Chapter 20 : The Measurement of National Income Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 20.1National Output and Value Added 1.see how the concept of value added solves the problem of "double counting" when measuring national income. 20.2National Income Accounting: The Basics 2.explain the income approach and the expenditure approach to measuring national income. 20.3National 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. Copyright © 2014 Pearson Canada Inc. 2 Chapter 20, Slide

20.1National 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 Copyright © 2014 Pearson Canada Inc. 3 Chapter 20, Slide

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). 4 Copyright © 2014 Pearson Canada Inc. APPLYING ECONOMIC CONCEPTS 20-1 Value Added Through Stages of Production Chapter 20, Slide

20.2National 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. Copyright © 2014 Pearson Canada Inc. 5 Chapter 20, Slide

Fig The Circular Flow of Expenditure and Income 6 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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 (C a ) includes expenditure on all final goods during the year. 7 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

Actual investment expenditure (I a ) is expenditure on the production of goods not for present consumption, including: inventories plant and equipment residential housing Actual government purchases (G a ) is the purchase of currently produced goods and services by government excluding transfer payments. 8 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

Actual net exports (NX a ) is the difference between exports and imports: NX a = (X a – Im a ) 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 = C a + I a + G a + NX a 9 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

Table 20-1 GDP from the Expenditure Side, Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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 11 Copyright © 2014 Pearson Canada Inc. net domestic income Chapter 20, Slide

GDP from the income side is therefore equal to: GDP = Net domestic income + Indirect taxes (less subsidies) + Depreciation 12 Copyright © 2014 Pearson Canada Inc. EXTENSIONS IN THEORY 20-1 Arbitrary Decisions in National Income Accounting Chapter 20, Slide

Table 20-2 GDP from the Income Side, Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

14 Copyright © 2014 Pearson Canada Inc. MyEconLab 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 Growth in Canada and Other G7 Countries in the Additional Topics section of this book's MyEconLab. Chapter 20, Slide

20.3National 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. Copyright © 2014 Pearson Canada Inc. 15 Chapter 20, Slide

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 16 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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. 17 Copyright © 2014 Pearson Canada Inc. GDP Deflator = Nominal GDP Real GDP x 100 Chapter 20, Slide

18 Copyright © 2014 Pearson Canada Inc. 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 Chapter 20, Slide

Table 20-3 Nominal and Real GDP in Canada 19 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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" 20 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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. 21 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

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. 22 Copyright © 2014 Pearson Canada Inc. Chapter 20, Slide

23 Copyright © 2014 Pearson Canada Inc. MyEconLab 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. Chapter 20, Slide