0
Net Domestic Income at factor cost
Non Factor Payments
Statistical discrepancy
Total
-0.3 1142.1
-0.1 100.0
Source: Statistics Canada website: www.statcan.ca. Go to “Canadian Statistics” and click on “Economic Conditions” and then “National accounts.” Copyright © 2005 Pearson Education Canada Inc.
19 of 22
20.3 National Income Accounting: Some Extra Issues GDP and GNP A measure of national output closely related to GDP is Gross National Product (GNP). The difference between GDP and GNP is the difference between income produced and income received.
EXTENSIONS IN THEORY 20-1 Arbitrary Decisions in National Income Accounting Copyright © 2005 Pearson Education Canada Inc.
20 of 22
GDP measures the total output produced in Canada and the total income generated as a result of that production. GNP measures the total amount of income received by Canadian residents, no matter where the income was generated. GDP is superior to GNP as a measure of domestic economic activity. GNP is superior to GDP as a measure of the economic wellbeing of domestic residents. Disposable Personal Income (DPI) is GNP minus: • any part of it that is not actually paid to households, • personal income taxes paid by households, and • plus transfer payments received by households. Copyright © 2005 Pearson Education Canada Inc.
21 of 22
Real and Nominal GDP Total GDP that is valued at current prices is a nominal measure, often called nominal national income. GDP that is valued at constant base-period prices is a real measure, referred to as real national income. Implicit GDP Deflator =
GDP at current prices
x 100
GDP at base-year prices The GDP deflator is the most comprehensive available index of the price level because it includes the prices of all goods and services produced in the country. Practice with Study Guide Chapter 20, Extension Exercise E1.
Copyright © 2005 Pearson Education Canada Inc.
22 of 22
Do the CPI and the GDP Deflator Move Together? Broadly, the two price indexes move together, due to underlying inflationary forces. But because one tracks consumer prices and the other tracks the prices of goods produced in Canada, there will be some differences. For example, suppose the world price of coffee rises. This will push up the Canadian CPI. But since Canada produces no coffee, there will be a negligible effect on the Canadian implicit GDP deflator.
APPLYING ECONOMIC CONCEPTS 20-2 Calculating Nominal and Real GDP Copyright © 2005 Pearson Education Canada Inc.
23 of 22
Output and Well Being The rise in real GDP over the past century has had two main causes: 1. The increase in the amount of land, labour, and capital used in production, and 2. An increase in the amount of output produced per unit of input. Per capita output is the amount of output per person — it is computed by dividing GDP by total population. It measures the average output (and income) per person (but tells us nothing about how that income is distributed across people). Copyright © 2005 Pearson Education Canada Inc.
24 of 22
For studying changes in average living standards, per capita output is a better measure than total GDP. Canada and six other countries form what is called the “G7” group of advanced industrialized nations. For a comparison of economic growth in the G7 countries over the past decade, look for “Growth in Canada and Other G7 Countries” in the Additional Topics section of the Companion Website. http://www.pearsoned.ca/ragan
LESSONS FROM HISTORY 20-1 Living Standards and Long-Run Economic Growth Copyright © 2005 Pearson Education Canada Inc.
25 of 22
A better way of assessing average living standards is to consider measures of productivity. For example, GDP divided by the number of employed persons tells us the average output per employed person. This is one measure of labour productivity. GDP divided by the total number of hours worked measures output per hour of labour input, and provides a second measure of labour productivity. Changes in overall living standards are better reflected by changes in productivity than by changes in GDP per capita. GDP and related measures of national income must be interpreted with their limitations in mind. What are these limitations? See Chapter 20 of www.pearsoned.ca/ragan for a discussion of “Computers and Productivity in the Information Economy.” Copyright © 2005 Pearson Education Canada Inc.
26 of 22
Omissions from GDP National income and expenditure accounts cannot measure economic activity that takes place outside of regular and legal markets. Some of these activities are: • illegal activities (drugs, prostitution, etc.), • the underground economy (tax-avoided transactions), • home production (housework, do-it-yourself projects), and • economic “bads” (pollution). Hence, GDP does not measure everything that contributes to (or detracts from) human welfare.
Copyright © 2005 Pearson Education Canada Inc.
27 of 22
This is an important point — GDP is not a complete measure of economic well-being. However, income is a very important part of well-being and GDP is a very good measure of income. Unless the unmeasured economic activity changes rapidly, changes in GDP will do a quite satisfactory job of measuring changes in economic well-being. See Chapter 20 of www.pearsoned.ca/ragan for an excellent discussion of the role of per capita income in determining a country’s overall “human development”: William Watson, “If Canada is Number One, Why Would Anyone Leave?”
Copyright © 2005 Pearson Education Canada Inc.
28 of 22
1 of 22
Potential Output and the Output Gap: Potential national output measures what the economy could produce if all resources were employed at their normal levels of utilization. This is often called full-employment output. The output gap measures the difference between potential output and actual output.
Output Gap = Y-Y* APPLYING ECONOMIC CONCEPTS 19-1 The Terminology of Business Cycles Copyright © 2005 Pearson Education Canada Inc.
