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Chapter 20.docx

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ECON 1010
George Georgopoulos

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Chapter 20: Measuring GDP and Economic Growth GDP Defined 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:  Market value  Final goods and services  Produced within a country  In a given time period Market Value 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 period. 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 service. 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 expenditure. 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 markets. 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 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 expenditure, 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 measuring GDP. 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:
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