Mehdi Arzandeh, University of Manitoba PowerPoint Presentation by.

Mehdi Arzandeh, University of ManitobaPowerPoint Presentation by

7-2© 2016 McGraw‐Hill Education Limited

LEARNING OBJECTIVESLO7.1 Explain how gross domestic product (GDP) is defined and measured. LO7.2 Describe how expenditures on goods and services can be summed to determine GDP.LO7.3 Explain how GDP can be determined by summing all of the incomes that were derived from producing the economy’s output of goods and services.LO7.4 Discuss the nature and function of a GDP price index, and describe the difference

between nominal GDP and real GDP.LO7.5 List and explain the shortcomings of GDP as a measure of domestic output and well-being.

7

Measuring the Economy’s Output

National Income Accounting measures economy’s overall performance• Statistics Canada compiles National Income and

Product Accounts

• Assess health of economy

• Track the long-run course of the economy

• Formulate policies

LO1 © 2016 McGraw‐Hill Education Limited

7.1 Measuring the Economy’s Performance: GDP

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Gross Domestic Product

The main measure of the economy’s performance

• The total (aggregate) market value of all final goods

and services produced within the borders of a

country during a specific period of time

A Monetary Measure



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© 2016 McGraw‐Hill Education LimitedLO1 7-5

TABLE 7-1 Comparing Heterogeneous Outputs by Using Money Prices

Year Annual output Market value

1 3 sofas and 2 computers 3($500) + 2($2000) = $5500

2 2 sofas and 3 computers 2($500) + 3($2000) = $7000

Society is willing to pay $1500 more for the combination

of goods produced in year 2 than for the combination of

goods produced in year 1.

Avoiding Multiple Counting• To avoid multiple counting, only final goods and

services are counted• Final goods: Goods and services purchased for final

use and not for resale or further processing or manufacturing

• Intermediate goods: Products purchased for resale or further processing or manufacturing

• Value added



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TABLE 7-2 Value Added in a Five-Stage Production Process

(1)Stage of production

(2)Sales value of

materials or product

(3)Value added

0

Firm A, sheep ranch $ 120 $120 (= $120 – $0)

Firm B, wool processor 180 60 (= 180 – 120)

Firm C, suit manufacturer 220 40 (= 220 – 180)

Firm D, clothing wholesaler 270 50 (= 270 – 220)

Firm E, retail clothier 350 80 (= 350 – 270)

Total sales value $1140

Value added (total income) $350

GDP Excludes Nonproduction Transactions

Two types of nonproduction transactions:

• FINANCIAL TRANSACTIONS• Public Transfer Payments• Private Transfer Payments• Stock-Market Transactions

• SECOND-HAND SALES



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Two Ways of Calculating GDP: Expenditures and Income

• The Expenditures Approach: • The sum of all the money spent in buying final goods and services• By households, businesses, government, and buyers abroad

• The Income Approach• The income derived or created from producing final goods and

services• Payments to the suppliers of factors of production as wages, rent,

interest, and profit



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•The Expenditures Approach: adds up all the

expenditures made for final goods and services.

• The Expenditures Approach adds up • personal consumption expenditures (C)• gross investment (Ig)• government purchases (G)• net exports (Xn) = exports (X) – imports (M)


7.2 The Expenditure Approach

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TABLE 7-3 Value Added in a Five-Stage Production Process

GDP Percent of GDP

Personal consumption expenditures (C) 1073 54.3

Gross investment (Ig ) 467 23.6

Government current purchases of goods and services (G)

417 21.1

Net exports (Xn) +18 +1.0

Gross domestic product at market prices* 1975 100.0

*Includes adjustments and statistical discrepancy.Source: Statistics Canada Gross Domestic Product, expenditure-based.

• Gross investment (Ig) includes • All final purchases of machinery, equipment, and tools by

firms• All construction• Changes in inventories• Intellectual property products (R&D)

• Net investment = Gross investment - depreciation



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FIGURE 7-1 Gross Investment, Depreciation, Net Investment, and the Stock of Capital

January 1

Net investment Stock

ofcapital

December 31

Depreciation

Gross Investment

Stock ofcapital

• GDP as the sum of all the money spent in buying

final goods and services.

GDP = C + Ig + G + Xn

• For Canada in 2014 (in billions, from Table 7-3):

GDP = $1073 + $467 + $417 + $18 = $1975



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7.1 GLOBAL PERSPECTIVE

Comparative GDPs of Selected Nations, 2013 (trillions of dollars)


• The Income Approach: adds up expenditures that are allocated as income to those producing the output

• Wages, salaries, and supplementary labour income• Profits of corporations and government enterprises

before taxes• Interest and investment income • Net income of farm and unincorporated businesses• Indirect taxes less subsidies on products• Depreciation: Capital consumption allowances


7.3 The Income Approach

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• Net domestic income at factor cost

• All the income earned by Canadian-supplied factors of production

as wages, interest, rent, and profit.

• Personal income (PI)

• The earned and unearned income available to resource suppliers

and others before the payment of personal income taxes.

• Disposable income (DI)

• Personal income less personal taxes.


7.3 The Income Approach

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TABLE 7-4 Calculating GDP in 2014: 1: The Income Approach (billions of dollars)

GDP Percent of GDP

Wages, salaries, and supplementary labour income $994 50.3

Profits of corporations and government enterprises before taxes

278 14.0

Interest and investment income 169 8.5

Net income of farm and unincorporated businesses 55 2.8

Taxes less subsidies on factors of production 77 3.9

Indirect taxes less subsidies on products* 121 6.1

Capital consumption allowances 280 14.1

Statistical discrepancy 1 0.3

Gross domestic product at market prices 1975 100

*Includes inventory valuation adjustment.Source: Statistics Canada Gross Domestic Product, expenditure-based.

•Nominal GDP

• GDP measured in terms of the price level at the

time of measurement (unadjusted for inflation)

•Real GDP

• Nominal GDP adjusted for inflation.


7.4 Nominal GDP versus Real GDP

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TABLE 7-5 Calculating Real GDP (base year = year 1)

Year

(1) Units of output

(Q)

(2)Price of

pizzaper unit (P)

(3)Price index

(year 1 = 100)

(4)Unadjusted,

ornominal, GDP

(Q) x (P)

(5)Adjusted,

orreal, GDP

1 5 $10 100 $50 $502 7 20 200 140 703 8 25 250 200 804 10 30 ? ? ?5 11 28 ? ? ?

PRICE INDEX

• A measure of the price of a specified collection of

goods and services, called a “market basket,” in a

specific year as compared to the price of an

identical (or highly similar) collection of goods and

services in a reference year



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PRICE INDEXPrice index in specific year =

price of market basket in specific year x 100 price of same market basket in base year

For example, if in year 2, price of basket is $20Price of same basket in base year is $10, thenprice index, year 2 = ($20/$10) x 100 = 200.



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DIVIDING NOMINAL GDP BY THE PRICE INDEX

For example, if in year 2, nominal GDP is $140 and price index is 200, then Real GDP =

($140/200) x 100 = $70.



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100Index Price

GDP Nominal GDP Real


TABLE 7-5 Calculating Real GDP (base year = year 1)

Year

(1) Units of output

(Q)

(2)Price of

pizzaper unit (P)

(3)Price index

(year 1 = 100)

(4)Unadjusted,

ornominal, GDP

(Q) x (P)

(5)Adjusted,

orreal, GDP

1 5 $10 100 $50 $502 7 20 200 140 703 8 25 250 200 804 10 30 300 300 1005 11 28 280 308 110

An Alternative Method

For example, if in year 2, nominal GDP is $140 and real GDP is $70, then GDP Deflator =

($140/$70) x 100 = 200.



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100GDP Real

GDP Nominal Deflator GDP


TABLE 7-6 Steps for Deriving Real GDP from Nominal GDP

Method 1

1. Find nominal GDP for each year.2. Compute a price index.3. Divide each year’s nominal GDP by that year’s price index, then multiply by 100 to determine real GDP.

Method 2

1. Break down nominal GDP into physical quantities of output and prices for each year.

2. Find real GDP for each year by determining the dollar amount that each year’s physical output would have sold for if base-year prices had prevailed.

Real-World Considerations and DataChain-type annual-weights price index• Links each year to the previous year through the use of both the

prior-year prices and current-year prices.

• For example, the calculation of the chain-weighted index would use

both 2011 and 2012 prices to calculate real GDP growth in 2012.

Since the 2011 chain-weighted index was arrived at using both 2010

and 2011 prices, the year 2010 is linked back - as the links of a chain

are - to 2009, 2008 and previous years as well.



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TABLE 7-7 Nominal GDP, Real GDP, and the GDP Deflator*, Selected Years

(1)Year

(2)Nominal GDP

(3)Real GDP

(4)GDP deflator 2002 = 100

1981 366.6 778.8 -1985 495.6 859.0 57.71990 690.8 989.5 69.81995 826.2 - 76.62000 1098.2 - 82.92007 1565.9 1565.9 100.02010 1662.8 1593.4 -2014 1974.8 1747.2 113.0

*Chain-type annual-weights price index.Source: Statistics Canada. Gross GDP.

Measurement Shortcomings• NONMARKET ACTIVITIES

• THE UNDERGROUND ECONOMY

• IMPROVED QUALITY


7.5 Shortcomings of GDP

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7.2 GLOBAL PERSPECTIVE

The Underground Economy as a Percentage of GDP, Selected Nations


Shortcomings of the Well-Being Measure• GDP AND THE ENVIRONMENT

• LEISURE

• COMPOSITION AND DISTRIBUTAION OF OUTPUT

• NONMATERIAL SOURCES OF WELL-BEING


7.5 Shortcomings of GDP

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The LAST WORD Value Added and GDP

© 2016 McGraw‐Hill Education Limited7-32

• The value added approach sums up the value of total

output less the value of intermediate goods and

services.

• The expenditure approach sums up the expenditure on

final goods and services.

• The income approach tallies earnings of all factors of

productions.

LO7.1 Explain how gross domestic product (GDP) is defined and measured. LO7.2 Describe how expenditures on goods and services can be summed to determine GDP.LO7.3 Explain how GDP can be determined by summing all of the

incomes that were derived from producing the economy’s output of goods and services.

LO7.4 Discuss the nature and function of a GDP price index, and describe the difference between nominal GDP and real GDP.

LO7.5 List and explain the shortcomings of GDP as a measure of domestic output and well-being.

Chapter Summary

© 2016 McGraw‐Hill Education Limited7-33

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