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Chapter 5: Measuring a Nation’s Income 1
Chapter Objectives1
In this chapter you will learn:
o GDP – definition
o GDP – important facts
o How to distinguish between final and intermediate goods
o Items not included in GDP
o Three ways to measure GDP
o Value Added Approach o Income Approach o Expenditure Approach
Expenditure Approach
o C + I + G + NX
1 In notes
Chapter 5: Measuring a Nation’s Income 2
Chapter Objectives - continued2
Income Approach to Measuring GDP
o First determine:
o Net Domestic Income at Factor Cost – (NDI)
o Wages, salaries and supplementary labour
income
o Corporate profits before taxes
o Government enterprise profits before taxes
o Interest and miscellaneous investment income
o Accrued net income of farm operators
o Net income of non-farm unincorporated
business, including rent
o Inventory valuation adjustment
2 In notes
Chapter 5: Measuring a Nation’s Income 3
Chapter Objectives - continued3
Add the following to NDI to get GDP:
o Indirect taxes less subsidies
o Capital Consumption Allowance
o Statistical Discrepancy
Gross National Product (GNP) =
o GDP
o -
o Net investment income paid to foreigners
Investment Income
o Payment for ownership of capital
o Difference between Gross National Product and Gross Domestic Product
3 In notes
Chapter 5: Measuring a Nation’s Income 4
Chapter Objectives - continued4
Personal Disposable Income
o Consumption (C) + Savings (S)
To calculate real GDP, first calculate the Fisher Volume Index using three steps:
Step 1:
o Calculate the Laspeyres Volume Index
Step 2:
o Calculate the Paasche Volume Index
Step 3:
o Calculate the Fisher Volume Index
Real GDP in base year
o = Nominal GDP in the base year
4 In notes
Chapter 5: Measuring a Nation’s Income 5
Chapter Objectives - continued5
Real GDP in current year
o Real GDP base year (Fisher Volume Index)
GDP Deflator
GDP Deflator in Yeart:
= Nominal GDP in Yeart * 100Real GDP in Yeart
Formula for Percent Change
o [Final value – Initial value] * 100
o [Initial value]
5 In notes
Chapter 5: Measuring a Nation’s Income 6
Chapter 5 – Reading6
Please note the following for Chapter 5 reading:
o Course Content: Read about the Fisher Volume
Index in the notes for Chapter 5: Measuring a
Nation’s Income
o Omit reading on the following concepts:
o Page 102 - FYI – “Other Measures of Income” -
Net National Product (NNP) and Personal Income
o pages 106-108 - Omit reading on real GDP
versus nominal GDP
6 In notes
Chapter 5: Measuring a Nation’s Income 7
Gross Domestic Product – GDP
o Is the _____ value of all ______ goods and
services produced
o (And income earned) within a ______
o In a given ___________________
o Valued at _______ _________
Chapter 5: Measuring a Nation’s Income 8
Gross Domestic Product - GDP
o Is the market value of all final goods and
services produced
o (And income earned) within a country
o In a given period of time (such as a year)
o Valued at market prices
Chapter 5: Measuring a Nation’s Income 9
Important Facts about GDP:
o GDP is basically a _______ concept
o GDP is a _____ variable
o Market Value – see example next page
Chapter 5: Measuring a Nation’s Income 10
Important Facts about GDP:
o GDP is basically a production concept
o GDP is a flow variable
o Market Value – see example next page
Chapter 5: Measuring a Nation’s Income 11
Example:
Item Price Quantity
CDs $15 1000
Tapes $ 5 2000
o Calculate GDP by multiplying P * Q for
each good and then adding your results together
Chapter 5: Measuring a Nation’s Income 12
Example:
Item Price Quantity
CDs $15 1000
Tapes $ 5 2000
o Calculate GDP by multiplying P * Q for
each good and then adding your results together:
o GDP =
o ($15 *1000) + ($5 * 2000) = $25,000
Chapter 5: Measuring a Nation’s Income 13
Important Facts about GDP continued…
o GDP does not include:
o ______ goods (only _____ goods)
