# ECON 209 Lecture Notes - Transfer Payment, Fixed Investment, Investment Goods

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Published on 12 Apr 2013
School
McGill University
Department
Economics (Arts)
Course
ECON 209
Page:
of 5
Economics Chapter 20 Summary
20.1
- Production occurs in stages: firms produce outputs that are used as inputs by others and these
firms produce outputs that are inputs by yet another firm so it isn’t as simple as just adding up the
output of each firm to find total economic output
- Double counting: adding up values of all sales, the same output would be counted every time it
was sold by one firm to another
- Intermediate goods: outputs of some firms used as inputs by other firms
- Final goods: products not used as inputs by other firms, not in same time pd. under consideration
- Distinguishing the two would, in theory, solve the problem of double counting
- It is difficult to distinguish b/c no firm, once their product is sold, knows what use it goes into. If
steel sold to a car company is for building purposes or reselling it in the form of a car
- Value added must be used instead which is: amount of value firms and workers add to their
products over and above costs of intermediate goods. In other words: Revenue- cost of
intermediate goods
- Payments made to factors of production like wages or profits paid to owner are not purchases
from other firms thus aren’t subtracted from firm’s revenue when computing value added
- Firms revenue equals cost of intermediate goods plus payments to factors of production, value
added is exactly equal to sum of these factor payments
- Therefore value added= payments to factors of production (land, labour and capital)
- The sum of all values added in an economy is a measure of the economy’s total output
Value Added Through Stages of Production
- Value added is how much more the firm is selling a product for than it bought its inputs for
- So if the firm buys 1000 dollars’ worth of steel to produce a \$1500 car, then its value added
would be the \$500 extra it tacked onto the \$1000 intermediate input which is due to some means
of production, so this \$500 may go towards rebuilding capital, paying workers, paying off
investors, etc. any factors of production
20.2 National Income Accounting: the Basics
- National Income and Expenditure Accounts (NIEA)- based on circular flow of income and
measures national income and national product
- Value of domestic output is equal to value of expenditure on that output and is equal to total
income claims generated by producing that output
- National income= national product
- Injections into circular flow of income= money coming into system (exports, investment and
gov’t purchases)
- Withdrawals= money leaving system (imports, savings, and taxes)
- Circular flow suggests 3 ways to measure national income:
- 1.) add up value of all goods and services produced requiring value added: GDP by value added
- 2.) add up total flow of expenditure on final domestic output: GDP on the expenditure side
- 3.) add total flow of income generated by flow of domestic production: GDP on the income side
- They all yield the GDP
GDP from the Expenditure side
- Adding up expenditures needed to purchase final output produced in that year
- The sum of consumption, investment, gov’t purchases and net exports
1.) Consumption Expenditure
- Expenditure on all goods and services sold to their final users during the year; durable, semi-
durable, and non-durable goods as well as services
- C a denotes actual measured consumption expenditure
2.) Investment Expenditure
- Expenditure on goods not for present consumptions, including inventories, capital goods (like
factories, machines) and residential housingthese are called investment goods
Changes in Inventories
- Stocks of raw materials, goods in process and finished goods held by firms to mitigate effect of
short-term fluctuations in production or salessteady stream of production despite interruptions
in deliveries of inputs bought from other firms
- Accumulation of inventory= positive investment b/c it reps goods produced but not consumed;
included at market value which includes wages, other costs firm incurred in producing them and
profit firm will make when they are sold
- Decumulation counts as negative investment b/c it reps a reduction in stock of finished goods
available to be sold
New Plants and Equipment
- Capital stock: aggregate quantity of capital goods
- Creating new capital goods is investment called business fixed investment (AKA fixed
investment)
New Residential Housing
- durable asset yielding utility over long period of time
- building new houses are new investment rather than consumption
- when an individual purchases a house though, since it is an existing asset being transferred,
transaction is not part of national income; only when new house is built
Gross and Net Investment
- Replacement investment is 1 of 2 parts of gross investment: amount of investment required to
