LESSON 1. National Income Accounts

LESSON 1 National Income Accounts Assigned Reading 1. Mankiw, N. Gregory, et al. 2011. Principles of Macroeconomics (5 th Canadian Edition). Toronto: Thomson Nelson. Chapter 5: Measuring a Nation's Income Recommended Reading 1. Mankiw, N. Gregory, et al. 2011. Study Guide for use with the Principles of Macroeconomics, (5 th Canadian Edition). Toronto: Thomson Nelson. Chapter 5: Measuring a Nation's Income Learning Objectives After studying this lesson, students should be able to: 1. Explain why, for the economy as a whole, total income equals total expenditures. 2. Define and calculate Gross Domestic Product (GDP). 3. Explain the four major components of GDP. 4. Discuss the difference between real GDP and nominal GDP. 5. State the relationship between nominal GDP, real GDP, and the GDP deflator. 6. Recognize the difference between GDP as a measure of output and as a measure of economic wellbeing. Instructor's Comments This lesson introduces students to the basic terms used to measure the macro economy, the economy of a country or region. It does this by introducing Gross Domestic Product (GDP), using the traditional circularflow model of the economy to do so. GDP is the single most important measure of the health of the macro economy. It is the most widely reported statistic in every developed country. Also introduced is the use of a price index (the GDP price deflator) and how it is used to derive real GDP from nominal GDP. The basic concepts underlying these issues are fairly straightforward. However, measuring the quantity of the production of goods and services to end-users and consumers can be quite complex. The mechanics of measuring price changes and domestic income and product are quite complicated. For example, domestic product is calculated using the total value of final products, in order to avoid double-counting the value added in intermediate processes. Yet the distinction between final products, intermediate goods, and value added is not always clear. For instance, stores like Revy or Home Depot sell lumber to contractors and to 1.1

Lesson 1 private individuals. If they buy $400 worth of lumber and sell it for $500 there is $100 of added value. When this $500 worth of lumber sales is made to a private individual the value is added to domestic product. However, if the lumber was sold to a contractor it would not count, because in this case the lumber is an intermediate good in the contractor's provision of goods and services, such as a new deck or renovation, to a household. Real estate presents a number of challenges in measuring GDP. Foremost among these is the treatment of the purchase of houses by individuals. This is because owner-occupied housing is both an investment good and a consumption good. When people buy a house they are making an investment in an asset, which they hope will gain in value. At the same time, when they occupy the unit, they are enjoying on an on-going per period basis, the consumption benefits that result from living in the house. When consumers buy new housing, this is included in the national income accounts as an increase in investment equal to the value of the house. In contrast, the purchase of an existing unit has no net effect on national income because the positive investment by the purchaser is exactly matched by the negative investment by the seller, who is disposing of his or her asset. The consumption benefit that households get from occupying housing must be included in GDP as a consumer expenditure. Economists call this periodic benefit derived from housing as "housing services". While a housing unit is a fixed asset, housing services are benefits that flow from the unit. Since it is a service consumed by households, it is housing services that should be included in GDP. As the text notes, measuring housing services for rental units is straightforward. It is the market rent a household pays. For owner-occupied housing, this issue is more complicated, as the household does not actually pay an explicit rent. Economists estimate the rent that would be paid for the unit if it was rented out. This "rent" that owner-occupiers are implicitly paying themselves is included in the GDP accounts. It also is one of the benefits of being an owner-occupier because governments in Canada do not tax this implicit rent. Review and Discussion Questions 1. Discuss how each of the following transactions will affect the gross domestic product (GDP) of Canada: (a) (b) (c) (d) (e) (f) a rental apartment is sold and the new owner carries out renovations. the new owner of the apartment buildings in (a) converts the rental units into condominiums and now all of the previous rental tenants own their apartments. a mother looks after her children full-time instead of putting them in daycare. sales of cigarettes produced in Canada have been steadily decreasing for the past forty years and, as a result, medical services required for lung cancer patients decreased. there are millions of dollars of trade in endangered species of animals even though this trade is a criminal offence. Canada maintains an army even though this army does not produce any tangible goods. 2. Explain why individuals other than economists might be interested in macroeconomic statistics. 3. Why doesn't the purchase of an automobile from Japan increase Canadian GDP, since it is counted as consumption? 4. What is the process used to separate the change in GDP due to increased output of goods and services from the change due to increased prices? Why do we make this distinction? 5. Suppose you know that Canada's GDP last year was $900 billion, and Canada's GDP in 1933 was $9 billion. What judgement about the change in the economic well-being of average Canadians could you make? Explain. 1.2