o ____ or ____ _____ goods
o ________ goods and services
o Financial assets
Chapter 5: Measuring a Nation’s Income 14
Important Facts about GDP continued…
o GDP does not include:
o Intermediate goods (only final goods)
o Used or second hand goods
o Non-marketed goods and services
o Financial assets
Chapter 5: Measuring a Nation’s Income 15
How do we actually measure GDP?7
Three Methods:
o Value-added (production) Approach
o Expenditure Approach
o Income Approach
7 In notes
Chapter 5: Measuring a Nation’s Income 16
Value-Added Example
Col (i) Col (ii) Col (iii) Col (iv) = Col (ii – iii)
Stage of Production
Total Value
Cost of Intermediate Products
Value Added = Total Value - Cost of Intermediate Products
Sheep Ranch $60 $0 60
Wool Processor $100 $60 40
Suit Manufacturer
$175 $100 75
Retail Outlet $250 $175 75
250
Contribution to GDP: $____
Total value of all transactions: $ _____
Chapter 5: Measuring a Nation’s Income 17
Value-Added Example
Col (i) Col (ii) Col (iii) Col (iv) = Col (ii – iii)
Stage of Production Total
Value
Cost of Intermediate Products
Value Added =
Total value - Cost of Intermediate Products
Sheep Ranch $60 $0 $60
Wool Processor $100 $60 $40
Suit Manufacturer $175 $100 $75
Retail Outlet
(1 suit)
$250 $175 $75
Contribution to GDP: 1 suit valued at $250
Total value of all transactions: $585
Chapter 5: Measuring a Nation’s Income 18
Income Approach
Factors Compensation
Land
Labour
Capital
Entrepreneurship
Chapter 5: Measuring a Nation’s Income 19
Income Approach
Factors Compensation
Land Rent
Labour Wages and Salaries
Capital Interest and dividends
Entrepreneurship Profits
Income approach
Measures GDP by adding together the incomes
earned by all the factors that went into producing
it.
Chapter 5: Measuring a Nation’s Income 20
Income Approach8
First determine:
o NET DOMESTIC INCOME AT FACTOR COST9
o Wages, salaries and supplementary labour income
o Corporate profits before taxes
o Government enterprise profits before taxes
8 In notes9 NET DOMESTIC INCOME AT FACTOR COST IS THE PAYMENT TO THE FACTORS OF PRODUCTION USED TO PRODUCE GDP
Chapter 5: Measuring a Nation’s Income 21
Income Approach - Continued10
o Interest and miscellaneous investment income
o Accrued net income of farm operators
o Net income of non-farm unincorporated
business, including rent
o Inventory valuation adjustment
o =
o NET DOMESTIC INCOME AT FACTOR COST
10 In notes
Chapter 5: Measuring a Nation’s Income 22
Income Approach - Continued 11
o NET DOMESTIC INCOME AT FACTOR COST
o +
o Indirect taxes less subsidies
o Capital Consumption Allowance
o Statistical Discrepancy
o =
o GDP INCOME BASED
11 In notes
Chapter 5: Measuring a Nation’s Income 23
Expenditure Approach
C - Consumption
Chapter 5: Measuring a Nation’s Income 24
Expenditure Approach
I - Business Gross Investment
o ______ construction
o _____ construction
o ________
o ______ investment
o Depreciation
Chapter 5: Measuring a Nation’s Income 25
Expenditure Approach
I - Business Gross Investment
o Residential construction
o Non-residential construction
o Machinery
o Inventory investment
o Depreciation
Chapter 5: Measuring a Nation’s Income 26
Expenditure Approach
G -
o Government Expenditure on
Goods and Services
Chapter 5: Measuring a Nation’s Income 27
Expenditure Approach
o G -
o Government Expenditure on
Goods and Services
Chapter 5: Measuring a Nation’s Income 28
Expenditure Approach
G -
o Continued
o Does not include:
o _______ payments
o _____ payments on national debt
Chapter 5: Measuring a Nation’s Income 29
Expenditure Approach
G -
o Continued
o Does not include:
o Transfer payments
o Interest payments on national
debt
Chapter 5: Measuring a Nation’s Income 30
Expenditure Approach
NX - Net Exports
o Exports – Imports
o Exports are _______ in GDP
o Imports are ____ _____ in GDP
o NX is the same as ____
o Both terms mean ____ ______
