Lec- Week 2

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University of Toronto Scarborough
Economics for Management Studies
Iris Au

1 ECMA06 – National Income Measurement of National Income – GDP Outline • Why we want to measure output? • The 3 approaches to measure national income: ⇒ The expenditure approach. ⇒ The income approach. ⇒ The value-added approach. • Other issues related to national income: ⇒ Gross national income vs. net national income. ⇒ GDP vs. GNP. ⇒ Nominal GDP vs. Real GDP. ⇒ GDP deflator. www.notesolution.com 2 Why We Want to Measure Output? • A measure of the country’s economic activity – what kind of goods and services we produced? What are the levels of production? • A simple way to measure our standard of living and compare it to other countries. How To Measure Aggregate Output • We call the aggregate output as Gross Domestic Product (GDP) – the total value of goods and services produced in the economy during a given period. • There are 3 ways to measure GDP: 1) The expenditure approach Use by the government 2) The income approach 3) The value added approach www.notesolution.com 3 ECMA06 – National Income www.notesolution.com 4 The Expenditure Approach • The expenditure approach, sometime called gross domestic expenditure (GDE), adds up the expenditure needed to purchase the final output (end use, not for the production for goods and services)produced during a given period. • Total expenditure is the sum of 4 major broad categories: 1) Consumption (C) – spending by households on goods and services. (55% of our GDP represented by this) 2) Investment (I) – spending on goods that are not for present consumption. There are 3 types of investment: i) Business fixed investment – the purchases of capital equipments, machinery and production plants. ii) Residential investment – the building of new houses. iii) Inventory investment – the change in the quantity of goods that firms hold in storage, including materials and supplies, work in process, and finished goods. 3) Government spending (G) – spending on goods and services by different levels of government, exclusive of government transfer payment. www.notesolution.com ECMA06 – National Income 4)Net exports (NX), NX = Exports (X) – Imports (IM) Why net exports not export? - Because consumption, investment and government spending may include final goods and services produced outside the country (i.e. imported goods) - Given GDP measures final goods and services produced within the country, we need to subtract imports. GDP from the expenditure approach = C + I + G + NX GDP, Expenditure Base, at Market Prices, $ millions, 2009 + Consumption 898,728 + Private investment 261,217 + Government spending 393,017 + Exports 438,553 trade - Imports 464,722 deficit www.notesolution.com 6 + Statistical discrepancy 465 GDP 1,527,258 Source: Statistics Canada. The Income Approach • The income approach looks at all the incomes earned by Canadians as a result of production. • It takes into account of the followings: ⇒ Factor incomes – wages, salaries, interest, business profits. Associated with production factors ⇒ Non-factor payments – indirect taxes (HST, PST AND GST) and subsidies, capital consumption allowances (CCA, depreciation of capital), inventory valuation adjustments (IVA, change in physical inventory held by firms) Not associated with production factors www.notesolution.com 7 ECMA06 – National Income GDP, Income Base, at Market Prices, $ millions, 2009 Wages 819,066 Interest & investment income 63947 Corporate profits 159,872 (incl. Gov’t enterprises) Unincorporated profit (incl rent) 99879 Indirect taxes, net of subsidies 163,634 Inventory valuation adjustment 2541 Capital consumption allowance 218,785 Statistical discrepancy −466 GDP 1,527,258 Source: Statistics Canada • Note: Both the expenditure approach and the income approach give the same GDP, why? • Answer: one’s spending = another’s income - For a country as a whole, total income = total expenditure www.notesolution.com 8 The Value-Added Approach • The government does not use this approach. • Question: How do we measure output? • Answer: Value added = Output of every firm in Canada – Intermediates purchased by firm Example: Consider the followings: Wheat farmers produce $1000 wheat and sold all of them to the millers. The millers turn the wheat into flour and sell all the flour at $1500 ($400 sold to consumers and $1100 sold to bakers). Finally, the bakers bake $3000 worth of bread from the flour and sold all the bread to consumers. • What is value of final products? For end use: $400 + $3,000 = $3,400 • What is the valued added? Value-added = $1,000 + ($1,500-$1,000) + ($3,000-$11,000) = $3,400 www.notesolution.com 9 ECMA06 – National Income Note: Value-added gives us the same answer as final products. Why? • Answer: - The value-added measures the contributions of each firm to total output - When we add ALL firms’ contribution together, it must get us the measure of the economy’s total output. www.notesolution.com 10 Problem – Expenditure Approach, Income Approach, and Value-Added Approach Suppose a firm produces $4000 output Sells Pay
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