CHAPTER 5Measuring the

Economy’s Output

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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

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In This Chapter You Will Learn:

3LO5.1

• 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

4LO5.1

• 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

5LO5.1

(1)Stage of production

(2)Sales value ofmaterials 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 ProcessTable 5-2

6LO5.1

Two types of nonproduction transactions:1. Financial transactions- Public Transfer Payments- Private Transfer Payments- Stock-Market Transactions2. Second-hand sales

GDP Excludes Nonproduction Transactions

Table 5-3 Calculating GDP in 2008: The Expenditures Approach (billions of dollars)

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Stock of Stock of capitalcapital

January 1January 1

Net Net investmentinvestment StockStock

ofofcapitalcapital

December 31December 31

DepreciationDepreciation

Gross Investment

Figure 5-1 Gross Investment, Depreciation, Net Investment, and the Stock of Capital

9LO5.1

• 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)

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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

13LO5.1

• 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

15LO5.2

• 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

16LO5.2

• 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 StatesJapan

GermanyChina

United KingdomFrance

ItalyCanada

SpainBrazil

RussiaIndia

South KoreaMexico

Australia

0 1 2 3 4 5 6 7 8 9 10 12 13GDP in Trillions of Dollars

18LO5.3

• 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

19LO5.3

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 $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

20LO5.3

• 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

21LO5.3

How do we calculate a price index?

For example, if in year 2, price of basket is $20, and price of same basket in base year is $10, then:

22LO5.3

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

How do we calculate Real GDP?

23LO5.3

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 $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

24LO5.3

An implicit price index

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

GDP Deflator

25LO5.3

• 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.

26LO 5.3

Table 5-6 Steps for Deriving Real GDP from Nominal GDP

27LO5.3

• 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

28LO5.4

• Measurement Shortcomings: Non-Market Transactions not included: services of

self-supplied household services etc (hiring a nanny vs. doing it yourself)

The Underground Economy not included: illegal drugs, prostitution etc.

Leisure amount of leisure not included: two countries might have same GDP, but one achieves with population working half time, therefore has more leisure time

Improved Quality: quality of g & s not included

5.4 Shortcomings of GDP

29LO5.4

• Shortcomings of the Well-Being Measure GDP and the environment: environment not considered

(two countries with same GDP, but one produces with clean technology)

Composition and Distribution of Output: GDP doesn’t tell us if composition of output is welfare enhancing (g & s) or not (output for war); also doesn’t tell us if the wealth in a country is concentrated or equally distributed.

Non-material sources of well-being: material output doesn’t necessarily measure “total happiness”

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.

31LO5.1

• 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

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5.1 Measuring the Economy’s Performance: GDP5.2 Other National Accounts5.3 Nominal GDP versus Real GDP5.4 Shortcomings of GDP

Chapter 5 Summary