Chapter 20 - Gross Domestic Product
GDP: market value of final goods and services produced within a country in a given time period.
1. Market value
- The prices at which items are traded in marketsconsistent with economist’s concept of
value. Something is worth what someone will pay to obtain it.
- If price of an apple is 10 cents, the market value of 50 apples is $5
2. Final goods and services
- Final good: item that is bought by its final user during a specified time period
- Intermediate good: item that is produced by one firm, bought by another, and is used as a
component of a final good or service
- Double counting: occurs if we were to add the value of intermediate goods to the value of
final goods. But some goods can be final or intermediate in different situations.
- Ex: ice cream on a hot summer day vs. ice cream restaurant buys for sundaes is intermediate
- Items that are not a part of GDP are neither final nor intermediate goods
3. Produced within a country
- GNP (gross national product): measure of income earned by domestic residents (includes
income earned by Canadian owners of shares in foreign firms) regardless of WHERE
better measure of the income of domestic residents (GDP better for economic activity)
4. In a given time period
- Either a quarter of a year (quarterly GDP data) or a year (annual GDP data)
Final demand: purchase of final goods for consumption, investment (inventory accumulation
included), use by governments, and export.
Circular flow of expenditure and income
GDP measures the value of production, which also = total expenditure = total income
Equality between production and income shows link between productivity and living standards.
Our standard rises with our incomes, but we must produce more if we want to buy more.
Rising incomes and rising value of production go together
Households and firms
Households sell and firms buy the FoP in factor markets. Firms pay income for these factor
services to households: wages, interest, rent, profit. Firms’ retained earnings are part of the
household’s income. Aggregate income is received by households, including retained earnings.
Firms sell and households buy consumer goods in the goods market. The total payment is
consumption expenditure. Firms buy and sell new capital in the goods market. Some of what
firms produce but is not sold is added to inventory seen as firm buying goods from itself.
Households save and pay taxes; firms borrow of what households save to finance invstment Governments
Buy goods and services from firms and their expenditure is called government expenditure
Governments finance their expenditure with taxes taxes are not part of the circular flow
Governments also make financial transfers to households (ex: unemployment benefits) and
subsidize firms. These financial transfers are not part of the circular flow.
Rest of the world
Firms in Canada sell and buy goods and services to the rest of the world (exports and imports).
Net exports: value of exports X minus the value of imports M
if net exports are positive, the net flow of goods and services is from Canadian firms to the rest
of the world, and vice versa.
GDP = expenditure = income
Aggregate expenditure: sum of red flows
Aggregate income: total amount pad for the services of FoP used to produce goods
firms pay out all their receipts from the sale of final goods, so income = expenditure
Gross and depreciation
Gross: before subtracting the deprecation of capital (vs. Net: after subtracting)
Depreciation: decrease in value of a firm’s capital from wear and tear and obsolescence.
- Capital consumption allowance according to Income Tax Act
- way of spreading the cost of the asset over the multi-period “economic life” each
accounting period, a portion of the value of the asset is included in current period costs
Net investment: amount by which value of capital increases (gross investment – depreciation)
Gross investment: total amount spent buying new capital and replacing depreciated capital. One
of the expenditures include in the expenditure approach to measuring GDP gross measure
Gross profit: firm’s profit before subtracting depreciation, so it is one of the incomes included in
the income approach to measuring GDP resulting value of total product is a gross measure.
Measuring Canada’s GDP
Value added: gross value of the firm’s output minus all intermediate goods it uses
aggregate production = aggregate expenditure = aggregate income: 2 approaches for measuring
Expenditure approach: G + I + C + X - M
Measures GDP as sum of expenditure, investment, government expenditure, and net exports
To calculate income generated, we add the values of expenditure on the currently produced
goods any sale in previous years should not be counted, and the values of goods produced
but not sold must be accounted for somewhere
Consumer expenditures: expenditures by Canadian households on goods and services produced
in Canada and in the rest of the world. They exclude purchase of new homes (investment).
Business investment is expenditure on capital equipment and buildings by firms and the
additions to business inventories. It also includes expenditure on new homes by households.
- only new house construction counts as investment otherwise, it’s previously produced
- if bought, it is an investment by buyers; if not, it’s an investment by firms that built it.
- Purchases/sales of purely financial assets are excluded as they’re claims on FUTURE income
Government expenditures on goods and services is the expenditure by all levels of government
on goods, excluding transfer payments (these are counted when spent by consumers)
- Measured by cost of production (vs. market prices) because government expenditure is
mostly used on services, and there’s no objective way to put a value on the output produced
Net exports of goods and services are the value of exports – the value of imports. Income approach: wages + interest + profits + indirect taxes (net of subsidies) + depreciation
Measures GDP by summing the incomes that firms pay households for the FoP
National income and expenditure accounts divide incomes into 5 categories
1. Wages/salaries, supplementary labor income: payment for labor, including net wages/salaries
(take-home pay) + taxes withheld on earnings + benefits like pension contributions
2. Corporate profits: profits of corporations, some of which are paid to households as dividends
and some which are retained as undistributed profits all income
3. Interest and miscellaneous investment income: interest households receive on loans they make
minus the interest households pay on their own borrowing (NOT gross private investment)
4. Farmers’ income& Income from non-farm unincorporated businesses: include compensation for
the owner’s labor, as well as investment for the use of the owner’s capital, and profit. The typical
small business/farmer does not separate these all are reported for tax purposes as income.
Net domestic income at factor cost: the sum of the incomes above
Market prices and factor cost diverge because of indirect taxes and subsidies
- Indirect tax is paid by consumers when they buy goods and services (direct = income).
- Subsidy: payment by government to producer consumer pays less than producers receive
Indirect taxes net of subsidies: To get from factor cost to market price (GDP), + indirect taxes, -
subsidies net domestic income at market prices add depreciation to get GDP (not NDP)
- Taxes on commodities = a difference between amount spent and received by buyer/seller. So
if we want to count expenditure, we must adjust for amounts spent by buyers that don’t
become income to sellers because they are taxed away, by adding taxes.
- Similarly, we must adjust amounts received by sellers not paid by buyers for subsidies
Statistical discrepancy is the gap between