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Chapter 5

ECN 204 Chapter Notes - Chapter 5: Gdp Deflator, Market Basket, Consumer Spending

Course Code
ECN 204
Thomas Barbiero

of 5
Chapter 5 Review
5.1 Measuring the economy’s performance: GDP
Gross Domestic Product (GDP), a basic measure of economic performance, is
the market value of all final goods and services produced within the borders
of a nation in a year.
Final goods are those purchased by end users.
o Intermediate goods are those purchased for resale or for further
processing or manufacturing.
o Intermediate goods, nonproduction transactions, and second-hand
sales are purposely excluded in calculating GDP.
GDP may be calculated by summing total expenditures on all final output or
by summing the income derived from the production of that output.
By the expenditures approach, GDP is determined by adding consumer
purchases of goods and services, gross investment spending by businesses,
government purchases, and net exports: GDP = C + Ig + G + Xn
Gross investment is divided into:
o (a) Replacement investment (required to maintain the nation’s stock
of capital at its existing level)
o (b) Net investment (the net increase in the stock of capital)
Positive net investment associated with an expanding
production capacity
Negative net investment with a declining production capacity
Personal consumption expenditures consist of expenditures on goods
(durable goods and nondurable goods) and services.
o About 60 percent of consumer expenditures in Canada are on
services, leading economists to refer to the Canadian economy as a
service economy.
By the income approach, GDP is calculated as the sum of:
o Wages and salaries
o Profits of corporations and government enterprises before taxes
o Interest and investment income
o Net income of farmers and unincorporated businesses
o And two noninvestment transactions
Indirect taxes less subsidies
Capital consumption allowances
5.2 Nominal GDP versus real GDP
Price indexes are computed by dividing the price of a specific collection or
market basket of output in a particular period by the price of the same
market basket in a base period and multiplying the result (the quotient) by
The implicit price index, or GDP deflator, is used to adjust nominal GDP for
inflation or deflation and thereby obtain real GDP.
Nominal (current-dollar) GDP measures each year’s output valued in terms
of the prices prevailing in that year.
Real (constant-dollar) GDP measures each year’s output in terms of the
prices that prevailed in a selected base year.
o Because real GDP is adjusted for price-level changes, differences in
real GDP are due only to difference in production activity.
A chain-weighted index to compute real GDP is constructed using an average
of current and past prices as weights. It is particularly useful in an economy
in which the prices of some outputs are declining.
5.3 Shortcomings of GDP
GDP is a reasonably accurate and very useful indicator of a nation’s economic
performance, but it has it limitations.
o It fails to account for
Nonmarket and illegal transactions
Changes in leisure and in product quality
The environmental effects of production
The composition and distribution of output
GDP should not be interpreted as a complete measure of well-being.
Key Terms:
National income accounting the techniques used to measure the overall
production of the economy and other related variables for the nation as a
Gross domestic product (GDP) the total market value of all final goods and
services produced with the boundaries of Canada.
Intermediate goods products purchased for resale or further processing or
Final goods goods and services purchased for final use and not for resale or
further processing or manufacturing.
Multiple counting wrongly including the value of intermediate goods in the
Value added the value of the product sold by a firm, less the value of the
products purchased and used by the firm to produce the product.
Expenditures approach the method to measure GDP that adds up all the
expenditures made for final goods and services.
Income approach the method to measure GDP that adds up all the income
generated by the production of final goods and services.
Personal consumption expenditures the expenditures of households for
durable and nondurable consumer goods and services.
Durable goods products with expected lives of three years or more.
Nondurable goods products with expected lives of less than three years.
Services the work done by service providers
Gross investment expenditures for newly produced capital goods (such as
machinery, equipment, tools, and buildings) and for additions to inventories.
Noninvestment transaction an expenditure for stocks, bonds, or second-
hand capital goods.
Net investment gross investment less consumption of fixed capital