Chapter 4 GDP Measuring Total Production and Income PDF

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4.1 Gross Domestic Product Measures Total Production Economists measure total production by GDP. ◦ GDP: is the market value of all final goods and services produced in a geographic area during a period of time. • A final good or service is one that is purchased by its final user and is not included in the production of any other good or service. • Intermediate goods: a good or service that is an input into another good or service, such as car seats ◦ In calculating GDP, we include the value of the car, but not the separate value of the car seats. GDP Includes Only Current Production GDP includes only production that takes place during the indicated time period. • GDP does not included the value of used goods ◦ A good is only counted once towards the GDP Production, Income, and the Circular-Flow Diagram When measuring the value of total production in the economy (GDP), it simultaneously measures the value of total income. • when buying a product that cost turns into someone’s income. The circular-flow diagram is used to illustrate the interaction of firms and households in markets. • Firms sell goods and services to three groups: domestic households, foreign firms and households, and the government. • Firms use the factors of production— labour, capital, natural resources, and entrepreneurship— to produce goods and services. • Households supply the factors of production to firms in exchange for income. We divide income into 4 categories: wages, interest, rent, and profit. • Firms pay wages to households in exchange for the services of labour, interest for the use of capital, and rent for natural resources such as land. • As governments make payments of wages and interest to households in exchange for hiring workers and for other factors of production • Governments also make transfer payments ho households which include, social program payments and unemployment insurance payments. (Not included in GDP)

Measuring GDP Total income and total expenditure will both equal to GDP. There are 2 ways to measure GDP:

1. Expenditure Approach: all the spending on domestically produced goods and services is added up. 2. Income approach: all the income received by Canadians as the result of production that takes place in Canada is added up. Income Approach Broken down into four categories based on the type of the income: • Compensation of Employees: covers all the benefits workers receive from providing their labour to firms. Makes up 50% of GDP. (Salaries and wages, CPP, EI, health care) • Gross Operating Surplus: payments made to the owners of capital by firms and government for the use of their capital in producing goods and services. Broken down to 3 elements. (13.5% of GDP) ◦ Net operating surplus: payments to the owners of capital over and above compensation for the consumption of their capital. ◦ Consumption of capital by corporations: the depreciation of capital that occurs while that capital was being used by firms. (10.3% of GDP) ◦ Consumption of fixed capital by government, non-profit orgs, and households: depreciation of capital that happens when capital is used by government or other nonbusiness orgs. (3.3% of GDP • Gross Mixed Income: covers the income generated by small businesses. (11.7% GDP) Broken down into consumption of fixed capital by small business and net mixed income ◦ Consumption of fixed capital covers the depreciation of the capital used by small businesses. (2.9% GDP) ◦ Net mixed income is the payment to owners of small businesses over and above compensation for the deprivation of the capital owned by the business. (8.8% of GDP) • Taxes Less Subsidies: the payment to government that mimics income received by the owners of other inputs. (11.2% GDP) ◦ The government levies a variety of taxes on production, products, and imports. These taxes add to the prices of the products and increases spending.

Expenditure Approach

Grouped into 4 broad categories based on the motivation for the spending when measuring GDP: • Final Consumption: captures all the domestic purchases of goods and services used to satisfy individual or community needs and wants. (78.6% GDP expenditure approach) Household consumption, spending on food, clothing, etc is by far the largest component. (71.7% of final expenditure) • Gross Fixed Capital Formation: is the purchases of fixed assets by firms, governments, and households. (22.5% GDP) ◦ Fixed assets are tangible goods that will provide benefits over a long period of time and cannot be easily converted into cash. • Investments in Inventories: finished products to sell or inputs to turn into finished products. (0.3% GDP) • Net Exports of Goods and Services: are the value of a country’s total exports minus its imports. ◦ Exports are fixed goods and services produced domestically but sold to foreign firms, governments, and households. (32.4% GDP) ◦ Imports are goods and services produced in foreign countries and purchased by Canadian firms, governments, and households. ‣ Subtract imports from total expenditures because otherwise we would be including spending that does not represent the production fo new goods and services in Canada. Net exports came to -1.4% of GDP in 2018. Meaning we imported more than exported. Statistical Discrepancy One half of the difference between the estimates of GDP generated by the expenditure approach and income approach. Calculated by dividing it in half, adds one half to the lower of the two estimates and subtracts the other half from the greater of the two estimates. GDP- Income or Expenditure The income approach focuses on how much each factor of production is receiving. ◦ Reveals that labour receives more income than any other factor of production. The expenditure approach focuses on what the output produced in a country is being used for. ◦ Reveals that the vast majority of what is produced goes to final consumption. The Expenditure Approach in Macroeconomic Models A variation on the expenditure approach of measuring GDP is the basis for most models. • Represented the final consumption expenditure done by households is consumption (C). The money spent by firms on fixed capital formation and inventories is called investment (I). Both the final consumption spending and fixed capital formation done by government is called government spending (G). Net exports are identical in the newer method and traditional approach. Y = C + I + G + Nx

