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Chapter 20.


Measuring total output for an economy is NOT easy. Many goods produced by one firm are sold
to other firms, which use those goods to produce other goods.
GDP does not measure transactions in an economy, it measures FINAL OUTPUT.
Problem: production occurs at many stages and one firms output is another firms input.
Ex.: steel + glass + tires + etc. = car
Adding the value at each level of output means double counting intermediate goods.
3 ways to deal with this problem:
1. Expenditure approach
2. Value added approach
3. Income approach
1. Expenditure approach - measures activity by adding the amount spent by all ultimate users of
- Expenditures on FINAL goods + services only.
Ex. Households are ultimate users of apples. Juice Inc is not - makes juice and sells it to
you buy 10$ worth of apples + 40$ worth of apple juice.
Total output = 50$ using expenditure on final goods.
2. Value added approach - measures economic activity by adding the market value of G&S
produced, minus the cost of the intermediate goods.
Two types of Goods:
the other firm.

- Intermediate good - one firms output is used as an input by

- Final good - is not used as an input by other firms.

Value added = Revenue from sales - cost of intermediate goods

Ex. Farmer sells 10$ worth of apples to households, 25$ worth of apples to Juice Inc. Juice Inc
processed 25$ worth of apples into a juice worth 40$.
Farmer income (no intermediate product) = 10 + 25 = 35$

Juice Inc income = 40 - 25 = 15$

(Value added by the firm).
For Economy : Value added = 35 + 15 = 50$
Value added = Income to Factors of Production in wages to workers and profit to owners.
3. Income approach - measures economic activity by adding all income received:
wages, taxes (Govts income), profit (owners income).
- Total income = GDP on the income side.
All the approaches are equivalent - we get the same answer using each of them:
- because market value of G&S produced in a given period is equal to the amount that
buyers must spend to purchase them
- sellers receipts equal to total income generated by economic activity.
(Unsold goods are accounted as firms inventory.)
Fundamental Identity of N.I. accounting is:
Total Output = Total Income = Total Expenditure
(All measured in the same units, ex. Dollars).
1. GDP - Expenditures Approach
Expenditure approach measures GDP as total spending on FINAL goods and services
produced within a nation in the year.
4 General Categories

1. Consumption -----------------------C
2. Investment ------------------------- I
3. Govt purchases of G&S -------- G
4. Net exports ------------------------NX

Y = GDP = Total Output, Total Income, Total expenditure

GDP = Y = C + I + G + NX
1. Consumption = C (Actual consumption)
-domestic expenditures on all G&S sold to their final users in the year. (Includes
expenditure on Imported goods.).

Includes: I) spending on services (Restaurant meals, dentist, haircut, fin. Services, etc.)
II) consumer durables (long - lived items, such as cars, furniture, appliances).
III) semi - durable goods (shorter lived items - cloth).
IV) non - durable good (food, utilities, rent).
2. Investment = I (Actual investment expenditure)
Investment includes spending on the construction of new capital goods (fixed I) and increases in
firms inventory holdings (inventory I).
! Do not consider buying stocks or bonds - that is considered saving, not investing.
Fixed Investment has 3 components:
- residential housing (spending on NEW housing and apartment buildings is a real
capital - lasts long time).
- non-residential investment (factories, office buildings, etc.)
- machinery and equipment investment
Total investment is Gross Investment
Gross Investment = Net Investment + CCA
CCA - capital consumption allowance (depreciation - decrease in an assets value).
-investment involves expenditures to replace assets that have worn out.
Net investment shows the increase in the countrys productive capacity.
3. Government Purchases - G

(Actual Govt purchases)

-Govt payments for goods and services and investment in equipment and structures.
Ex. Roads, civil servants salaries, education (calculated at factor cost)
Transfer payments (S.a. public pensions, UI benefits, welfare payments,
interest on countrys debt).
4. Net Exports - NX
NX = X - IM

(Actual net exports)