Chapter 5: Measuring a Nation’s Income 31
Expenditure Approach
NX - Net Exports
o Exports – Imports
o Exports are included in GDP
o Imports are not included in GDP
o NX is the same as X- M
o Both terms mean net exports
Chapter 5: Measuring a Nation’s Income 32
Gross National Product (GNP)
First define:
Investment Income
o Payment of ______ and _______ for the
ownership of capital
Chapter 5: Measuring a Nation’s Income 33
Gross National Product (GNP)
First define:
Investment Income
o Payment of interest and dividends for the
ownership of capital
Chapter 5: Measuring a Nation’s Income 34
GNP
o =
o GDP
o -
o ____ ______ _____ paid to foreigners
Chapter 5: Measuring a Nation’s Income 35
GNP
o =
o GDP
o -
o Net investment income paid to foreigners
Chapter 5: Measuring a Nation’s Income 36
Foreign owned companies among Canada’s current
largest companies:12
General Motors Canada
o Owned by Detroit-based, General Motors
Wal-Mart Canada
o Wholly owned by Wal-Mart of the US
Honda Canada
o Owned by Honda of Japan
Costco
o Based in Seattle
Labatt Brewing Company
o Purchased by Belgian brewer Interbrew in 1995
12 In notes
Chapter 5: Measuring a Nation’s Income 37
Other Key National Accounts Concepts13
Personal Disposable Income
o Consumption (C) + Savings (S)
o Personal (Private) Saving
13 In notes
Chapter 5: Measuring a Nation’s Income 38
Chain Weighted Price Adjustments
In the last 5 years
o To express real GDP we could use the value of:
o Computer prices ______ and _____ computer
sales
o This would (overestimate/underestimate)
the value of computer output
Computer prices have ________
Computer sales have ____
Chapter 5: Measuring a Nation’s Income 39
Chain Weighted Price Adjustments
In the last 5 years
o To express real GDP we could use the value of:
o Computer prices 5 years ago and today’s
computer sales
o This would overestimate the value of
computer output
Computer Prices Have Fallen
Computer Sales Have Risen
Chapter 5: Measuring a Nation’s Income 40
Chain Weighted Price Adjustments
In the last 5 years
o OR
o To express real GDP we could use the value of:
o _______ computer prices and computer sales
value from ______
o This would (overestimate/underestimate)
the value of computer output
Computer Prices Have Fallen
Computer Sales Have Risen
Chapter 5: Measuring a Nation’s Income 41
Chain Weighted Price Adjustments
In the last 5 years
o OR
o To express real GDP we could use the value of:
o Today’s computer prices and computer
sales value from 5 years ago
o This would underestimate the value of
computer output
Computer Prices Have Fallen
Computer Sales have Risen
Chapter 5: Measuring a Nation’s Income 42
Chain Weighted Price Adjustments
o Therefore
o We need to use a _____ ______ method
o This methods allows the growth of real output
to be calculated by ______ the growth rates of
real GDP using both the
o ____ year
o and
o _____ year
o As the base years
Chapter 5: Measuring a Nation’s Income 43
Chain Weighted Price Adjustments
o Therefore
o We need to use a chain-weighted method
o This methods allows the growth of real output
to be calculated by averaging the growth rates
of real GDP using both the
o Current year
o and
o Base year
o As the base years
Chapter 5: Measuring a Nation’s Income 44
How to Calculate the Fisher Volume Index
First find:
o Nominal GDP and Real GDP
Example:
Price and Quantity Data for a Hypothetical Economy
Year 1 Year 2
Price Quantity Price Quantity
Apples $1.20 60 $1.25 80
Bread $1.00 90 $1.30 100
Find Nominal GDP for Year 1 and Year 2
Chapter 5: Measuring a Nation’s Income 45
How to Calculate the Fisher Volume Index
First find:
o Nominal GDP and Real GDP
Example:
Price and Quantity Data for a Hypothetical Economy
Year 1 Year 2
Price Quantity Price Quantity
Apples $1.20 60 $1.25 80
Bread $1.00 90 $1.30 100
NGDPYear 1 = ($1.20 * 60) + ($1.00 * 90) = $162
NGDPYear 2 = ($1.25 * 80) + ($1.30 * 100) = $230