National Income Accounts 6. (a) Complete the following table. Year 1 Year 2 Year 3 Gross Domestic Product 4,532 4,804 Consumption 3,320 3,544 Investment 589 629 673 Government Purchases 861 977 Net Exports -45-58 -54 (b) (c) (d) (e) What is the largest expenditure component of GDP? Does investment include the purchase of stocks and bonds? Why? Does government purchases include government spending on Employment Insurance benefits? Why? What does it mean to say that net exports are negative? 7. You are watching a news report with your spouse. The news anchor points out that a certain troubled Caribbean nation generates a GDP per person of only $340 (Canadian) per year. Since your spouse knows Canadian GDP per person is approximately $34,000, he or she suggests that we are materially 100 times better off in Canada than in the Caribbean nation. (a) (b) Is your spouse's statement accurate? What general category of production is not captured by GDP in both Canada and the Caribbean nation? 8. Why do you think households' purchases of new housing are included in the investment component of GDP rather than the consumption component? Can you think of a reason why households' purchases of new cars should also be included in investment rather than in consumption? To what other consumption goods might this logic apply? 9. One day Boutros the Barber, Inc., collects $400 for haircuts. Over this day, his equipment depreciates in value by $50. Of the remaining $350, Boutros sends $30 to the government in sales taxes, takes home $220 in wages, and retains $100 in his business to add new equipment in the future. From the $220 that Boutros takes home, he pays $70 in income taxes. Based on this information, compute Boutros' contribution to the following measures of income: (a) (b) (c) (d) (e) gross domestic product net national product national income personal income disposable personal income NOTE Answers to selected review and discussion questions may be found on the Course Resources webpage. However, to develop their understanding, students are encouraged to attempt answering review questions before accessing the answers. 1.3

Lesson 1 ASSIGNMENT 1 CHAPTER 5: Measuring a Nation's Income Multiple choice assignments should be submitted using the Real Estate Division's website www.realestate.ubc.ca. See "How to Submit Multiple Choice Assignments" in the Real Estate Division Student Handbook for more information. COURSE BULLETINS Remember to check the Course Resources webpage for course bulletins and note any changes in your workbook and manual. Marks: 1 mark per question. 1. Dell Computers produces a laptop in November 2009, and sells it to Staples in August 2010 for $800. Staples sells it to a household in January of 2011 for $1,200. In the GDP accounts, the computer appears as a(n): (1) investment of $800 in 2009. (2) investment of $1,200 in 2009. (3) consumption of $800 in 2009. (4) consumption of $1,200 in 2009. The next TWO (2) questions are based on the following information: National Product in a Simple Economy (with Only Two Goods) 2001 2011 Production of Tubies 200 250 Price of Tubies $250 $1,000 Production of Mountain Bikes 1,000 2,000 Price of Mountain Bikes $1,500 $3,000 2. Suppose that 2001 is the base year in this simple economy. Real GDP in 2011 is: (1) $1,550,000 (2) $3,062,500 (3) $6,250,000 (4) $3,200,000 3. Suppose that 2001 is the base year in this simple economy. The GDP deflator in 2011 is: (1) 49 (2) 198 (3) 204 (4) 255 1.4 ***Assignment 1 continued on next page***

National Income Accounts 4. Last summer, Paul Jones spent a week mowing his lawn. His rich neighbour, Megan McFarlane, hired a lawn mowing service to mow her lawn. The two yards are kept in the same condition. In the GDP accounts: (1) neither Paul nor Megan's lawn work is included, because most people mow their lawns. It would distort the GDP figures to include any lawn work. (2) both Paul and Megan's lawn work is included. (3) Megan's payments to her lawn service are included, but only Paul's labour cost paid at minimum wage would be included. (4) Megan's payments to her lawn service are included, but Paul's lawn work is excluded. 5. The study of economy-wide phenomena, including unemployment, economic growth and inflation is known as: (1) Microeconomics. (2) Macroeconomics. (3) GDP. (4) Real GDP. 6. The Lifesavers candy factory in Hamilton, Ontario, finds that it has produced 100,000 more rolls of Lifesavers than it sold during the year. The value of those 100,000 rolls: (1) will be written off as a loss; hence, will not be included as part of GDP. (2) will be included as part of GDP during the year in which they are finally sold. (3) will be included as part of current GDP in the category of consumption. (4) will be included as part of current GDP in the category of inventory investment. 7. Which statement represents most correctly the relationship between nominal GDP and real GDP? (1) Nominal GDP measures base-year production using base-year prices, while real GDP measures current production using current prices. (2) Nominal GDP measures current production using base-year prices, while real GDP measures current production using current prices. (3) Nominal GDP measures current production using current prices, while real GDP measures current production using base-year prices. (4) Nominal GDP measures current production using current prices, while real GDP measures base-year production using base-year prices. 8. The total income earned by the permanent residents of a small nation in 2004 was $158,000,000. Depreciation of the country's equipment and structure stock for that year totalled $42,000,000. Which of the following is TRUE? (1) The nation's GDP was $158,000,000 and the GNP was $116,000,000. (2) The nation's GNP was $158,000,000 and the NNP was $42,000,000. (3) The nation's GNP was $158,000,000 and the NNP was $116,000,000. (4) The nation's GNP was $158,000,000 and personal income was $116,000,000. ***Assignment 1 continued on next page*** 1.5

