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ECON 105
Gulriz Barkin

Chapter 7: Tracking the Economy The National Accounts The national income and national product used in Canada is derived from an accounting system called the National Income and Expenditure Accounts. It keeps track of the spending of consumers, sales of producers, business investment, government spending and a variety of other flows of money between different sectors of the economy. It has a logical structure based on the circular flow of income. The key point of the circular flow diagram is thatthe value of domestic output produced is equal to the value of expenditu res on that output and is equal to the income generated by producing that output. Circular-Flow Diagram: The Flows of Money through the Economy !Households earn income via the factor markets fromwages, interest on bonds, dividends on stocks, and rent on land. !A stock is a share in the ownership of a company held by a shareholder. !A bond is borrowing in the form of an IOU that pays interest. !In addition, households receive government transfers from the government. !Disposable income, total household income minus taxes, is availableto spend on consumption or to save. 1 Chapter 7: Tracking the Economy !Private savings, equal to disposable income minus consumer spending, is disposable income that is not spent on consumption. !The banking, stock, and bond markets — which channel private savings and foreign lending into investment spending, government borrowing, and foreign borrowing — are known as the financial markets. !Government purchases of goods and services (G) is paid for by tax receipts, as well as by government borrowing. !Exports (X) generate an inflow of funds into the country from the rest of the world, while imports (IM) lead to an outflow of funds to the rest of the world. !Investment spending (I) is spending on productive physical capital, such as machinery and construction of structures, and on changes to inventories. Inventories are stocks of goods and raw materials held to facilitate business operations. Gross Domestic Product !Gross domestic product,or GDP, measures the market value of all final goods and services produced in the economy within a certain time perid, i.e. quarterly or annual. This definition has 4 parts: !Market Value. GDP adds all the different kinds of products the economy produces together into a single measure of economic activity. To do this, it uses . !Final goods and services. Final goods and services are goods and services sold to the final, or end, users. Intermediate goods and services are goods and services—bought from one firm by another firm—that are inputs for production of final goods and services. Excluding intermediate goods avoids double counting. ! Produced within a country. It measures domestic production. !In a given time period Calculating GDP !GDP can be calculated three ways: "Output based; Adding up thevalue addedof all producers "Expenditure based; Adding up all spending on domestically produced final goods and services, leading to the equation GDP = C + I + G + X − IM "Income based; Adding up all the income paid to factors of production 2 Chapter 7: Tracking the Economy Output based GDP. This approach adds the value of all goods and services produced in the economy. Value added = Value of Output – Value of Intermediate Goods Calculating GDP ©2006WorthPublishers Slide 7-10 Expenditure based GDP. This approach measure GDP as the sum of consumption expenditure (C), investment (I), government expenditure (G) and net exports (X-IM). 1. Consumption expenditure (C) includes the expenditures of households for durable consumer goods (autos, refrigerators), non- durable goods (bread, milk) and consumer services (mechanics, barbers) 2. Investment (I) includes • Purchases of machinery, equipment and tools by businesses • All construction (including residential) • Changes in inventories (unconsumed output) Note: Does not include financial transactions or transfer of tangible assets. 3 Chapter 7: Tracking the Economy Flows and Stocks in MacroeconomicsA flow is a quantity per unit of time; a stock is the quantity that exists at a point in time. For example, the water running from a faucet is a flow; the water inthe bathtub is a stock. Wealth, the value of all the things that people own, is astock.Saving is the flow that changes thestock of wealth. Capital which is a stock is the plant, equipment, and inventories of raw and semi-finished materials that are used to produce other goods and services. Two flows change the stock of capital: investment and depreciation. Investment which is the purchase of new capital increases the stock of capital, where as depreciation decreases the stock of capital. The total amount spent on purchases of new capital and on replacing depreciated capital is called gross investment. When we talk about the total investment in the economy we are talking about gross investment. 3. Government expenditure (G) includes expenditures ofall governments (federal, provincial and municipal) on final goods and services • Does not include transfer payments (e.g. EI benefits,welfare payments) • Government output is typically valued at cost rather than at market value 4. Net Exports (X-IM) • (X-IM) = Exports (X) – Imports(IM). Imports are domestic expenditure on foreign produced goods and services and exports are foreign expenditure on domestically produced goods and services 4 Chapter 7: Tracking the Economy Gross Domestic Product, expenditure based, 2012, S annual rates l a t o T f o % ) s n o i l l i m $ ( l a t o T GDP C I G NX (X -M) Source: Statistic Canada Income based GDP. The national income accounting conventions ensure that the output produces generates income exactly equal to the value of the output produced. Calculation of GDP from the income side involves adding up • factor incomes: wages and salaries interest profits -indirect taxe
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