Chapter 5: Measuring a Nation’s Income 46
To calculate real GDP, first calculate the Fisher
Volume Index using three steps:
Step 1:
o Calculate the Laspeyres Volume Index for Year
2:
Year2 GDP at Year1 prices
Year1 GDP at Year1 prices
Chapter 5: Measuring a Nation’s Income 47
To calculate real GDP, first calculate the Fisher
Volume Index using three steps:
Step 1:
o Calculate the Laspeyres Volume Index for Year2:
Year2 GDP at Year1 prices
Year1 GDP at Year1 prices
($1.20 * 80) + ($1.00 * 100) = $196 =1.2099($1.20 *60) + ($1.00 * 90) = $162
Chapter 5: Measuring a Nation’s Income 48
Step 2:
o Calculate the Paasche Volume Index for
Year2:
Year2 GDP at Year2 prices
Year1 GDP at Year2 prices
Chapter 5: Measuring a Nation’s Income 49
Step 2:
o Calculate the Paasche Volume Index for
Year2:
Year2 GDP at Year2 prices
Year1 GDP at Year2 prices
($1.25 * 80) + ($1.30 * 100) = $230 = 1.1979($1.25 * 60) + ($1.30 * 90) = $192
Chapter 5: Measuring a Nation’s Income 50
Step 3:
o Calculate the Fisher Volume Index for Year2:
o (Laspeyres Index) (Paasche Index)
Chapter 5: Measuring a Nation’s Income 51
Step 3:
o Calculate the Fisher Volume Index for Year2:
o (Laspeyres Index) (Paasche Index)
√ (1.2099) (1.1979)
= 1.2039
Chapter 5: Measuring a Nation’s Income 52
The Fisher Volume Index can now be used to
calculate real GDP:
o Calculation of Real GDP Using Year1 as the
Base Year:
Year Index of Real
GDP
Real GDP
1
2
Chapter 5: Measuring a Nation’s Income 53
The Fisher Volume Index can now be used to
calculate real GDP:
o Calculation of Real GDP Using Year1 as the
Base Year:
Year Index of Real GDP Real GDP
1 1 $162
2 1.2039 $162(1.2039) =
$195.03
Chapter 5: Measuring a Nation’s Income 54
GDP Deflator
GDP Deflator in Yeart:
Chapter 5: Measuring a Nation’s Income 55
GDP Deflator
GDP Deflator in Yeart:
= Nominal GDP in Yeart * 100
Real GDP in Yeart
Chapter 5: Measuring a Nation’s Income 56
Exercise
Calculate the GDP deflator for Year1:
o Use the numbers in the previous example
o and
o Use Year1 as the base year
o GDP deflator in Year1:
Chapter 5: Measuring a Nation’s Income 57
Exercise
Calculate the GDP deflator for Year1:
o Use the numbers in the previous example
o and
o Use Year1 as the base year
o GDP deflator in Year1:
o = $162/$162 * 100
o = 100
Chapter 5: Measuring a Nation’s Income 58
Exercise
Calculate the GDP deflator for Year2:
o Use the numbers in the previous example
o and
o Use Year1 as the base year
o GDP deflator in Year2:
Chapter 5: Measuring a Nation’s Income 59
Exercise
Calculate the GDP deflator for Year2:
o Use the numbers in the previous example
o and
o Use Year1 as the base year
o GDP deflator in Year2:
o = $230/$195.03 * 100
o = 117.93
Chapter 5: Measuring a Nation’s Income 60
Inflation Rate
o _______ in the GDP deflator from one year to
the next
Formula for Percent Change:
o [____ value – ____ value] * 100
o [_______ value]
Chapter 5: Measuring a Nation’s Income 61
Inflation Rate
o Percent change in the GDP deflator from one
year to the next
Formula for Percent Change:
o [Final value – Initial value] * 100
o [Initial value]
Chapter 5: Measuring a Nation’s Income 62
GDP and Economic Well Being14
GDP ignores:
o The Size of The Population
o Consumption Of Leisure
o Non-Marketed Economic Activities
o Environmental Quality
14 In notes
Chapter 5: Measuring a Nation’s Income 63
In Class Question
An art collector recently sold a piece of pottery for $300.
He had purchased it for $200 two years earlier. Based on
this information GDP will increase by:
a) $100
b) $0
c) $300
d) $200
Chapter 5: Measuring a Nation’s Income 64
In Class Question - Answer
An art collector recently sold a piece of pottery for $300.
He had purchased it for $200 two years earlier. Based on
this information GDP will increase by:
Answer b)
Because the pottery was purchased two years
earlier, it does not get counted in current year GDP