2 of 22
Chapter 20 The Measurement of National Income
3 of 22
Learning Objectives 1. Describe the problem of “double counting” and how the concept of value added solves this problem when measuring national income. 2. Explain the income approach and the expenditure approach to measuring national income. 3. Explain the difference between real and nominal GDP, and why GDP per person is a better measure of living standards than just GDP itself. 4. List some of the many things affecting overall well-being that are omitted from official measures of GDP.
Copyright © 2005 Pearson Education Canada Inc.
4 of 22
20.1 National Output and Value Added Production occurs in stages. Many firms produce outputs that are used as inputs by other firms. Intermediate products are outputs of some firms that are used as inputs by other firms. Final products are outputs that are not used as inputs by any other firms. Final products are outputs that are consumed, used as investment goods (inventories), part of government expenditure or exported Practice with Study Guide Chapter 20, Exercises 1 and 2.
Copyright © 2005 Pearson Education Canada Inc.
5 of 22
Each firm’s contribution to total output is its value added, which is the gross value of the firm’s output minus the value of all intermediate goods and services that it uses. Value added = Revenue – Cost of intermediate goods Value added = Income paid to factors of production Example: The baker Note: factor of production vs. intermediate input
6 of 22
The total value added produced in the economy is called Gross Domestic Product (GDP). GDP is a measure of all final output that is produced in the economy. Adding up value added avoids the statistical problem of double counting. If we simply added up each firm’s gross output, we would vastly overestimate GDP. The term final demand refers to the purchase of final goods for consumption, for investment (including inventory accumulation), for use by governments, and for export.
APPLYING ECONOMIC CONCEPTS 20-1 Value Added Through Stages of Production
Copyright © 2005 Pearson Education Canada Inc.
7 of 22
20.2 National Income Accounting: The Basics There are three different ways of measuring national income. • adding up the total value added from domestic production, • adding up the total flow of expenditure on domestic output, and • adding up the total flow of income generated by domestic production. Because of the circular flow of income, these three measures yield the same total, which is called the Gross Domestic Product (GDP).
Copyright © 2005 Pearson Education Canada Inc.
8 of 22
Start with a very simple economy
Domestic Households
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
9 of 22
How does household income actually get used up?
Domestic Households
Imports
Savings Consumption
Taxes
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
10 of 22
Do any other agents buy final G & S from Cdn firms?
Domestic Households Investors Consumption
Governments Foreigners (Exports)
Factor income: wages, rents profits
Domestic Firms
Revenue from sales of final G & S
11 of 22
Copyright © 2005 Pearson Education Canada Inc.
12 of 22
GDP from the Expenditure Side Consider adding up the expenditures needed to purchase the final output produced in any given year. There are four broad expenditure categories. Actual consumption expenditure, denoted as Ca, includes expenditure on all final goods during the year. For the most recent data on national income, see Statistics Canada’s website: www.statcan.ca.
Copyright © 2005 Pearson Education Canada Inc.
13 of 22
Actual investment expenditure, denoted as Ia, is expenditure on the production of goods not for present consumption, including: • inventories, • plant and equipment, and • residential housing. Actual government purchases of goods and services, denoted as Ga, is the purchase of currently produced goods and services by government and, therefore, does not include transfer payments.
Copyright © 2005 Pearson Education Canada Inc.
14 of 22
Actual net exports, denoted as NXa, is the difference between exports and imports: NXa = (Xa - IMa). Exports are purchases of Canadian-produced goods and services by foreigners. They are part of the total expenditure on Canadian output. Imports are the purchases of foreign-produced goods by Canadians. This does not represent spending on Canadian output, and so it is subtracted from total expenditure. From the circular flow of income, we know that total output equals total expenditure. Calculated from the expenditure side, GDP is therefore given by: GDP = Ca + Ia + Ga + (Xa - IMa) Copyright © 2005 Pearson Education Canada Inc.
15 of 22
Does the expression GDP = Ca + Ia + Ga + (Xa - IMa) imply that everything that firms produce each year is automatically sold to customers?
NO!
INVENTORIES INVENTORIES INVENTORIES
16 of 22
Aggregate Expenditures in 2002 Category $billion $651.2 Consumption 243.4 Government purchases 200.2 Investment (incl. invent. adj.) 47.0 Net exports 0.3 Statistical discrepancy $1142.1 Total
% of GDP 57.0 21.3 17.5 4.1 0.1 100.0
Source: Statistics Canada website: www.statcan.ca. Go to “Canadian Statistics” and click on “Economic Conditions” and then “National accounts.”
GDP measured from the expenditure side gives the major components of aggregate expenditure. Practice with Study Guide Chapter 20, Short-Answer Question 1. Copyright © 2005 Pearson Education Canada Inc.
17 of 22
GDP from the Income Side When calculated from the income side, GDP is the sum of factor incomes and other claims on the value of output. Factor incomes include wages, rent, interest, and profits. These factor incomes are combined to be net domestic income. Other claims on the value of output include: • indirect taxes (net of subsidies), and • depreciation of existing physical capital. GDP from the income side is therefore equal to: GDP = Net domestic income + Indirect taxes + Depreciation
Copyright © 2005 Pearson Education Canada Inc.
