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ECO100Y5 (290)
Chapter 20

Chapter 20- The Measurement of National Income.docx

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Kalina Staub

Chapter 20- The Measurement of National Income 20.1 National Output and Value Added • Obtaining a total for the nation’s output is not as simple as adding up each separate output values to get the nation’s output because one firm’s output is often another firm’s input • Production occurs in stages: Some firms produce output that are used as inputs by other firms, and these other firms, in turn, product output that are used as inputs by yet other firms • Multiple counting is the problem that arises if we added up the values of all sales, and the same output would be counted every time that is was sold by one firm to another; can be solved by distinguishing between:  Intermediate Goods- All outputs that are used as inputs by other products in a further stage of production  Final Goods- Goods that are not used as inputs by other firms but are produced to be sold for consumption, investment, government, or export during the period under consideration • Difficult to distinguish final from intermediate goods so the problem of double counting must therefore be resolved in another manner:  Value Added- The value of a firm’s output minus the value of the inputs that is purchases from other firms  Value Added = Sales Revenue – Cost of intermediate goods (purchased from other firms)  Payments made to factors of productions (wages, profits) are not purchases from other firms and are not subtracted from firm’s revenue  Value Added = Payments owed to the firm’s factors of production  Value added is the correct measure of each firm’s contribution to total output- the amount of market value that is produced by that firm  The firm’s value added is the net value of its output  firm’s contribution to the nation’s total output, representing the firm’s own efforts that add to the value of what it takes in as inputs  The sum of all values added in an economy is a measure of the economy’s total output 20.2 National Income Accounting: Basics  • The value of domestic output = value of expenditure on that output = total income claims generated by producing that output • The circular flow of income suggests three different ways of measuring national income (all 3 yield the same total =GDP): 1. Add up the value of all g/s produced in the economy 2. Add up total flow of expenditure on final domestic output 3. Add up total flow of income generated by the flow of domestic production • Gross Domestic Product (GDP)- The total value of g/s produced in the economy during a given period  GDP on the expenditure side is when GDP is calculated by adding up total expenditure for each of the main components of final output o Example: What will be the likely future path of the nation’s capital stock (need to know consumption and investment)  GDP on the income side is when GDP is calculated by adding up all the income claims generated by the act of production o Example: What is happening to the distribution of income between labour and capital? (need to know composition of factor incomes) • Having two independent ways of measuring the same quantity provides useful check on statistical procedures and on errors in measurement GDP from the Expenditure Side • Add up expenditures needed to purchase final output produced in that year from 4 categories: 1. Consumption Expenditure  Consumption Expenditure- Household expenditure on all g/s (haircuts, vegetables, etc) 2. Investment Expenditure  Investment Expenditure- Expenditure on the production of goods not for present consumption and three categories include: o Changes in Inventories  Inventories- Stocks of raw materials, goods in process, and finished goods held by firms to mitigate the effect of short term fluctuations in production/sales  Accumulation of inventories = positive investments because it represents goods produced but not used for current consumption  Decumulation of inventories = negative investments because it represents a reduction in stock of finished goods that are available to be sold o New Plant and Equipment  Capital Stock- Aggregate quantity of capital goods  Fixed Investment/Business Fixed Investment- Creation of new plant and equipment o New Residential Housing  Housing construction is investment expenditure rather than consumption expenditure (only ownership of house is transferred and transaction is not part of national income) o Gross and Net Investment  Gross Investment- Total investment that occurs in the economy and has two parts: (1) Replacement investment (amount of investment required to replace part of capital stock that loses its value through wear and tear) and (2) Net Investment = Gross Investment – Depreciation  Positive NE = economy’s capital stock is growing  Negative NE = economy’s capital stock is shrinking (rarely happens)  Depreciation- Amount by which capital stock is depleted through the production process 3. Government Purchases o Government Purchases- All government expenditure on currently produced g/s, exclusive of government transfer payments o Cost VS. Market Value  Government output is valued at cost, rather than at market value  Consequence: what the government actually produces has not changed if increase in production changes resources (such as labour) o Government Purchases VS. Government Expenditure  Only government purchases of currently produced g/s are included  Example: No transaction when government makes payment to retired person through Canada Pension Plan  Transfer Payments- Payments to an individual/institution not made in exchange for g/s  Recipients of transfer payments choose to spend their money on consumption goods  consumption expenditure 4. Net Exports o Imports- Value of all domestically produced g/s purchased from firms, households, or government in other countries  Investment expenditure on g/s mean only part of expenditure is on Canadian production, the rest is expenditure on foreign production o Exports- Value of all g/s sold to firms, households, and governments in other countries  All g/s produced in Canada and sold to foreigners must be counted as part of Canadian production and income; produced in Canada and create incomes for Canadian residents who produce them o Net Export- The value of total exports minus value of total imports  E > I = NE is positive and when E < I = NE is negative • Total expenditure on domestically produced output: GPD = C + I + G +NX GDP from the Income Side • Add up factor incomes and other claims on the value of output until all of that value is accounting for 1. Factor Incomes o Wages and Salaries  Payment for services of labour which include all pre-tax labour earnings
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