Chapter 20 Measuring GDP and Economic Growth

GDP Defined
GDP (gross domestic product) is the market value of the final goods and services
produced within a country in a given period of time.
Market Value: Using market prices to value production
Final Goods and Services: A final good (or service) is an item that is bought by its
final user during a specific time period. An intermediate good (or service), which is
an item that is produced by one firm, bought by another firm, and used as a
component of a final good or service. Double counting is a problem that we get from
adding the value of intermediate goods and final goods. Whether a good is an
intermediate good or a final good depends on what it is used for, not what it is.
Some items that people buy are neither final goods nor intermediate goods and
they are not part of GDP.
Produced Within a Country: Only goods and services that are produced within a
country count as part of that countrys GDP.
In a Given Time Period: GDP measures the value of production in a given time
period normally either quarterly and annually.
GDP and the Circular Flow of Expenditure
Households and Firms: Households sell and firms sell the services of labour,
capital and land in factor markets. Total income (aggregate income) received by
households, including retained earnings, as the (flow Y). The total payment for these
goods and services is consumption expenditure (flow C). The purchase of a new
plant, equipment, and buildings and the additions to inventories are investment
(flow I).
Governments: Governments buy goods and services from firms and their
expenditure on goods and services is called government expenditure. Taxes and
other financial transfers are not part of circular flow.
Rest of the World: Firms sell goods and services to the rest of the world (exports)
and buy from the rest of the world (imports). The value of net exports is the value of
exports (X) minus the value of imports (M) (flow X-M).
GDP Equals Expenditure Equals Income: Aggregate income (blue flow) =
Aggregate (red flow) = Y = C+I+G+X-M
Why is Domestic Product Gross?
Gross means before subtracting the depreciation of capital. Depreciation is the
decrease in the value of a firms capital that results from wear and tear and

obsolescence. The total amount spent both buying new capital and replacing
depreciated capital is called gross investment. The amount by which the value of
capital increases is called net investment. Net investment = gross investment
depreciation.
Measuring Canadas GDP
Two ways of measuring:

Expenditure approach
Income approach

The Expenditure Approach: C+I+G+X-M

Consumption expenditure is the expenditure by households on goods and services
produced. Investment is the expenditure on capital equipment and buildings by
firms and additions to business inventories. Government expenditure is the
expenditure by the government on goods and services. Net exports are the value of
exports minus value of imports.
The Income Approach: sum of what firms pay households for the factors of
production they hire
Wages, salaries, and supplementary labour income is the payment for labour
services. Other factor incomes include corporate profits, interest, farmers income,
and income from non-farm unincorporated businesses. Indirect taxes less subsidies
is tax paid by consumers when they buy goods and services minus payment by the
government to a producer = net domestic income at market prices + depreciation =
GDP
Nominal and Real GDP: Real GDP is the value of final goods and services
produced in a given year when valued at the prices of a reference base year.
Nominal GDP is the value of final goods and services produced in a given year when
valued at the prices of that year.
Calculating Real GDP: calculate real and nominal GDP in 2002. Calculate nominal
GDP in 2012 using current prices. Calculate real GDP in 2012 using 2002 prices.
The Uses and Limitations of Real GDP
Two main purposes:

To compare the standard of living over time

To compare the standard of living across countries

The Standard of Living Over Time: method is to calculate real GDP per person.
Real GDP per person is real GDP divided by the population.

Long-Term Trend: comparing real GDP per person (express it as a ratio to some
reference year)
Two features of our expanding living standard:

The growth of potential GDP per person potential GDP is the maximum level
of real GDP that can be produced while avoiding shortages of factors of
production that would bring rise to inflation. Grows at a steady pace but not
at a constant pace.
Fluctuations of Real GDP real GDP per person fluctuates around potential
GDP per person.

Productivity Growth Slowdown: Lucas wedge is the dollar value of the

accumulated gap between what real GDP per person would have been if the growth
rate of the 1960s had persisted and what real GDP per person turned out to be.
Real GDP Fluctuations The Business Cycle: the fluctuations in the pace of
expansion of real GDP is the business cycle. The business cycle is a periodic but
irregular up and down movement of total production and other measure of
economic activity. Two phases:

Expansion period during which real GDP increases.

Recession period during which real GDP decreases

Two turning points:

Peak expansion ends and recession begins

Trough recession ends and expansion begins

The Standard of Living Across Countries: two problems

Real GDP of one country must be converted into the same currency units as
the real GDP of the other country.
Goods and services in both countries must be valued at the same prices.
(purchasing power parity)

Limitations of Real GDP

Some factors that influence the standard of living and that are not part of GDP are:

Household production preparing meals, cutting grass not traded in markets

so not in GDP. This omission underestimates total production but it also
means that the growth rate of GDP overestimates the growth rate of total
production. Reason is more families eat at restaurants and day-care services.
Underground Economic Activity avoid taxes and regulations or goods and
services are illegal. Some part of expansion may be a result of underground
economy shifting rather than increase of production.

Health and Life Expectancy good health and long life do not show up in real
GDP. A higher real GDP enables us to spend more on medical research, but
negative influences (AIDS, drugs) make real GDP growth overstate the
improvements in standard living.
Leisure Time working time is part of GDP, but our leisure time is not and is
improvement in economic well-being
Security security from jobs, national defence, and local police
Environmental Quality resources that are used to protect the environment
are valued as part of GDP, but pollution is not counted as a negative part of
GDP.
Political Freedom and Social Justice A country might have a very large real
GDP per person but have limited political freedom and social justice. An elite
group might have freedom and majority dont which would be regarded as
having a lower standard of living.
The Bottom Line developing countries have a larger amount of household
production so the gap between GDP is exaggerated. Growth rate of real GDP
overstates the growth rate in the standard of living.