Measuring National Output and National Income

Chapter 7

Gross Domestic Product (GDP)

z GDP is the market value of all final goods and services produced within a given period by factors of production located within a country.

Copyright 2002, Pearson Education Canada

Copyright 2002, Pearson Education Canada

Gross National Product (GNP)

z The total market value of all final goods and services produced within a given period by factors of production owned by a countrys residents, regardless of where the output is produced.

Calculating GDP
z The expenditure approach is a method of computing GDP that measures the amount spent on all final goods during a given period. z The income approach is a method of computing GDP that measures the income wages, rents and profits - received by all factors of production in producing final goods.

Copyright 2002, Pearson Education Canada

Copyright 2002, Pearson Education Canada

Expenditure Approach

Consumption (C)
z Consumption or personal consumption expenditures is the largest component of GDP. It is comprised of expenditures by consumers on:
y Durable goods: goods that last a relatively long time y Semidurable goods: goods like clothing that last longer than nondurables but not as long as durables y Nondurable goods: goods which are perishable y Services: goods which do not involve the production of physical things
6 Copyright 2002, Pearson Education Canada

GDP = C + I + G + (EX - IM)

Copyright 2002, Pearson Education Canada

41

Investment (I)
z Investment or gross private investment is comprised of private sector spending on new capital. z It has two components:
y Fixed capital formation which is the investment in durable capital assets, such as machinery or housing. y Change in business inventories which is simply the amount by which firms inventories change during a period. Inventories are goods produced now to sell later.
7 Copyright 2002, Pearson Education Canada

Gross Investment Versus Net Investment

z Depreciation is the amount by which an assets value falls in a given period. z Gross investment is the total value of all newly produced capital goods (plant, equipment, housing and inventory) produced in a given period. z Net investment is simply gross investment minus depreciation. z Net domestic product is GDP minus depreciation
8 Copyright 2002, Pearson Education Canada

Government Purchases (G)

z Expenditures by federal, provincial and local governments for final goods and services. z Does not include transfer payments (such as welfare payments or seniors benefits) or payment on the national debt, because they are not payments for goods or services.

Net Exports (EX-IM)

z Net exports are the difference between exports (sales to foreigners of Canadian-produced goods and services) and imports (Canadian purchases of goods and services from abroad). The Figure can be positive or negative.

Copyright 2002, Pearson Education Canada

10

Copyright 2002, Pearson Education Canada

Income Approach
z A method of computing GDP that measures the incomes - wages, rents, interest, and profits received by all factors of production in producing final goods. z Consists of three components:
y Net domestic income y Depreciation (capital consumption) y Indirect taxes less subsidies
11 Copyright 2002, Pearson Education Canada

Net Domestic Income

z Net domestic income is the total income earned by the factors of production located in a country. It is the sum of six items:
y Labour income is the wages, salaries and fringe benefits paid to households by firms or government. y Corporate profits are the income of corporate businesses (dividends and retained earnings) y Interest income is the difference between interest households receive and the interest they pay out.
12 Copyright 2002, Pearson Education Canada

42

Net Domestic Income (Cont.)

y Farm income is the income earned by farms y Unincorporated business income is income earned by unincorporated businesses (also includes most rental income). y Inventory valuation adjustment is the increase in the value of inventories during the year, subtracted in the calculation of net domestic income because it is included in profits, but does not correspond to new production.
13 Copyright 2002, Pearson Education Canada

Depreciation
z Depreciation is the decline in value of capital assets as they wear out or become obsolete. z Depreciation is added to the net domestic income when we calculate GDP by the income approach because income results in the replacement of existing plants and equipment.

14

Copyright 2002, Pearson Education Canada

Indirect Taxes Less Subsidies

z Indirect Taxes: sales taxes, custom duties, license fees, etc. z Subsidies: payments made by the government for which it receives no goods or services in return.

Components of GDP by Income and Expenditure Approach (Figure 7.1)

15

Copyright 2002, Pearson Education Canada

16

Copyright 2002, Pearson Education Canada

Net National Income

z Net domestic income plus investment income from nonresidents minus investment income to nonresidents.

