CHAPTER 20.docx

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12 Dec 2013
Production occurs in stages: some firms produce outputs that are used as inputs by other firms, and
these other firms, in turn, produce outputs that are used as inputs by yet another firms.
The error that would arise in estimating the nation’s output by adding all sales of all firms is called
double counting.
Must distinguish between two types of output:
Intermediate goods: all outputs that are used as inputs by other producers in a further stage of
Final goods: goods that are not used as inputs by other firms but are produced to be sold for
consumption, investment, government, or exports during the period under consideration
It is extremely difficult, if not impossible, to distinguish final from intermediate goods.
To avoid double counting, economists use the concept of value added: the value of a firm’s output
minus the value of the inputs that it purchases from other firms.
| Value added = revenue costs of intermediate goods |
Payments made to factors of production, such as wages or profits, are not subtracted. But revenue must
equal cost of intermediate goods plus payments to factors of production, so:
| Value added = payments to factors of production |
Value added is the correct measure of each firm’s contribution to total output – the amount of market
value that is produced by that firm.
the sum of all values added in an economy is a measure of the economy’s total output.
National Income and Expenditure Accounts (NIEA) produced by Statistics Canada.
The value of domestic output is equal to the value of the expenditure on that output and is also equal to
the total income claims generated by producing that output.
Red simple circle from households to
producers and back to households.
Blue injections (exports, investments,
and government purchases).
Green withdrawals (imports, saving,
and taxes).
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Three ways of measuring national income:
1. Add up the value of all goods and services produced in the economy (value added)
2. Add up total flow of expenditure on final domestic output
3. Add up total flow of income
All add up to gross domestic product (GDP): the total value of goods and services produced in the
economy during a given period. (GDP by value added, GDP on the expenditure side, GDP on the income
GDP from the Expenditure Side
Adding up the expenditures needed to purchase the final output produced in that year.
Sum of consumption, investment, government purchases, and net exports.
These four categories are exhaustive all expenditure on final output falls into one of the four
1. Consumption Expenditure
Consumption expenditure: household expenditure on all goods and services. Represented by the symbol
Actual measured consumption expenditure is denoted by symbol CA
2. Investment Expenditure
Investment expenditure: expenditure on the production of goods not for present consumption.
Represented by the symbol I.
- Changes in inventories
o Inventories: stocks of raw materials, goods in process, and finished goods held by firms
to mitigate the effect of short-term fluctuations in production or sales.
o Accumulation of inventories counts as positive investment. Decumulation
- New plant and equipment
o Manufactured aids to production such as tools and machines
o Capital stock: the aggregate quantity of capital goods
o fixed investment: the creation of new plant and equipment
- new residential housing
o house only appears in national accounts when built when it is transferred between
individuals later, the transaction is not included in national income
- gross and net investment
o replacement investment and net investment.
o Replacement investment amount of investment required to replace that part of the
capital stock lost through depreciation: the amount by which the capital stock is
depleted through the production process
o Net investment = gross investment depreciation
o Positive net investment means economy’s capital stock is growing.
Actual total investment expenditure is denoted by symbol IA.
3. Government Purchases
All government purchases: all government expenditures on currently produced goods and services,
exclusive of government transfer payments. Represented by symbol G.
Actual government purchases are GA.
- Cost versus market value
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