CHAPTER 20 â MEASURING GDP AND ECONOMIC GROWTH
ECON 1010 CHAPTER 20 TEXTBOOK NOTES
CHAPTER 20 – MEASURING GDP AND ECONOMIC GROWTH Gross Domestic Product GDP Defined
GDP = the market value of the final goods and service produced within a country in a given time period. A final good (an item that is bought by its final user during a specified time period) contrasts with intermediate good (an item that is produced by 1 time, bought by another, and used as a component of a final good) Some goods can be final goods in 1 situation and intermediate goods in another Some goods are neither final goods nor intermediate goods. (ex. Financial assets – stocks and bonds, secondhand goods –a second good was part of the GDP in the year in which it was produced) If a Canadian firm produce Tshirts in Taiwan, then the market value of those shirts is a part of Taiwan’s GDP GDP measures not only the value of total production but also total income and total expenditure Rising income and rising value of production = increased productivity
GDP and the Circular Flow of Expenditure and Income
Households and Firms Households have consumption expenditures (C) Firms have investments (I) Governments Government expenditures (G) Taxes and money transfers are NOT a part of GDP Trades exports (X) – imports (M) is called net exports GDP can be measured in 2 ways: 1) the total expenditure on goods and services or 2) total income earned producing goods and services gross investment = the total amount spent both buying new capital and replacing depreciated capital net investment = the amount by which the value of capital increases (gross investment – depreciation) gross investment is included in the expenditure GDP approach and gross profit is included in the income GDP approach
Measuring Canada’s GDP The Expenditure Approach
Consumption (C) DO NOT includes purchase of new homes. They count as Investments (I)
The Income Approach
Measure GDP by summing the incomes that firms pay households for the factors of production they hire (wages for labor, interest for capital, rent for land, and profit for entrepreneurship) We divide the incomes into 2 broad categories: • Wages. Salaries, and supplementary labor income (payment for labour services. Ex. Gross wage + benefits) • Other factor incomes (corporate profits, interest, farmers’ income, and income from nonfarm unincorporated business ex. Self employment) An indirect tax is tax paid by consumers when they buy goods and services A direct tax is a tax on income An indirect tax makes the market price exceed factor cost A subsidy is payment by the government to a producer With a subsidy, factor cost exceeds market price Market price = factor cost + indirect taxes – subsidies (net domestic income at market price) Gross domestic income = net domestic income + depreciation The GDP amount is not exactly the same when using the expenditure approach vs. the income approach The gap between the 2 approaches is called the statistical discrepancy (GDP expenditure total – GDP income total) This gap is never large though. (0.1% of GDP in 2011)
Nominal GDP and Real GDP
Real GDP = the value of final goods and services produced in a given year when valued at the prices of a reference base year Nominal GDP = the value of final goods and services produced in a given year when valued at prices of that year
Calculating Real GDP
Use the quantities produced this year x base price of xxx year = real GDP
The Uses and Limitations of Real GDP
Economists use estimates of real GDP for 2 main purposes: 1) To compare standard of living over time 2) To compare standard of living across countries
The Standard of Living Over Time
Real GDP per person = real GDP/population
By using real GDP, we remove any influence that rising prices and rising cost of living might have
LongTerm Trend • The growth of potential GDP per person • Fluctuations of real GDP per person The Growth of Potential GDP Potential GDP is the maximum level of real GDP that can be produced while avoiding shortages of labour, capital, land, and entrepreneurial ability that would bring rising inflation Productivity Growth Slowdown Measured by the Lucas Wedge Real GDP Fluctuations – The Business Cycle Business cycle = the fluctuations in the pace of expansion of real GDP The business cycle is irregular up and down movement of total production and other measures of economic activity Every business cycle has 2 phases: • Expansion (real GDP increases) • Recession (real GDP decreases) Every business cycle has 2 turning points: • Peak • Trough
The Standard of Living Across Countries
Problems of using real GDP as comparison: • Real GDP must be converted into the same currency units • Goods and services of both countries must be valued at the same prices
Limitations of Real GDP
Some factors that influence the standard of living that are not part of GDP are: • Household production (underestimates total GDP production, overestimates the growth rate of total production) • Underground economic activity (illegal drugs, illegal labour, jobs done for cash to avoid taxes) The underground economy expands relative to the rest of the economy if taxes become especially high or if regulations become especially restrictive. And vice versa • Health and life expectancy (real GDP overstates the improvements in the standard of living) • Leisure time (the improvements in economic wellbeing are not reflected in real GDP) • Security
• •