X - foreign expenditure on domestic G&S

IM - domestic expenditure on foreign G&S
Add exports to total spending, they represent spending on domestically produced G&S.
Subtract Imports from total spending, because in the C, I, G - are defined to include imported
Ex. Canadians buy more Japanese cars - lowers Canadian expenditure on domestic Goods.
Total expenditures: Y = C + I + G + (X - IM)
-refers to expenditures on Final Output.
2. GDP - Income Approach
National Income is the sum of four types of income:
1. Employee compensation - labor income (wages + salaries)
-include income taxes, UI, Pension fund contributions ( income before taxes and contributions).
2. Interest and investment income
-include all interest earned on bank deposits, loans to firms (excludes interest on Govt debt - is a
transfer payment).
3. Rent
-payment for any factor s.a. land, buildings that is rented.
4. Profit (before tax) + dividends
-all profit from business (Revenue less cost), dividends (profit) to shareholders.
These four types of income are called FACTOR PAYMENTS
To make value of income = expenditures need to add:
5. Add Indirect taxes
-S.a. provincial sales tax and federal GST - income of the Govt, must be added.
6. Subtract subsidies
-such as those made to some dairy farmers, public transportation, post offices, etc.
7. Add Depreciation (CCA)
-the value that must be reinvested, is not income earned by any Factors of production.
CCA is a part of GDP, but not part of Net Domestic product - NDP

NDP = GDP - Depreciation or GDP = NDP + Depreciation

: GDP = Sum of factor payments + Indirect taxes - Subsidies + Depreciation
! N.Income and N. Expenditures should give the same values of GDP, but there is always some
errors due to measurement and arbitrary decisions. !
Govt purchases of G&S - G
Indirect Taxes less subsidies
Personal Income Tax
Wages (includes income T)
Interest on Govt debt
Consumption - C
Exports - X
Imports - IM
Investment - I
Interest Income
Profit (before tax)

= 58.5
= 29.0
= 41.5
= 165.5
= 15.5
= 168.4
= 90.9
= 33.5
= 93.3
= 67.2
= 19.0
= 45.1

Find GDP using expenditure approach and GDP using Income approach.


GDP - the value of all goods and services produced in an economy during a year.
GNP - (Gross National Product) - total income received by Canadians during the year.
Specifically: GNP is the market value of final goods and services produced by domestic factors
of production during the year.
1. some incomes from Canadian production goes to foreigners (part of
2. Some incomes from foreign production received by Canadians.(part of
GDP - 1 + 2 = GNP;

2 - 1 = NFP Net factor payments from abroad

NFP is income paid to domestic factors of production by the rest of the world, minus income
paid to foreigners by domestic economy.
Real and Nominal GDP:

GDP deflator

Nominal GDP: money value of total output in current prices.

Nominal GDP can increase for 2 reasons:
-increase in total output (real increase in production and income).
-increase in prices (inflation).
Real GDP: value of the output calculated at base year prices (constant $ GDP).
Ex. Nominal GDP increased by 68% from 90 to 2002.
Real GDP increased by 40% over that period.
Super bowl economy:

Year 1
Pizza = 500
Price of pizza = 15$
Beer = 250 cases
Price of beer = 17.6$

Year 2
Pizza = 500
Price of pizza = 15$
Beer = 200 cases
Price of beer = 22$

Nominal income has not changed = 11.900$ in both years.

Real income (at base year prices) = 11.020$.

Real income fell from 11.900$ to 11.020$
In order to see the change in the price level (not just a price for a single good or service) we use
GDP deflator.
GDP deflator = nom GDP/ real GDP
Super bowl economy:
Production versus productivity
1. Per Capita GDP = GDP / population
-shows how much output there is on average for each person in the economy.
Per capita GDP is used to compare various nations income. It tells countries standards of living.
Why GDP rises:

- more inputs (Labor, capital)

- inputs are more productive

2. Output per employee = GDP / # of employed

-shows income, production with number of people employed
3. Output per hour worked = GDP / # of hours worked
- shows how productive workers are.
1. Illegal activities

(Gambling, drug smuggling, etc. produce incomes, but are

is not included in GDP).

2. Unreported activities (Underground economy - working for cash to avoid paying

3. Non-market activities (house spouse - rising family hard work, but not part of GDP,
Home production, volunteering, doing work around the
4. Economic bads (Pollution, natural recourse depletion).
Estimation of the underground , non-measured economy range from 1.5 to 20% of GDP in