Lesson 1 9. A Canadian citizen owns a cattle ranch in Texas. The profits from the cattle ranch: (1) are part of both Canada's GNP and Canada's GDP. (2) are part of Canada's GNP, but not part of Canada's GDP. (3) are part of Canada's GDP, but not part of Canada's GNP. (4) are part of US' GNP, but not part of Canada's GNP. 10. The percentage change in some measure of the price level from one period to the next is known as (the): (1) GDP deflator. (2) Inflation. (3) Inflation rate. (4) Appreciation. 11. If a textbook publishing company buys new computer equipment to increase worker productivity, then: (1) investment will be higher, but GDP will be unchanged, since the computers will replace workers. (2) neither investment nor GDP will be higher, since computers are not final goods. (3) investment will be higher, but GDP will be higher only if workers are, indeed, more productive. (4) investment and GDP will both be higher because computers are final goods, and investment is a component of GDP. 12. In the country of Welch, GDP consists of grapes and sugar. In 2010, 100 units of grapes are sold at $15 per unit, and 50 units of sugar are sold at $10 per unit. Which of the following statements is correct if the 2009 price of grapes was $10 per unit and the price of sugar was $12.50 per unit? (1) Nominal 2010 GDP is $2,000, real 2010 GDP is $2,000, and the GDP deflator is 100. (2) Nominal 2010 GDP is $2,000, real 2010 GDP is $1,625, and the GDP deflator is 123.08. (3) Nominal 2010 GDP is $2,000, real 2010 GDP is $1,625, and the GDP deflator is 1.23. (4) Nominal 2010 GDP is $2,000, real 2010 GDP is $1,750, and the GDP deflator is 1.14. 13. You send a gift of $500 to your sister in New Brunswick. When it is received: (1) GDP increases because the $500 represents income to your sister. (2) GDP decreases because the $500 represents a reduction in your income. (3) GDP is unaffected because the $500 represents a transfer, not a purchase. (4) GDP increases because your sister will probably spend it. 14. GDP has been disputed as the best single measure of the economic well-being of society for all of the following reasons EXCEPT: (1) GDP does not account for leisure. (2) GDP excludes the value of goods and services produced at home. (3) GDP does not account for the distribution of income. (4) GDP excludes intangible services. 1.6 ***Assignment 1 continued on next page***

National Income Accounts 15. Personal income differs from GDP and NNP in that: (1) it includes retained earnings, and excludes interest and transfer payments received by households. (2) it excludes retained earnings, and excludes interest and transfer payments received by households. (3) it excludes retained earnings, and includes interest and transfer payments received by households. (4) it includes retained earnings, and includes interest and transfer payments received by households. 16. International studies of the relationship between GDP per person and quality of life measures, such as life expectancy and literacy rates, show that: (1) larger GDP per person is associated with longer life expectancy and lower levels of illiteracy. (2) larger GDP per person is associated with longer life expectancy and higher levels of illiteracy. (3) larger GDP per person is associated with shorter life expectancy and lower levels of illiteracy. (4) larger GDP per person is associated with shorter life expectancy and higher levels of illiteracy. 17. If a Canadian citizen buys a tractor made in Russia, then: (1) Canadian net exports decrease, and Canadian GDP decreases. (2) Canadian net exports are unaffected, and Canadian GDP decreases. (3) Canadian net exports are unaffected, and Canadian GDP is unaffected. (4) Canadian net exports decrease, but Canadian GDP is unaffected. 18. Oiko Nomos buys a new car in June 2011 and then sells it to a friend in December. The 2011 GDP will include: (1) the value of both the June sale and the December sale. (2) the full value of the June sale, but only part of the value of the December sale, since the car had been used. (3) the value of the June sale only. (4) the value of the December sale only, since that was the final sale of the car in 2011. 19. The value of the housing service provided to individuals who live in housing they own themselves is included in GDP by: (1) estimating the rental value of the housing. (2) using the monthly mortgage payment. (3) using the purchase price of the house. (4) none of the above, because the value cannot be measured directly, it is excluded. ***Assignment 1 continued on next page*** 1.7

Lesson 1 20. Which of the following statements best explains the equality between total income and total expenditure in an economy? (1) Government taxes firms and redistributes the money to households until household income is high enough to equal total expenditures. (2) Total income and total expenditure are always equal in an economy because only households purchase goods and services. (3) Total income and total expenditure are equal in an economy because firms use the money they receive in sales to pay for workers' wages, landowners' rent, and firm owners' profit. (4) All of the above are correct explanations. 20 Total Marks Viewing Assignment Answer Guides As soon as your assignment has been submitted on the Real Estate Division's website, you can immediately download the answer guide. See your Student Handbook or visit your Course Resources webpage for more information on how to download assignment answer guides. PLANNING AHEAD Project 1 requires you to submit written answers to questions based on Lessons 1-6. You should read ahead to Project 1 so that you have a better idea of what is expected on this assignment. You may want to prepare answers to the questions from Lesson 1 now, while the materials are fresh in your mind, rather than waiting until Project 1 is due. 1.8 ***End of Assignment 1***