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Chapter 20 The Measurement of National Income.docx

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Brock University
Marilyn Cottrell

Chapter 20 The Measurement of National Income Production occurs in stages –  Many firms produce outputs that are used as inputs by other firms Intermediate goods (and services):  Outputs of firms that are used as inputs by other firms Final products:  Outputs that are not used as inputs by any other firms Value added:  The value of the firm`s output minus the value of all intermediate goods and services that it uses Value Added = Revenue – Costs of Intermediate g & s e.g.  Company buys iron ore for $200  Produces steel that is sells for $500  Iron ore is the intermediate good  Steel is the output  Steel company`s value added is $500 -$200 = $300 Total value added for a product = final selling price of the product. Example: Product Selling Price Value Added Cotton $2 $2 Cloth $5 $3 ($5-$2) Shirt $20 $15 ($20-$5) Total value added $20 Shirt sells for $20, and the sum of value added ($2+$3+$15) equals $20 Also, Value added = Income to Factors of Production  A firms contribution to total output is its value added  Total value added in the economy is Gross Domestic Product (GDP):  Measure of all final output that is produced in the economy valued at market prices  Adding up value added avoids double counting  Must not add up each firm`s output – overestimates GDP E.g. adding up cotton, plus cloth, plus shirt overestimates value of production – prices of cotton and cloth are include in price of shirt. National Income Accounting: The Basics Three different ways of measuring notional income:  Add up the total value added from domestic production  Add up the total expenditure on domestic output  Add up the total income from domestic production  Because of circular flow of income  3 measures yield the same total Gross Domestic Product (GDP) GDP form the Expenditure Side  Add up expenditures needed to purchase final output produced (in year) Four expenditure categories: 1) Actual consumption expenditure (C):  Expenditure on all final consumer g & s in year 2) Actual investment expenditure (I):  Expenditure on g&s not for present consumption, including:  New plant and equipment (additions to capital stock), also called business fixed investment  Inventory accumulation  New residential construction [ I ]Used in two ways  Replacement investment  Investment to cover depreciation (or capital consumption)  Maintains existing capital stock  Net investment  Addition to capital stock Gross I = Depreciation + Net I  Since all of Gross I is new production  It is includes in GDP 3) Government purchases of g&s (G)  Does not include transfer payments, e.g. Pensions  Government output must be measured by cost since  No market price  No market value of output  (If fewer police do the same job, measure of G falls, although output is the same.) 4) Net exports: NX = (X - IM)  Exports (X):  Purchases of Canadian-produced g&s by foreigners  Part of the total expenditure on Canadian output  Imports (IM):  Purchases of foreign-produced g&s by Canadians  Not spent on Canadian output  Subtract it from total expenditure GDP = C + I + G + X – IM GDP from the Income Side  GDP is the sum of factor incomes and other claims on the value of output. Factor incomes include:  Wages and salaries (total payment for services of labour)  Interest (e.g. From banks and loans to businesses)  Business profits both  Distributed (e.g., dividends)  Undistributed (retained earnings)  Sum of factor incomes is net domestic income at factor cost. To get to market prices add in “non-factor” payments:  To move from factor to market prices: add  Indirect taxes (e.g. Sales taxes) less subsidies  To move from Net to Gross: add  Depreciation of physical capital (firms subtract “capital consumption al
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