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Chapter 20 Notes.docx

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Western University
Economics 1022A/B
Jeannie Gillmore

Chapter 20 Notes Gross Domestic Product  GDP is the market value of the final goods and services produced with in a country in given time period o market value refers to the price at which items are traded in the market o final goods/services refer to the item that is bought by its final user during a specified time period  an intermediate good is an item that is produced by one firm, bought by another, and used as a component of a final good  only counting final goods avoids double counting items (e/x the tires used in cars)  secondary goods (e/x used cars and existing houses) are only counted in GDP in the year is was produced in  financial goods (e/x stocks and bonds) are not included in GDP o only goods that are produced within a country count towards it’s GDP  a Canadian company cannot count goods produced overseas as part of the Canadian GDP  GDP measures not only the value of total production, but also total income and total expenditure o the equality between total production and total income is important because it shows the direct link between productivity and living standards  living standard rises when income rises and we can afford to buy more goods, but we must produce more to consume more Circular Flow of Expenditure and Income  households sell and firms buy the services of labour, capital, and land in factor markets o for these factor services, firms pay income to households o a firm’s retained earnings are considered part of the household sector for economics o “what the households save and lend back to firms” o total income (aggregate income) is what is received by households, including retained earnings (Y)  firms sell and households buy consumer goods and services in the goods market o the total payment for these goods and services is consumption expenditure (C)  firms buy and sell new capital equipment in the goods market o if firms produce a good that is not sold, it is added to the inventory anyway… acts as if the firm bought it from itself o the purchase of new plant, equipment, and buildings and the additions to inventories are investment (I)  governments buy goods and services from firms and their expenditure on these is called government expenditure (G) o financed by taxes, which is NOT part of the circular flow of expenditure  firms in Canada sell goods and services to the rest of the world exports (X) and but goods from the rest of the world imports (M) o the value of exports minus the value of imports is called net exports  GDP equals expenditure equals income o GDP can be measured in two ways:  by the total expenditure on goods and services or by the total income earned producing goods and services o aggregate expenditure equals consumption expenditure plus investment plus government expenditure plus net exports o aggregate income is equal to the total amount paid for the services of the factors of production used to produce final goods and services (wages, interest, rent, profit) o because firms pay out as incomes everything they receive from the sale of their output, aggregate income equals aggregate expenditure (equals GDP)  Y = C + I + G + X – M Why Domestic Product is “Gross”  gross means before subtracting the depreciation of capital o net means after subtracting the depreciation of capital  depreciation is the decrease in the value of a firm’s capital that results from use and obsolescence o the total amount spent both buying new capital and replacing depreciated capital is called gross investment o the amount by which the value of capital increases is called net investment  equals gross investment minus depreciation  e/x if an airline buy 5 new airplanes and retires 2 old airplanes, its gross investment is the value of 5 new airplanes, depreciation is the value of 2 old airplanes, and net investment is the value of 3 new airplanes  gross investment is one of the expenditures included in the expenditure approach to measuring GDP o the resulting value of total product is a gross measure  gross profit (a firms profit before depreciation) is one of the incomes included in the income approach to measuring GDP o the resulting value of total product is a gross measure Measuring GDP: Expenditure Approach  the expenditure approach measure GDP as the sum of consumption expenditure (C), investment (I), government expenditure (G), and net exports of goods and services (X – M) o consumption expenditure  what Canadian households spend on goods and services produced in Canada and in the rest of the world o investment  expenditure on capital equipment and buildings by firms in addition to business inventories o government expenditure  expenditure by the government (e/x National Defence)  does not include transfer payments (e/x unemployment benefits) o net exports of goods and services  value of imports minus exports Measuring GDP: Income Approach  the income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire (wages for labour, interest for capital, rent for land, profit for entrepreneurship) o incomes are divided into two categories:  wages, salaries, and supplementary labour income  payment for labour services, including gross wages plus benefits (e/x pension contribution)  other factor incomes  include corporate profits, interest, farmers’ income, and income from non-farm unincorporated business  mixture of interest, rent, and profit and include some labour from self- employment  an indirect tax is a tax paid by consumers when the buy goods and services (direct tax is a tax on income) o makes the market price exceed factor cost  a subsidy is a payment by the government to a producer o factor cost exceeds market price with a subsidy  to get from factor cost to market price, we add indirect taxes and subtract subsidies o this brings us to net domestic income at market price  to get form net income to gross income, we add depreciation Real vs. Nominal GDP  real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year o this allows us to see the change in production o current base year is 2002  nominal GDP is the value of final goods and services valued at the price of that year o nominal GDP is just a more precise name for GDP The Uses of Real GDP  used to compare the standard of living over time o real GDP per person is real GDP divided by the population  tells us the value of goods and services that the average person can enjoy  by using real GDP, we remove any influence that rising prices
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