18 of 22
Category
Billions of $
% of GDP
Factor Incomes Wages, salaries and supplementary income Interest and miscellaneous investment income Business profits (including net income of farmers and unincorporated businesses)
595.3
52.1
49.7
4.4
210.4
18.4
855.4
74.9
Capital consumption allowance
149.6
13.1
Indirect taxes less subsidies
137.6
12.0
Net Domestic Income at factor cost
Non Factor Payments
Statistical discrepancy
Total
-0.3 1142.1
-0.1 100.0
Source: Statistics Canada website: www.statcan.ca. Go to “Canadian Statistics” and click on “Economic Conditions” and then “National accounts.” Copyright © 2005 Pearson Education Canada Inc.
19 of 22
20.3 National Income Accounting: Some Extra Issues GDP and GNP A measure of national output closely related to GDP is Gross National Product (GNP). The difference between GDP and GNP is the difference between income produced and income received.
EXTENSIONS IN THEORY 20-1 Arbitrary Decisions in National Income Accounting Copyright © 2005 Pearson Education Canada Inc.
20 of 22
GDP measures the total output produced in Canada and the total income generated as a result of that production. GNP measures the total amount of income received by Canadian residents, no matter where the income was generated. GDP is superior to GNP as a measure of domestic economic activity. GNP is superior to GDP as a measure of the economic wellbeing of domestic residents. Disposable Personal Income (DPI) is GNP minus: • any part of it that is not actually paid to households, • personal income taxes paid by households, and • plus transfer payments received by households. Copyright © 2005 Pearson Education Canada Inc.
21 of 22
Real and Nominal GDP Total GDP that is valued at current prices is a nominal measure, often called nominal national income. GDP that is valued at constant base-period prices is a real measure, referred to as real national income. Implicit GDP Deflator =
GDP at current prices
x 100
GDP at base-year prices The GDP deflator is the most comprehensive available index of the price level because it includes the prices of all goods and services produced in the country. Practice with Study Guide Chapter 20, Extension Exercise E1.
Copyright © 2005 Pearson Education Canada Inc.
22 of 22
Do the CPI and the GDP Deflator Move Together? Broadly, the two price indexes move together, due to underlying inflationary forces. But because one tracks consumer prices and the other tracks the prices of goods produced in Canada, there will be some differences. For example, suppose the world price of coffee rises. This will push up the Canadian CPI. But since Canada produces no coffee, there will be a negligible effect on the Canadian implicit GDP deflator.
APPLYING ECONOMIC CONCEPTS 20-2 Calculating Nominal and Real GDP Copyright © 2005 Pearson Education Canada Inc.
23 of 22
Output and Well Being The rise in real GDP over the past century has had two main causes: 1. The increase in the amount of land, labour, and capital used in production, and 2. An increase in the amount of output produced per unit of input. Per capita output is the amount of output per person — it is computed by dividing GDP by total population. It measures the average output (and income) per person (but tells us nothing about how that income is distributed across people). Copyright © 2005 Pearson Education Canada Inc.
24 of 22
For studying changes in average living standards, per capita output is a better measure than total GDP. Canada and six other countries form what is called the “G7” group of advanced industrialized nations. For a comparison of economic growth in the G7 countries over the past decade, look for “Growth in Canada and Other G7 Countries” in the Additional Topics section of the Companion Website. http://www.pearsoned.ca/ragan
LESSONS FROM HISTORY 20-1 Living Standards and Long-Run Economic Growth Copyright © 2005 Pearson Education Canada Inc.
25 of 22
A better way of assessing average living standards is to consider measures of productivity. For example, GDP divided by the number of employed persons tells us the average output per employed person. This is one measure of labour productivity. GDP divided by the total number of hours worked measures output per hour of labour input, and provides a second measure of labour productivity. Changes in overall living standards are better reflected by changes in productivity than by changes in GDP per capita. GDP and related measures of national income must be interpreted with their limitations in mind. What are these limitations? See Chapter 20 of www.pearsoned.ca/ragan for a discussion of “Computers and Productivity in the Information Economy.” Copyright © 2005 Pearson Education Canada Inc.
26 of 22
Omissions from GDP National income and expenditure accounts cannot measure economic activity that takes place outside of regular and legal markets. Some of these activities are: • illegal activities (drugs, prostitution, etc.), • the underground economy (tax-avoided transactions), • home production (housework, do-it-yourself projects), and • economic “bads” (pollution). Hence, GDP does not measure everything that contributes to (or detracts from) human welfare.
Copyright © 2005 Pearson Education Canada Inc.
27 of 22
This is an important point — GDP is not a complete measure of economic well-being. However, income is a very important part of well-being and GDP is a very good measure of income. Unless the unmeasured economic activity changes rapidly, changes in GDP will do a quite satisfactory job of measuring changes in economic well-being. See Chapter 20 of www.pearsoned.ca/ragan for an excellent discussion of the role of per capita income in determining a country’s overall “human development”: William Watson, “If Canada is Number One, Why Would Anyone Leave?”
Copyright © 2005 Pearson Education Canada Inc.
28 of 22