Environmental quality Political freedom and social justice
CHAPTER 20 – MEASURING GDP AND ECONOMIC GROWTH Gross Domestic Product GDP Defined
GDP = the market value of the final goods and service produced within a country in a given time period. A final good (an item that is bought by its final user during a specified time period) contrasts with intermediate good (an item that is produced by 1 time, bought by another, and used as a component of a final good) Some goods can be final goods in 1 situation and intermediate goods in another Some goods are neither final goods nor intermediate goods. (ex. Financial assets – stocks and bonds, secondhand goods –a second good was part of the GDP in the year in which it was produced) If a Canadian firm produce Tshirts in Taiwan, then the market value of those shirts is a part of Taiwan’s GDP GDP measures not only the value of total production but also total income and total expenditure Rising income and rising value of production = increased productivity
GDP and the Circular Flow of Expenditure and Income
Households and Firms Households have consumption expenditures (C) Firms have investments (I) Governments Government expenditures (G) Taxes and money transfers are NOT a part of GDP Trades exports (X) – imports (M) is called net exports GDP can be measured in 2 ways: 1) the total expenditure on goods and services or 2) total income earned producing goods and services gross investment = the total amount spent both buying new capital and replacing depreciated capital net investment = the amount by which the value of capital increases (gross investment – depreciation) gross investment is included in the expenditure GDP approach and gross profit is included in the income GDP approach
Measuring Canada’s GDP The Expenditure Approach
Consumption (C) DO NOT includes purchase of new homes. They count as Investments (I)
The Income Approach
Measure GDP by summing the incomes that firms pay households for the factors of production they hire (wages for labor, interest for capital, rent for land, and profit for entrepreneurship) We divide the incomes into 2 broad categories: • Wages. Salaries, and supplementary labor income (payment for labour services. Ex. Gross wage + benefits) • Other factor incomes (corporate profits, interest, farmers’ income, and income from nonfarm unincorporated business ex. Self employment) An indirect tax is tax paid by consumers when they buy goods and services A direct tax is a tax on income An indirect tax makes the market price exceed factor cost A subsidy is payment by the government to a producer With a subsidy, factor cost exceeds market price Market price = factor cost + indirect taxes – subsidies (net domestic income at market price) Gross domestic income = net domestic income + depreciation The GDP amount is not exactly the same when using the expenditure approach vs. the income approach The gap between the 2 approaches is called the statistical discrepancy (GDP expenditure total – GDP income total) This gap is never large though. (0.1% of GDP in 2011)
Nominal GDP and Real GDP
Real GDP = the value of final goods and services produced in a given year when valued at the prices of a reference base year Nominal GDP = the value of final goods and services produced in a given year when valued at prices of that year
Calculating Real GDP
Use the quantities produced this year x base price of xxx year = real GDP
The Uses and Limitations of Real GDP
Economists use estimates of real GDP for 2 main purposes: 1) To compare standard of living over time 2) To compare standard of living across countries
The Standard of Living Over Time
Real GDP per person = real GDP/population
By using real GDP, we remove any influence that rising prices and rising cost of living might have
LongTerm Trend • The growth of potential GDP per person • Fluctuations of real GDP per person The Growth of Potential GDP Potential GDP is the maximum level of real GDP that can be produced while avoiding shortages of labour, capital, land, and entrepreneurial ability that would bring rising inflation Productivity Growth Slowdown Measured by the Lucas Wedge Real GDP Fluctuations – The Business Cycle Business cycle = the fluctuations in the pace of expansion of real GDP The business cycle is irregular up and down movement of total production and other measures of economic activity Every business cycle has 2 phases: • Expansion (real GDP increases) • Recession (real GDP decreases) Every business cycle has 2 turning points: • Peak • Trough
The Standard of Living Across Countries
Problems of using real GDP as comparison: • Real GDP must be converted into the same currency units • Goods and services of both countries must be valued at the same prices
Limitations of Real GDP
Some factors that influence the standard of living that are not part of GDP are: • Household production (underestimates total GDP production, overestimates the growth rate of total production) • Underground economic activity (illegal drugs, illegal labour, jobs done for cash to avoid taxes) The underground economy expands relative to the rest of the economy if taxes become especially high or if regulations become especially restrictive. And vice versa • Health and life expectancy (real GDP overstates the improvements in the standard of living) • Leisure time (the improvements in economic wellbeing are not reflected in real GDP) • Security
• •
Environmental quality Political freedom and social justice
