Chapter 20 – Measuring GDP and Economic Growth
GROSS DOMESTIC PRODUCT (GDP)
The market value of the final goods & services produced within a country in a given time period. It has 4
Market Value: Market value is the price at which items are traded in the
Final Goods and Services: A final good/service is an item bought by its final user during a
specified time period (Ford truck). On the other hand, an intermediate good/service is an item
produced by one firm, bought by another firm, and used as a component of a final good/service
(Tire used in truck). If the value of intermediate goods/services produced were added to the
value of final goods/services, the same thing would be counted many times. This is known as
double counting (value of truck includes value of tires). Items such as financial assets and
second-hand goods are neither final nor intermediate goods, and are not part of the GDP.
Second-hand goods were part of the GDP in the year they were produced.
Produced Within a Country: Only goods produced within the country are counted
In a Given Time Period: GDP measures value of good in a given time period – normally either a
quarter of the year (quarterly GDP data), or a year (annual GDP data).
GDP also measure total income and total expenditure. The equality between the value of total
production and total income is important because it shows the direct link between productivity and
living standards. Our standard of living rises as our income rises and we can afford more goods/services,
for which production needs to rise. Rising production and income are 2 parts of the same phenomenon:
GDP and the Circular Flow of Expenditure and Income
The economy consists of households, firms, governments, and the rest of the world, which trade in
factor markets and goods (and services) markets.
Households and Firms: Households sell and firms buy the services of labour, capital, and land in
factor markets, for which firms pay households income: Wages for labour services, interest for
the use of capital, rent for the use of land, profit for entrepreneurship.
Firms’ retained earnings (profit not distributed to households) are part of the household sector’s
income – part of the total (aggregate) income. The total payment for consumer goods and
services bought by households and sold by firms is consumer expenditure (C). Goods produced
by firms but aren’t sold are added to the inventory, which can be thought of as the firm buying
goods from itself. The purchase of new plant, equipment, building and additions to inventories
are investments (I).
Governments: Governments expenditure on goods and services bought by all levels of the
government from firms is called government expenditure (G) – financed by taxes (not part of
the circular flow of expenditure and income). Government makes financial transfers to
households (social security benefits and unemployment benefits), and pay subsidies to firms
(these financial transfers are called transfer payments), which are not part of the circular flow.
Rest of the World: Exports and Imports. The value of exports (X) minus the value of imports (M)
is called net exports. If net exports is +ve, the net flow of goods and services is from Canadian
firms to the rest of the world, if net exports is –ve, the net flow of goods/services is from the
rest of the world to Canadian firms. GDP Equals Expenditure Equals Income: Aggregate expenditure (a.k.a. total expenditure) =
consumption expenditure + investment + government expenditure + net exports. Aggregate
income (Y) is equal to the total amount paid for the services of factors of production used to
produce final goods and services – wages, interest, rent, and profit. Since firms pay out in
incomes (including retained profits), everything they receive from sales, aggregate income,
equals aggregate expenditure. Therefore, Y = C + I + G + X – M. Since aggregate expenditure =
aggregate income, the two methods give the same answer, so GDP equals total expenditure
equals total income.
Why is Domestic Product “Gross”?
“Gross” means before subtracting the depreciation of capital, and “net” means after subtracting the
depreciation of capital. Depreciation is the decrease in the value of a firm’s capital that results of wear
and tear and obsolesce. The total amount spent on buying new capital and replacing depreciated capital
is called gross investment. The amount by which the value of capital increases is called net investment.
Net investment = gross investment – depreciation. Gross investment is one of the expenditures included
in the expenditure approach, and gross profit (firm’s profit before subtracting depreciation) is one of the
incomes included in the income approach of measuring GDP.
MEASURING CANADA’S GDP
StatsCan uses the concepts in the circular flow and its components to measure GDP. Since aggregate
production = aggregate expenditure and aggregate income, there are two ways for measuring GDP and
both are used: expenditure approach and income approach.
The Expenditure Approach
Measures GDP (Y) as the sum of consumption expenditure (C), investment (I), government expenditure
(G), and net export (X – M).
Consumption expenditure includes purchase of goods and services such as pop, books, and legal
services, durable goods, such as computers, but not the purchase of homes, which is an investment. See
page 2 for investments, but it also includes purchase of new homes by households. See page 2 for
government expenditure, and net exports.
NOTE: Y (GDP) IS ALSO THE INCOME (AS SHOWN ABOVE), BUT WILL BE CALLED GDP.
So, Y = C + I + G + X – M
The Income Approach
Measured by summing the incomes that firms pay for the factors of production they hire. Income in the
National Income and Expenditure Accounts is divided into two broad categories:
1. Wages, salaries, and supplementary labour incomes – payment for labour services, includes
gross wages plus benefits, such as pension contributions.
2. Other factor incomes – corporate profits, interest, farmers’ income, and income from non-farm
unincorporated businesses. These incomes are a mixture of interest, rent, and profit, and
include some labour income from self-employment.
THE SUM OF THE TWO BROAD CATEGORIES IS CALLED NET DOMESTIC INCOME AT FACTOR COST. An indirect tax is a tax paid by consumers when they buy goods and services, which makes market price
exceed factor cost. Direct tax is a tax on income. A subsidy is a payment by the government to the
producer – factor costs exceed market price. To get from factor costs to market price, add indirect taxes
and subtract subsidies. This is called net domestic income at market price (NET DOMESTIC INCOME AT
FACTOR COST + (INDIRECT TAXES – SUBSIDIES)). Total expenditure is a gross number as it includes gross
investment. Net domestic income at market price is a net income because corporate profits are
measured after deducting depreciation. So to get from net income to gross income, add depreciation.
The GDP calculated using the expenditure and income approaches is different, and the gap is called
statistical discrepancy, calculated by subtracting the GDP expenditure total and the GDP income total.
Gap is never large.
Nominal GDP and Real GDP
When comparing GDP in two periods, an increase in the GDP is a combination of an increase in
production and a rise in prices. To isolate between the increase in production and rise in prices, we
distinguish between real GDP and nominal GDP.
Real GDP – the value of final goods and services produced in a given year when valued at the price of a
reference base year (currently the reference base year is 2002, and the real GDP measured is described
in 2002 dollars – in terms of what the dollar would buy in 2002). By comparing the value of production
in two years at the same prices, we reveal the change in production.
Nominal GDP is the value of goods and services produced in a given year when valued at the prices of
that year. It is a more precise name for GDP.
Calculating Real GDP
In part (a), the Nominal GDP is calculated by
multiplying the quantity produced in 2002 by
its price in 2002 for each good to find the total
expenditure for that item, and then summing it
to get the nominal GDP. Since 2002 is the base
year, both nominal GDP and real GDP are $100
In part (b), calculate the Nominal GDP for 2012