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Chapter 20

EC140 Study Notes - Chapter 20.docx

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Wilfrid Laurier University
Rizwan Tahir

Economics Study Notes – Chapter 20: Measuring GDP and Economic Growth Gross Domestic Product (GDP) Defined: - Market value of the final goods and services produced within a country in a given time period 4 Parts of GDP: 1. Market Value o GDP values items at their market values  The prices at which items are traded in markets  Price x Quantity  Ex. If apples are 10 cents each, then the market value of 50 apples is $5 2. Final Goods and Services o Final Good/Service: An item that is bought by its final user during a specified time period o Intermediate Good/Service: An item that is produced by one firm, bought by another firm, and used as a component of a final good/service o Only final goods/services are included because otherwise the problem of double counting occurs  Ex. A car is a final good and the tire of the car is an intermediate good (if you were to include both the car and the tire, then you will be accounting for the tire twice) o Some goods can be final in some cases and intermediate in others  Depends on what it is used for  Ex. Ice-cream sold at a grocery store is a final good, but ice-cream sold to a restaurant to use for sundaes is an intermediate good (the sundae is the final good) o Some goods are neither final nor intermediate (not part of GDP)  Financial assets (stocks and bonds)  Second-hand goods (used cars, existing homes)  These goods are included in GDP the year they were produced, but not subsequent years 3. Produced Within a Country o Only goods produced within a country are included in that country’s GDP  Ex. Roots is a Canadian company but produces T-shirts in Taiwan  The market value of those shirts is part of Taiwan’s GDP, not Canada’s 4. In a Given Time Period o Normally a quarter of a year (quarterly GDP) or a year (annual GDP) GDP and the Circular Flow of Expenditure and Income: GDP Measures Two Things at Once: 1. Total income of everyone in economy 2. Total expenditure on the economy’s output of goods and services Households and Firms: - Households sell services of labour, capital, land in factor markets - Firms buy services of labour, capital, land in factor markets o Pay income to households – wages for labour, interest for use of capital, rent for use of land - Fourth factor of production = entrepreneurship o Receives profit - Firm’s retained earnings (profits not distributed to households) are part of household sector’s income o Think of retained earnings as income that households save and lend back to firms - Consumption Expenditure: The total payment for consumer goods and services - Investment: The purchase of new plant, equipment, and buildings, and additions to inventories Government: - Buy goods and services from firms - Government Expenditure: Goods and services bought by the government - Finance expenditure with taxes o Taxes aren’t part of circular flow - Make financial transfers to households (Ex. Social security benefits, unemployment benefits) o Not part of circular flow Rest of the World: - Exports: Selling goods and services to another country - Imports: Buying goods and services from another country - Net Exports = Value of exports minus value of imports o If positive, net flow of goods and services is from Canadian firms to the rest of the world o If negative, net flow of goods and services is from rest of the world to Canadian firms GDP = Expenditure = Income: - Aggregate expenditure is the total expenditure (red flows) o Equals consumption expenditure + investment + government expenditure + net exports - Aggregate income = Total amount paid for the services of the factors of production used to produce final goods/services (blue flow) o Wages, interest, rent, profit - Because firms pay out everything they receive from the sale of their output as incomes (including retained profit), this means that aggregate income = aggregate expenditure Why is Domestic Product “Gross”? - Gross means before subtracting depreciation of capital o Opposite of gross is net - Depreciation: The decrease in the value of a firm’s capital that results from wear and tear and obsolescence - Gross Investment: The total amount spent both buying new capital and replacing depreciated capital o Included in expenditure approach to measuring GDP - Net Investment: The amount by which the value of capital increases o Net Investment = Gross Investment – Depreciation o Ex. If an airline buys 5 new airplanes and retires 2 old ones…  Gross Investment = Value of 5 new airplanes  Depreciation = Value of the 2 old airplanes  Net Investment = Value of 3 new airplanes - Gross Profit: A firm’s profit before subtracting depreciation o Included in the income approach to measuring GDP Measuring Canada’s GDP: The Expenditure Approach: - Measures GDP as a sum of consumption expenditure (C), investment (I), government expenditure on goods/services (G), and net exports of goods/services (X – M) - Consumption Expenditure: o The expenditure by Canadian households on goods/services produced in Canada and in the rest of the world o Does not include the purchase of new homes (this is part of investment) - Investment: o The expenditure on capital equipment and buildings by firms and the additions to business inventories o Includes expenditure on new homes by households - Government Expenditure on Goods/Services: o The expenditure by all levels of government on goods/services  Ex. National defence, garbage collection o Does not include transfer payments (this is because they are not expenditures on goods/services)  Ex. Unemployment benefits - Net Exports of Goods/Services: o The value of exports minus the value of imports o Ex. Telephone equipment that Nortel sells to AT&T (Canadian export) o Ex. Japanese DVD player that Sears buys from Sony (Canadian import) The Income Approach: - Measures GDP by summing the incomes that firms pay households for the factors of production they hire o Wages for labour, interest for capital, rent for land, profit for entrepreneurship - Incomes divided into two categories: 1. Wages, salaries, supplementary labour income  The payment for labour services  Includes gross wages plus benefits such as pension contributions 2. Other factor incomes  Include corporate profits, interest, farmers’ income, income from non-farm unincorporated businesses  Mixture of interest, rent, and profit  Includes some labour income from self-employment - Indirect Tax: A tax paid by consumers when they buy goods/services o Makes market price exceed factor cost - Direct Tax: A tax on income - Subsidy: A payment by the government to a producer o Factor cost exceeds market price - Net Domestic Income at Market Price: Factor cost + Indirect Taxes – Subsidies o Need to get from a net measure to a gross measure o To do this, you add depreciation - Statistical Discrepancy: The gap between the value of the Expenditure Approach and the Income Approach o SD = GDP Expenditure – GDP Income Nominal GDP and Real GDP: - Increases/decreases in GDP are a result of a combination of change in production and change in prices - Real GDP: o The value of final goods/services produced in a given year valued at prices of a reference base year o Reveal change in production - Nominal GDP: o The value of final goods and services produced in a given year valued at the prices of that year Calculating Real GDP: Example: Calculate real GDP for an economy that produces one consumption good, one capital good, and one government service – net exports are zero - If you are calculating GDP in 2012 and 2002 is the reference year, then you multiply the quantity produced in 2012 by the prices of the goods/services in 2002 - Then, you sum up all of the expenditures (consumption good, capital good, government service) to find the real GDP - The number you get i
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