Chapter 20: Measuring GDP and Economic Growth
GDP or gross domestic product is the market value of all final goods and services
produced in a country in a given time period.
This definition has four parts:
Final goods and services
Produced within a country
In a given time period
GDP is a market value—goods and services are valued at their market prices.
To add apples and oranges, computers and popcorn, we add the market values so
we have a total value of output in dollars.
Final Goods and Services
GDP is the value of the final goods and services produced.
A final good (or service) is an item bought by its final user during a specified time
A final good contrasts with an intermediate good, which is an item that is produced
by one firm, bought by another firm, and used as a component of a final good or
Excluding the value of intermediate goods and services avoids counting the same
value more than once.
Produced Within a Country
GDP measures production within a country—domestic production.
In a Given Time Period
GDP measures production during a specific time period, normally a year or a
quarter of a year.
GDP and the Circular Flow of Expenditure and Income
GDP measures the value of production, which also equals total expenditure on final
goods and total income.
The equality of income and value of production shows the link between productivity
and living standards.
The circular flow diagram in Figure 20.1 illustrates the equality of income and
The circular flow diagram shows the transactions among households, firms,
governments, and the rest of the world. Households and Firms
Households sell and firms buy the services of labour, capital, and land in factor
For these factor services, firms pay income to households: wages for labour services,
interest for the use of capital, and rent for the use of land. A fourth factor of
production, entrepreneurship, receives profit.
In the figure, the blue flow, Y, shows total income paid by firms to households.
Firms sell and households buy consumer goods and services in the goods market.
Consumption expenditure is the total payment for consumer goods and services,
shown by the red flow labelled C .
Firms buy and sell new capital equipment in the goods market and put unsold
output into inventory.
The purchase of new plant, equipment, and buildings and the additions to
inventories are investment, shown by the red flow labelled I.
Governments buy goods and services from firms and their expenditure on goods
and services is called government expenditure.
Government expenditure is shown as the red flow G.
Governments finance their expenditure with taxes and pay financial transfers to
households, such as unemployment benefits, and pay subsidies to firms.
These financial transfers are not part of the circular flow of expenditure and income.
Rest of the World
Firms in Canada sell goods and services to the rest of the world—exports—and buy
goods and services from the rest of the world—imports.
The value of exports (X ) minus the value of imports (M) is called net exports, the
red flow X – M.
If net exports are positive, the net flow of goods and services is from Canadian firms
to the rest of the world.
If net exports are negative, the net flow of goods and services is from the rest of the
world to Canadian firms.
The circular flow shows two ways of measuring GDP.
GDP Equals Expenditure Equals Income
Total expenditure on final goods and services equals GDP.
GDP = C + I + G + X – M.
Aggregate income equals the total amount paid for the use of factors of production:
wages, interest, rent, and profit.
Firms pay out all their receipts from the sale of final goods, so income equals
Y = C + I + G + (X – M). Why Is Domestic Product “Gross”?
“Gross” means before deducting the depreciation of capital.
The opposite of gross is net.
“Net” means after deducting the depreciation of capital.
Depreciation is the decrease in the value of a firm’s capital that results from wear
and tear and obsolescence.
Gross investment is the total amount spent on purchases of new capital and on
replacing depreciated capital.
Net investment is the increase in the value of the firm’s capital.
Net investment = Gross investment Depreciation.
Gross investment is one of the expenditures included in the expenditure approach to
So total product is a gross measure.
Gross profit, which is a firm’s profit before subtracting depreciation, is one of the
incomes included in the income approach to measuring GDP.
So total product is a gross measure.
Measuring Canadian GDP
The Bureau of Economic Analysis uses two approaches to measure GDP:
The expenditure approach
The income approach
The Expenditure Approach
The expenditure approach measures GDP as the sum of the red flow: