CHAPTER 5

Measuring the Economy’s Output

1

Slides prepared by Bruno Fullone, George Brown College

© 2010 McGraw-Hill Ryerson Limited

PART 2: GDP, GROWTH AND

FLUCTUATIONS

• Learning Objective 5.1: How gross domestic product (GDP) is defined and measured

• Learning Objective 5.2 : Other measures of a nation’s production of goods and services

• Learning Objective 5.3 : The distinction between nominal GDP and real GDP

• Learning Objective 5.4 : The shortcomings of GDP as a measure of domestic output and well-being

2

In This Chapter You Will Learn:

3 LO5.1

• Gross Domestic Product is:

• The main measure of the economy’s performance

• The total market value of all final goods and services produced annually within the boundaries of Canada

• A Monetary Measure

5.1 Measuring the Economy’s

Performance: GDP

4 LO5.1

• 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 are not counted

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

Avoiding Multiple Counting

5 LO5.1

(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

Value Added in a Five Stage

Production Process Table 5-2

6 LO5.1

Two types of nonproduction transactions:

1. Financial transactions

- Public Transfer Payments

- Private Transfer Payments

- Stock-Market Transactions

2. Second-hand sales

GDP Excludes Nonproduction

Transactions

Table 5-3 Calculating GDP in 2008: The

Expenditures Approach (billions of dollars)

. 8

Stock of

capital

January 1

Net

investment Stock

of

capital

December 31

Depreciation

Gross

Investment

Figure 5-1 Gross Investment, Depreciation, Net

Investment, and the Stock of Capital

9 LO5.1

• 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)

Two Ways of Calculating GDP:

Expenditures and Income

Approach

Table 5-4 Calculating GDP in 2008: The

Income Approach (billions of dollars)

11

Table 5-3 Calculating GDP in 2008:

The Expenditure Approach

GDP = C + IG+ G + XN

Table 5-3 GDP

($billions)

C 891

IG 309

G 375

XN 25

GDP $1600

5-1 Global Perspective

13 LO5.1

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

• The Income Approach adds up • 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 • Taxes less subsidies on factors of production • Indirect taxes less subsidies on products • Capital consumption allowances

The Income Approach

©2006 McGraw-Hill

Ryerson Ltd.

Chapter 4.1 14

Table 5-4 Calculating GDP in 2008:

The Income Approach

Table 5-4 GDP ($billions)

Wages, salaries, etc. $823

Profits of corporations, etc. 2231

Interest & investment income 81

Net income of farms & unincorp. businesses 93

Taxes less subsidies on factors of prod. 70.0

Indirect taxes less subsidies on products 93

Capital consumption allowances 208

Statistical discrepancy 1

GDP at market prices 1600

15 LO5.2

• Gross National Product (GNP)

• -the total income that residents of a country earn within the year

• Net Domestic Product (NDP)

• -measures the total annual output that the entire economy can consume without impairing its capacity to produce in ensuing years

• Net National Income at Basic Prices (NNI)

• - includes all income earned through the use of Canadian-owned factors, whether they are located at home or abroad

5.2 Other National Accounts

16 LO5.2

• Personal Income (PI)

• - 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 and other personal transfers to government

5.2 Other National Accounts

Global Perspective 5-1: Comparative

GDP

Source: World Bank

Selected Nations GDPs, 2007

United States Japan

Germany China

United Kingdom France

Italy Canada

Spain Brazil

Russia India

South Korea Mexico

Australia

0 1 2 3 4 5 6 7 8 9 10 12 13

GDP in Trillions of Dollars

18 LO5.3

• 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.

5.3 Nominal GDP versus Real GDP

19 LO5.3

Year (1) Units of output (Q)

(2) Price of pizza per unit (P)

(3) Price index (year 1 = 100)

(4) Unadjusted, or nominal, GDP (Q) x (P)

(5) Adjusted, or real, GDP

1 5 $10 100 $50 $50

2 7 20 200 140 70

3 8 25 250 200 80

4 10 30 ? ? ?

5 11 28 ? ? ?

Table 5-5 Calculating Real GDP

20 LO5.3

• 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

Price Index

21 LO5.3

• Price 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 $20

Price of same basket in base year is $10, then

price index, year 2 = $20 x 100 = 200

$10

How do we calculate a price index?

22 LO5.3

• Real GDP = nominal GDP x 100

price index

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

Real GDP = 140 x 100 = 70

200

How do we calculate Real GDP?

23 LO5.3

Year (1) Units of output (Q)

(2) Price of pizza per unit (P)

(3) Price index (year 1 = 100)

(4) Unadjusted, or nominal, GDP (Q) x (P)

(5) Adjusted, or real, GDP

1 5 $10 100 $50 $50

2 7 20 200 140 70

3 8 25 250 200 80

4 10 30 300 300 100

5 11 28 280 308 110

Revisiting Table 5-5 Calculating Real

GDP

24 LO5.3

An implicit price index

GDP deflator = nominal GDP x 100

real GDP

For example, if in year 2, nominal GDP = 140, real GDP = 70, then,

GDP deflator = 140 X 100 = 200

70

GDP Deflator

25 LO5.3

• 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.

Table 5-6 Steps for Deriving Real

GDP from Nominal 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.

26 LO 5.3

Table 5-6 Steps for Deriving Real

GDP from Nominal GDP

27 LO5.3

• 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 2008 and 2009 prices to calculate real GDP growth in 2009. Since the 2008 chain-weighted index was arrived at using both 2007 and 2008 prices, the year 2009 is linked back—as the links of a chain are—to 2008, 2007, and previous years as well.

Chain-Weighted Index

28 LO5.4

• Measurement Shortcomings: • Non-Market Transactions

• The Underground Economy

• Leisure

• Improved Quality

5.4 Shortcomings of GDP

29 LO5.4

• Shortcomings of the Well-Being Measure

• GDP AND THE ENVIRONMENT

• COMPOSITION AND DISTRIBUTION OF OUTPUT

• NONMATERIAL SOURCES OF WELL-BEING

5.4 Shortcomings of GDP

The Last Word: Value Added and

GDP

• 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.

31 LO5.1

• 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

The Last Word: Value Added and GDP

32

5.1 Measuring the Economy’s Performance: GDP

5.2 Other National Accounts

5.3 Nominal GDP versus Real GDP

5.4 Shortcomings of GDP

Chapter 5 Summary