Chapter 20 : The Measurement of National Income

Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives

Section Learning ObjectivesAfter studying this chapter, you will be able to

20.1 National Output and Value Added

1. see how the concept of value added solves the problem of "double counting" when measuring national income.

20.2 National Income Accounting:The Basics

2. explain the income approach and the expenditure approach to measuring national income.

20.3 National Income Accounting: Some Further Issues

3. explain the difference between real and nominal GDP and understand the GDP deflator.

4. discuss the many important omissions from official measures of GDP.

5. understand why real per capital GDP is a good measure of average material living standards but an incomplete measure of overall well-being.

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20.1 National Output and Value Added

Production occurs in stages—most firms produce outputs that are other firms' inputs

• intermediate products

• final products

Each firm’s contribution to total output is its value added

value added = revenues — non-labour costs

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Summing value added avoids the problem of double counting when measuring total output.

Total value added in the economy is called Gross Domestic Product (GDP).

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APPLYING ECONOMIC CONCEPTS 20-1

Value Added Through Stages of Production

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20.2 National Income Accounting: The Basics

Three methods for measuring national income (output):

• total value added from domestic production

• total expenditures on domestic output

• total income generated by domestic production

Because of the circular flow of income, these three measures yield the same total—GDP.

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Fig. 20-1 The Circular Flow of Expenditure and Income

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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:

• consumption

• investment

• government purchases

• net exports

Actual consumption expenditure (Ca) includes expenditure on all

final goods during the year.

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Actual investment expenditure (Ia) is expenditure on the production

of goods not for present consumption, including:

• inventories• plant and equipment• residential housing

Actual government purchases (Ga) is the purchase of currently

produced goods and services by government

• excluding transfer payments.

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Actual net exports (NXa) is the difference between exports and

imports: NXa = (Xa – Ima)

Exports are purchases of Canadian-produced goods and services by foreigners. We subtract imports because they are not produced in Canada.

Since total domestic output must equal total expenditure on domestic output, we have:

GDP = Ca + Ia + Ga + NXa

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Table 20-1 GDP from the Expenditure Side, 2011

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GDP from the Income Side

GDP is also the sum of factor incomes and other claims on the value of output.

Factor incomes include:

• wages

• rent, interest, and profits

Non-factor payments include:

• indirect taxes (net of subsidies)

• depreciation of existing physical capital

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net domestic income

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GDP from the income side is therefore equal to:

GDP = Net domestic income +

Indirect taxes (less subsidies) +

Depreciation

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EXTENSIONS IN THEORY 20-1

Arbitrary Decisions in National Income Accounting

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Table 20-2 GDP from the Income Side, 2011

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MyEconLab

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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 Growthin Canada and Other G7 Countries in the Additional Topics section of this book's MyEconLab.

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20.3 National Income Accounting: Some Further 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.

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GDP and GNP

GDP is superior as a measure of domestic economic activity.

GNP is superior as a measure of living standards of residents.

A more "refined" measure is disposable personal income:

It equals GNP minus:

• any part not actually paid to households

• personal income taxes

• plus transfer payments received by households

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Real and Nominal GDP

GDP that is valued at constant base-period prices is real national income.

The GDP deflator is a comprehensive index of prices because it includes the prices of all goods and services produced in the country.

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GDP Deflator = Nominal GDP

Real GDP x 100

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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.

APPLYING ECONOMIC CONCEPTS 20-2

Calculating Nominal and Real GDP

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Table 20-3 Nominal and Real GDP in Canada

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Omissions from the GDP

National income accountants cannot measure economic activity that takes place outside of regular, legal markets:

• illegal activities

• leisure

• the underground economy

• home production

• economic "bads"

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The current approach is useful because:

1. It would be difficult to correct the major omissions.

2. The level of GDP may be inaccurate but the change in GDP is a good indication of the changes in economic activity.

3. To design policies to control inflation it is necessary to know the flow of money payments made to produce and purchase Canadian output.

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GDP and Living Standards

"Well-being" is a broader concept than material living standards:

• GDP is not a complete measure of economic well-being

• but income is a very important part of well-being and GDP is a good measure of income.

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MyEconLab

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Some recent economic research attempts to uncover the determinants of individual well-being, or "happiness." One of the interesting findings is that income appears to be less important than several other aspects of life. See What Makes People Happy? in the Additional Topics section of this book's MyEconLab.

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