Chapter 20. The Measurement of National Income

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1 Chapter 20 The Measurement of National Income

2 National Output and Value Added -many production processes involve multiple stages, only some which are done within the same firm -this raises an important issue when we try to measure the total value of output -if we simply added up all the sales of the firms involved we would be double-counting (multiple counting) stages in the value of the final output -to avoid this we use the Value Added (VA) approach to calculating the value of output VA = Revenues Cost of Intermediate Goods -each stage s sales are counted only once Note: National Output = VA VA = Income to Factors of Production

3 National Income Accounting: The Basics -equivalence of national output and income -taken as a whole, people in the economy can only spend as much as they earn in income -since the market value of a transaction is the same for a buyer and a seller, income must equal expenditure -looking at the circular flow suggests that there are two approaches to measuring this flow, called Gross Domestic Product (GPD) -the market value of all final goods and services produced within a country in a given period of time (usually expressed annually) -the income approach adds up all of the income generated by domestic production -the expenditure approach adds up all of the money spent purchasing the outputs of domestic producers -the value added, income, and expenditure approaches should all give the same result for GDP (+ or any measurement error)

4

5 GDP from the Expenditure Side -measuring the flow through the product mkts GDP = Y = C + I + G + (X IM) Consumption (C) spending by households on goods and services (excluding new home sales) Investment (I) spending by firms on capital equipment, inventories, and structures including new homes -this is gross investment (the amount of capital goods actually produced) -the addition to the capital stock is net investment Net Inv = Gross Inv Depreciation Government Purchases (G) spending on goods and services by all levels of government -excludes transfers (counted when spent) -often valued at cost

6 Net Exports (NX= X IM) Exports (X) spending by foreigners on domestic goods and services Imports (IM) domestic spending on foreign goods and services -imports are subtracted from GDP not because they are bad, but because they represent purchases on items that were not produced domestically -if we didn t remove them we would be overestimating the amount of economic activity taking place in the country

7 Gross domestic product, expenditure-based (quarterly) 3rd quarter rd quarter rd quarter 2009 to 3rd quarter 2010 seasonally adjusted at annual rates $ millions % of GDP % change Gross domestic product at market prices 1,524,860 1,621, % 6.3 Personal expenditure on consumer goods and services 901, , % 5.0 Durable goods 109, , % 3.5 Semi-durable goods 68,976 71, % 3.0 Non-durable goods 215, , % 5.3 Services 507, , % 5.5 Government Expenditure 395, , % 5.6 Investment Expenditure 260, , % 16.8 Residential structures 98, , % 13.0 Structures and equipment 167, , % 9.2 Inventories -4,856 10, % NA Exports of goods and services 429, , % 9.6 Deduct: Imports of goods and services 463, , % 11.7 Source: Statistics Canada, Economic Accounts, Gross Domestic Product, Summary Tables (www.statcan.gc.ca Jan 30, 2011)

8 GDP from the Income Side -measuring the flow through the factor mkts GDP = Factor Incomes + Indirect Taxes Subsidies + Depreciation Factor Incomes: Net Domestic Income includes wages and salaries paid in exchange for labour services, interest earned on financial assets, and business profits in the form of dividends or retained earnings. Non-Factor Payments: Indirect taxes cause the income generated for the factors of production to be less than the price paid so must be added Subsidies cause the actual income generated to exceed the expenditure on the product and are subtracted Depreciation is not factor income and it is not included in business profits (because it must be paid to maintain the existing capital stock), so we must adjust for it in computing GDP

9 Gross domestic product, income-based (quarterly) 3rd quarter rd quarter rd quarter 2009 to 3rd quarter 2010 seasonally adjusted at annual rates $ millions % of GDP % change Gross domestic product at market prices 1,524,860 1,621, % 6.3 Wages, salaries and supplementary labour income 816, , % 4.7 Business profits including farm net income, gov't enterprises and non corporate profits 260, , % 12.7 Interest and miscellaneous investment income 63,944 69, % 8.2 Indirect taxes less subsidies 164, , % 5.5 Depreciation including inventory valuation adjustment 221, , % 4.2 Source: Statistics Canada, Economic Accounts, Gross Domestic Product, Summary Tables (www.statcan.gc.ca Jan 30, 2011)

10 National Income Accounting: Some Further Issues GDP and GNP Gross national product (GNP) is the total value of income earned by domestic residents GNP = GDP + payments from foreign sources payments made to foreigners -because Canada is a net debtor nation its GDP exceeds its GNP -GNP may be a better measure of the income available to domestic residents, but GDP is a better measure of the economic activity taking place in the country

11 Real and Nominal GDP Nominal GDP is that year s total (physical) output valued at that year s prices Real GDP measures that year s total output valued at constant prices (the prices in effect during an arbitrarily chosen base year) -this is usually done on a chain basis -that is, today s output is measured at last year s prices Applying Economic Concepts 20-2 shows an example of this procedure. The GDP Price Deflator can be calculated using nominal and real GDP -thus, it is a price index that uses a bundle of all final goods and services GDP deflator nomgdp = realgdp 100

12 GDP Deflator Versus the CPI -measures of inflation using the CPI and the GDP deflator will be similar but not identical 1. the two baskets of goods are different -GDP deflator basket is GDP -CPI basket is the basket consumed by the average Canadian household EXAMPLES: -forestry products (and the goods derived from forestry) have a larger weight in the Canadian GDP deflator than in the CPI because Canada is a large net exporter of forestry products -coffee, sugar, and tropical fruits have a larger weight in the CPI than in the GDP deflator because Canada consumes but does not produce these goods 2. calculated in a slightly different way GDP deflator base prices current basket CPI current prices base basket

13 Omissions from GDP -a limitation of GDP as a measure of national income is that many transactions take place outside the market and are not recorded Illegal Transactions -such as those relating to illicit drugs or prostitution are not reported (for obvious reasons) Underground Economy -refers to otherwise legal transactions that are not reported (usually for tax evasion reasons) -the size of the underground economy varies substantially from country to country. Home production or other Non-Market Activities -refer to goods and services provided by households for themselves (cooking meals, cleaning, childcare, plumbing, repairs, yard maintenance, etc) -if households contract out these services to commercial businesses, these services are included in GDP

14 -the market value of home production is substantial; the omission of home production results in a significant understatement of the value of goods and services produced in an economy. Economic Bads -things (like pollution) that are incurred while producing output are not subtracted from GDP as they probably should be -this is because the value is often inherently hard to measure -unless the importance of these factors changes dramatically over time then measuring changes in GDP will still give us a good measure of the changes in economic activity

15 GDP and Living Standards -all measures of national income, though capturing pretty well the changes in the level of overall economic activity, are not measures of welfare or well-being (nor are they intended to measure such things) -however GDP or GDP/capita is probably the best measure we have for economic well-being since the other things are likely correlated Alternatives: Green GDP = GDP Depreciation of Environmental Assets -measurement problems since no market exists for many of these assets UN Human Development Index = equally weighted combination of GDP/capita, literacy, and health outcomes (life expectancy and infant mortality) -attempt to add apples and oranges? -arbitrary weighting

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