Measuring a Nation's Income
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Chapter 5: Measuring a Nation’s Income Gross Domestic Product – GDP Is the market value of all final goods and services produced It is strictly a measure of PRODUCTION (And income earned) within a country In a given period of time (such as a year) Valued at market prices Domestic means within the borders of a country Important Facts about GDP: GDP is basically a production concept GDP is a flow variable (through time) – ie not Stock variable Market Value – see following example Example: Item
Price
Quantity
Price * Quantity
CDs
$15
1000
15000
Tapes
$5
2000
10000
Calculate GDP by multiplying P * Q for each good and then adding your results together GDP = (15 * 1,000) + ($5 * 2,000) = $25,000 Important Facts about GDP continued… In the national accounts, firms and the government are the units which produce output in the domestic economy GDP includes only final goods not intermediate goods o (input into the production process) Items not included in GDP: Used or second hand goods Non-marketed goods and services Financial assets
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
How do we actually measure GDP? Three Methods: Value-added (production) Approach o Measures items included in GDP by measuring value added at each stage of production Expenditure Approach o Calculates GDP by adding together spending by all the sectors (groups) in the economy Income Approach o Measures GDP by adding together the incomes of the factors of production used to produce domestic product
Col (i) Stage of Production
Sheep Ranch
Value-Added Example Col (ii) Col (iii) Col (iv) = Col (ii – iii) Total Value Cost of Value Added = Intermediate Total Value - Cost of Products Intermediate Products $60 $0 $60
Wool Processor Suit Manufacturer Retail Outlet
$100
$60
$40
$175
$100
$75
$250
$175
$75
Total
$585
$335
$250
Contribution to GDP:
$250
Total value of all transactions: $585
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Income Approach
Factors Land Labour Capital Entrepreneurship
Compensation (Income) Rent Wages Interest & Dividends Profits
Income Approach to Measuring GDP First determine: Net Domestic Income at Factor Cost Wages, salaries and supplementary labour income Corporate profits before taxes Government enterprise profits before taxes Interest and miscellaneous investment income Accrued net income of farm operators Net income of non-farm unincorporated business, including rent Inventory valuation adjustment Add the following to Net Domestic Income at Factor Cost to obtain GDP: o Indirect taxes less subsidies o Capital Consumption Allowance: • Also known as depreciation o Statistical Discrepancy
Expenditure Approach C - Consumption I – Business Gross Investment Residential construction Non-residential construction Machinery Inventory investment
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
G – Government Expenditure on Goods and Services Can be divided into two categories: o Current expenditures o Investment expenditures Does not include: o Transfer payments o Interest payments on national debt NX – Net Exports (X-M) = Exports – Imports Exports are included in GDP o Goods produced domestically and sold to foreigners Imports are not included in GDP o Goods produced by foreigners and sold to domestic residents Equation for GDP expenditure based: C+I+G+X-M GDP vs GNP Anything that happens within the borders of Canada is GDP, and anything that happens in the rest of the world is GNP Gross National Product (GNP) Measures the income earned by a country’s domestic residents The income could have been earner domestically or abroad First define: Investment Income: Payment of interest and dividends for the ownership of capital
o
GNP = GDP Net investment income paid to foreigners Foreign owned companies among Canada’s current largest companies: General Motors Canada Owned by Detroit-based, General Motors Wal-Mart Canada Wholly owned by Wal-Mart of the US Honda Canada
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Owned by Honda of Japan Costco Based in Seattle Labatt Brewing Company Purchased by Belgian brewer Interbrew in 1995 Other Key National Accounts Concepts Personal Disposable Income Consumption (C) + Savings (S) Personal (Private) Saving The difference between Personal Disposable Income and Consumption Question: What is another word for personal disposable income? Take home pay. Nominal GDP vs. Real GDP Nominal GDP aka “Current Dollar GDP” Current production expressed in current dollars or current prices Real GDP Consider the following: Five years ago: computer prices were high and computer production was low Today: Computer prices are low (decreased by 25%) and computer production is high If we express today’s production in terms of the prices of five years ago GDP will be (underestimated/overestimated) If we express the production of five years ago in terms of the prices of today GDP will be (overestimated/underestimated) Example: Price and Quantity Data for a Hypothetical Economy Year 1
Year 2
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Price
Quantity
Price
Quantity
Apples
$1.20
60
$1.25
80
Bread
$1.00
90
$1.30
100
