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Chapter 20

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Marilyn Cottrell

January 14, 2014 Chapter 20 – The Measurement of National Income National Output and Value Added 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 ther firms. One company expects it to be its final product, however it used by another company as an input. • We need to make sure not to double count these intermediate goods. Final Products: • Outputs that are not used as inputs by any other firms • What is sold to the public Value Added: • Measures each firm’s contribution to total output (minus intermediate goods) • The amount of market value that is produced by that firm (how much do we price in market value on each contribution) Value Added = Revenue – Costs of Intermediate Goods & Services • The main thing is to NOT double count items. Eg. • Company buys iron ore for $200 • Produces steel that it sells for $500 • Iron Ore is the intermediate good • Steel company’s value added is $500 - $200 = $300 Total value added for a product = final selling price of the product. (different from Value Added) Example: Product Selling Price Value Added Cotton $2 $2 Cloth $5 $3 ($5-$2) Shirt $20 $15 ($20-$5) TOTAL VALUE ADDED $20 Note how the Total Value Added is equal to the selling price of the good. Shirt sells for $20, and sum of value added ($2 + $3 + $15) equals $20. Adding $20, $5, and $2 would be double counting and would be bad. Also, Value Added = Income to Factors of Production Total Value added in the economy is the 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 Eg. Adding up cotton, plus cloth, plus shirt overestimates value of production – prices of cotton and cloth are included in price of the shirt. National Income Accounting: The Basics Three different ways of measuring national 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 The circular flow of income • Yield 3 measures of Gross Domestic Product (GDP) Circular Flow Diagram – In Textbook GDP From 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 consumers goods and services 2. Actual gross investment expenditure (I): • Expenditure on goods and services not for present consumption, including: o New plant and equipment (additions to capital stock), also called business fixed investment (Stats Can) o Inventory Accumulation o New Residential Construction (I) used in two ways: • replacement investment o investment to cover depreciation (or capital consumption) o Maintains existing capital stock • Net investment (often tested on!) o Addition to capital stock o Increasing capital stock because we add to it • Gross Investment = Depreciation + Net Investment Since all of Gross Investment is new production is in included in GDP 3. Government Purchases of Goods & Services (G): • Does not include transfer payments, e.g. pensions, welfare, etc. Government output must be measured by cost since: • No market price • No market value of output • Measured by factor costs because when we look at something like policing, the question is “what does it cost us to run this department” because there is no market value/price to that. (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 goods and services by foreigners o Part of the total expenditure on Canadian Output Imports (IM): • Purchases of foreign-produced Goods and Services by Canadians o Not spent on Canadian Output o Subtract it from total expenditure because the money is leaving the country GDP = C + I + G + X – IM (do not bracket X – IM like some textbooks do) GDP From The Income Side GDP is the sum of factor incomes plus indirect taxes (net subsidies) plus depreciation. Factor Incomes include: • Wages and salaries (total payment for services of labour) • Interest (e.g. from banks and loads to businesses) • Business Profits both: o Distributed (eg. Dividends) o Undistributed (eg. Retained Earnings) Sum of these factor incomes is net domestic income at factor cost. All three of these methods were all the same, but here, we have a little bit of work to do before we get it to be the same. It’s not market prices, and its not gross. So we need to change it from net to gross, from factor to market prices. To get to market prices, add in “non-factor” payments: To move from factor to market prices: add • In
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