Measuring GDP Using the Value-Added Method

Refers to the additional market value a firm gives a product and is equal to the difference between the price the firm paid for intermediate goods and the price for which it sells the finished product. 4.2 Does GDP Measure What We Want It to Measure? Most economists believe that GDP does a good but not perfect job of measuring production. It is generally true that the more goods and services people have, the better off they are, GDP provides only a rough measure of well-being. Shortcomings of GDP as a Measure of Total Production GDP, does not include two types of production: production in the home and production in the underground economy. Household Production Refers to goods and services people produce for themselves. The most important type of household production is the services a homemaker provides to the family (looking after children, cleaning, and cooking). Underground Economy Individuals and firms sometimes conceal the buying and selling of goods and services. Occurs from 3 basic reasons: illegal goods and services, avoid paying taxes on income earned, or avoid government regulation. Estimated to be 2.3% of GDP. Shortcomings of GDP as a Measure of Well-Being GDP is used by some people as a measure of well-being. For example, levels of real GDP per person in different countries. Calculated by dividing the value of real GDP in a country by its population. Not a perfect measure of well-being for several reasons: • Value of Leisure is Not Included in GDP: a persons desire for leisure rather than income, well-being for such person increases, but GDP has decreased due to less income. • GDP Does Not Consider the State of the Environment: the value of cigarettes produced is included in GDP, but the cost of lung cancer that smokers develop is not included. • GDP is Not Adjusted for Changes in Crime and Other Social Problems: increase in crime reduces well-being but may actually increase GDP if it leads to greater spending on police. • GDP Measures the Size of the Pie but Not How the Pie is Divided: when GDP increases, the country has more goods and services, but those goods and services may be very unequally distributed. GDP per person may not provide a good description. 4.3 Real GDP vs. Nominal GDP Nominal GDP: the value of final goods and services evaluated at current year prices. • Calculated by summing the current values of final goods and services. Real GDP: the value of final goods and services evaluated at base-year prices. • Calculated by designating a particular year as the base year and then using the prices of goods and services in all other years. One drawback is that over time prices may change relative to each other.

Comparing Real GDP and Nominal GDP Real GDP holds prices constant, which makes it a better measure than nominal GDP of changes in the production of goods and services from one year to the next.

The GDP Deflator Price level measures the average prices of goods and services in the economy. These values are used for nominal GDP and real GDP to compute a measure of the price level called the GDP Deflator. GDP Deflator = (Nominal GDP / Real GDP) x 100 4.4 Other Measures of Total Production and Total Income National income accounting: the methods government agencies use to track total production and total income in the economy. Gross National Income (GNI) Is the value of incomes received by Canadians for the use of their factors of production no matter where in the world those factors of production are used, including outside of Canada. Net National Income (NNI) Subtracting the value of the consumption of fixed capital (depreciation) from the GNI, we are left with NNI. Household Income Income received by households. Calculated by subtracting the earnings that corporations retain rather than pay to shareholders in the form of dividends. Household Disposable Income Is equal to household income minus personal tax payments. Best measure of the income households actually have to spend. The Division of Income Labour income: payments households receive for supplying labour to firms and government. Corporate operating surplus: profits that get paid to households that own shares in these corps. Small business income: wages and profits earned by owners of unincorporated businesses

Taxes on production and imports: included in market price of the goods and services that Canadians buy....