replace part of capital stock lost through process of depreciation (amount by which capital stock
is depleted through production process)
- Net investment (part 2 of gross investment): equals gross investment minus depreciation
- When net investment is positive: economy’s capital stock is growing and vice versa
- All gross investment is included in calculation of national income
- Actual Investment Expenditure is denoted by I a
3.) Gov’t Purchases
- When gov’t provides goods and services that households ant they add to the sum total of valuable
output in the economy
- All gov’t purchases (gov’t expenditure on currently produced goods and services, exclusive of
gov’t transfer payments) is included, denoted by G or G a for actual gov’t purchases
Cost Versus market Value
- Gov’t output is valued at cost not market value; what is market value of law courts for example
- But it costs money to build and sustain it so we value gov’t output at their cost of production
- Problem: if one civil worker replaces that of another and the other goes to work in the private
sector—it costs gov’t less so they’re cost goes down but they may be contributing more
- Similarly if 2 are sent to do the job of 1, then it costs gov’t more so the value goes up but they’re
not necessarily doing more so it’s an overestimate of their contribution to national income
- Both of these cause changes in national income though how much they produce hasn’t changed
Gov’t Purchases versus Gov’t Expenditure
- What the gov’t buys is included in GDP but not what the gov’t spends money on
- For ex: if they transfer money from income from tax payers to holders of gov’t bonds, this is a
transfer payment, they’re allocating money from one area to another thus not adding to national
income
- This is why transfer payments (payment to an individual or institution not made in exchange for a
good or service)- is not included in GDP
- If the person at the receiving end then takes the money to buy things it is put as consumption
4.) Net Exports
- Import: value of domestically produced goods and services purchased from firms, households or
gov’ts in other countries
- Exports: value of all goods and services sold to firms, households and gov’ts in other countries
Imports:
- Country’s national income is total value of final goods produced in that country so if you buy a
car from Japan, it doesn’t rep Canadian production
- If parts of something are made from imported goods, the parts that aren’t made from imported
goods is what is included in our own GDP, the rest is included in foreign GDP
- The value of actual imports is represented by symbol IM a
Exports
- If Canada sells good to German households, goods are part of German consumption expenditure
but constitute expenditure on Canadian output
- Value of exports is X a
- Net exports is (X a IM a) and is denoted by NX a
- If exports exceeds imports, NX a is positive, if imports exceeds exports NX a is negative
Total Expenditures
- GDP= C a + I a + G a + (X a IM a)
GDP from the Income side
- Conventions of national income accounting ensure production of a nation’s output generates
income= to value of that production
- Must add up factor incomes and other claims on value of output until all value is accounted for
1.) Factor Incomes
- 3 main components: wages and salaries, interest and business profits
Wages and Salaries
- Payment for services of labouris pre-tax labour earnings
- Represent value of production paid to labour
Interest:
- Interest earned on bank deposits, loans to firms and other investment incomes
- Excludes interest income earned from loans to Canadian gov’t
- Some profits are paid out as dividends to owners and the rest is held by firms (retained earnings)
- Dividends and retained earnings are included in calculation of GDP
- Total profits include: corporate profits, incomes of unincorporated business (small business,
- Interest+ business profits is value of payment for the use of capital
Net Domestic Income
- Sum of wages and salaries, interest and profits is net domestic income at factor cost
- Net b/c excludes value of output used as replacement investment (money offsetting depreciation)
- Domestic income b/c it is income accruing to domestic factors of production
- At factor cost b/c it reps only part of value of final output that accrues to factors in form of
payments due to them for their services
2.) Non- factor payments: when someone spends \$10, less than \$10 is generated as income due to
indirect tax and depreciation
Indirect taxes and subsidies
- Indirect taxes: taxes on production and sale of goods and services
- Gov’t tax on goods and services is added to GDP
- When gov’t gives subsidies we must subtract value from GDP since it allows factor incomes to
exceed market value of output (if gov’t gives \$2 per unit of a \$5 good, then it really costs the
producer \$3 to produce so we must subtract the subsidy given to get how much it actually cost
them)