Personal Income (PI)

z The total income of households, calculated as net national income plus transfers to households less retained earnings.

17

Copyright 2002, Pearson Education Canada

18

Copyright 2002, Pearson Education Canada

43

Personal Disposable Income (PDI)

z Personal disposable income is simply personal income minus personal taxes.

Personal Savings and the Savings Rate

z Personal saving is the amount of disposable income that is left after total personal spending in a given period. z Personal saving rate is the percentage of personal disposable income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high households are spending cautiously.
20 Copyright 2002, Pearson Education Canada

PDI = PI - personal income taxes

19

Copyright 2002, Pearson Education Canada

Nominal GDP
z Nominal GDP is GDP measured in current dollars z Current dollars: the current prices that one pays for goods and services

Real GDP
z Real GDP is a measure of GDP that removes the effects of price changes from changes in nominal GDP. This allows us to measure real output growth by isolating the effect of prices. z A base year is the year which provides reference values. For example in the calculation of real GDP, the year which provides the prices that are used to value the outputs of all other years.
22 Copyright 2002, Pearson Education Canada

21

Copyright 2002, Pearson Education Canada

Calculating Real GDP - A Three-Good Economy (from Table 7.4)

GDP in Year 1 Production Price per Unit in Year 1 Prices Year 1 Year 2 Year 1 Year 2 P1*Q1 Q1 Q2 P1 P2 10 15 $10 $20 $100 5 10 6 10 $50 $15 $60 $14 $250 $150 $500 GDP in Year 2 in Year 2 Prices P2*Q2 $300 $360 $140 $800 GDP in Year 2 in Year 1 Prices P1*Q2 $150 $300 $150 $600

GDP Deflator
z The GDP deflator is the current dollar (nominal) GDP divided by constant dollar (real) GDP, converted to a percentage by multiplying by 100. Also called the GDP implicit price deflator or the GDP price index. z GDP deflator = Nominal GDP/Real GDP * 100

Pizza Sunglasses T-Shirts Total

23

Copyright 2002, Pearson Education Canada

24

Copyright 2002, Pearson Education Canada

44

Consumer Price Index (CPI)

z The CPI is a price index calculated every month using the price of a standardized bundle of goods meant to represent the consumption of the average consumer. z A fixed-weight price index is a price index calculated by pricing the same bundle of goods each period.

Calculating CPI (Table 7.5)

z CPI in Year 2 = $640/$500 * 100 = 128 z CPI in Year 1 = $500/$500 * 100 = 100 z Percentage change from Year 1 to Year 2 = (128-100)/100=28%

25

Copyright 2002, Pearson Education Canada

26

Copyright 2002, Pearson Education Canada

Limitations of the GDP Concept

z Social Welfare
y Increases in crime, poverty etc. not reflected in GDP.

Review Terms & Concepts

z base year z change in business inventories z consumer price index(CPI) z corporate profits z current dollars z depreciation z durable goods
28

z Underground Economy
y The part of the economy in which transactions take place and in which income is generated that is not reported and therefore not counted in GDP.

z Per Capita GDP/GNP

y A countrys GDP or GNP divided by its population.
27 Copyright 2002, Pearson Education Canada

expenditure approach farm income final goods & services fixed capital formation fixed-weight price index GDP deflator government purchases gross domestic product (GDP) z gross investment z z z z z z z z
Copyright 2002, Pearson Education Canada

Review Terms & Concepts (cont.)

z gross national product (GNP) z gross private investment z income approach z index z indirect taxes z interest income z intermediate goods
29

Review Terms & Concepts (cont.)

z per capita GDP or GNP z personal consumption expenditures z personal disposable income z personal income z personal saving z personal saving rate z real GDP
30

z inventory valuation adjustment z labour income z national income and expenditure accounts z net exports z net investment z net National Income z nominal GDP z nondurable goods
Copyright 2002, Pearson Education Canada

semidurable goods services subsidies underground economy unincorporated business income z value added z weight z z z z z

Copyright 2002, Pearson Education Canada

45