Find Nominal GDP for Year 1 and Year 2 Apples (Price * Quantity) + Bread (Price * Quantity) – for year year Year 1 NGDP = ($1.20*60) + ($1.00*90) = $72 + $90 = $162 Year 2 NGDP = ($1.25*80) + ($1.30*100) = $100 + $130 = $230 To calculate real GDP, first calculate the Fisher Volume Index using three steps: Step 1: o Calculate the Laspeyres Volume Index for Year 2: = Year2 GDP at Year1 prices = (1.2*80 + 1.0*100) = $196 = Year1 GDP at Year1 prices $162 $162
$1.2099
Year2 GDP is the output produced in Year 2 Year1 GDP is the output produced in Year 1 Laspeyres Volume Index Step 2: o Calculate the Paasche Volume Index for Year2: = Year2 GDP at Year2 prices = $230 = $230 = $1.1979 Year1 GDP at Year2 prices (60*1.25)+(90*1.3) $192
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Step 3: o Calculate the Fisher Volume Index for Year2: = √(Laspeyres Index) (Paasche Index) = √ (1.2099)(1.1979) = 1.2039 The Fisher Volume Index can now be used to calculate real GDP: Calculation of Real GDP Using Year 1 as the Base Year: Year
Index of Real GDP (Fisher Volume Index)
1
1
2
1.2039
Real GDP $162 $162*1.2039 = $195.03
Note: the index of real GDP = 1 in the base year Note: real GDP = Nominal GDP in the base year Calculation of Real GDP using Year 2 as the Base Year: Year
Index of Real GDP
1
1/1.2039
2
1
Real GDP 230/1.2039 = 191.05 $230
GDP Deflator A price index that indicates how much prices rise from one year to the next Includes prices of all the goods and services in GDP GDP Deflator in Yeart: = Nominal GDP in Yeart * 100% Real GDP in Yeart From the previous example, using Year1 as the base year, calculate the GDP deflator for Year1:
GDP deflator in Year1: = $162 * 100% = 100% $162
From the previous example, using Year1 as the base year
Econ 102 Chapter 5 Notes
calculate the GDP deflator for Year2: GDP deflator in Year2: = $230 $195.03
Prof: Angela Trimarchi
* 100% = 117.93%
Inflation Rate Percent change in the GDP deflator from one year to the next Formula for Percent Change: [Final value – Initial value]/ [Initial value] * 100% [117.93 – 100]/ [100] * 100% = 17.93% Formula for Percent Change can also be used for real GDP in current and real GDP in base year growth rates [195.03 – 162]/ [162] * 100% = 20.39% [230 – 191.05]/ [191.05] * 100% = 20.39% GDP and Economic Well Being GDP ignores: The Size of The Population Consumption Of Leisure Non-Marketed Economic Activities Environmental Quality GDP Per Capita Output per person Is a better measure of economic well-being than real GDP Example: Suppose the economy of Denmark had a real GDP of $40B and China had a real GDP of $220B. But suppose the population of China was much larger than the population of Denmark . The economy of Denmark would be much better off
GNP When considering the production (income) included in GNP, remember GNP is the production (income earned) by a country’s residents or nationals. It does not matter if that production (income earned) took place in the residents’ own country or in another country Problem:
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Suppose a person is a Canadian citizen and an American citizen. This person produces wine in Montreal, Quebec. Does the output of this person contribute to: a) Canadian GNP b) Canadian GDP c) American GNP d) American GDP Which of the following gets counted in GDP? a) b) c) d)
The tires on a brand new car (NO) The new tires on a used car (YES) The sale of an old pair of shoes (NO) A transaction involving financial assets (NO)
Next question… Which adds more to GDP? A pound of ground beef or a pound of caviar? Question One An art collector recently sold a piece of pottery for $300. He had purchased it for $200 two years earlier. Definitions: Subsidy: Payment by the government to a producer Not included in GDP – Income based Capital Consumption Allowance Also called depreciation Is wear and tear and obsolescence of capital equipment It is also a fall in the market value of a capital asset Ex. Jan 1, 2010 $20,000
Dec 31, 2010 $15,000
Depreciation = $5,000 Gross Investment = Net Investment + Depreciation Net Investment = Gross Investment – Depreciation
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
GNP vs GDP – Some Key Points Definition of GNP The total market value of all final goods and services produced by the citizens of a country, regardless of the location of production Key Point # 1 - GNP versus GDP o GNP would include some of the income/output from an Apple Computer factory in Singapore but would exclude some of the income produced by a Honda factory in Ontario Key Point # 2 - Size of GNP and GDP o The relative size of GDP and GNP depends on the balance between income from Canadian investments abroad and income from foreign investments in Canada o For most of Canada’s history Canada has been a net debtor country o Therefore, the value of foreign-based assets owned by Canadian residents has been less than the value of Canadian based assets owned by foreigners o This makes Canadian GNP less than Canadian GDP o But the difference is small o Alternatively, because there are many foreign owned firms in Canada (compared to Canadian-owned firms abroad) GNP is less than GDP o Canadian GNP for 2005 totaled $1274.0 billion whereas GDP was $1368.7 billion Key Point # 3 – GNP, Interest on Bonds and Earnings of Companies o Estimates of Canadian GNP differ slightly from estimates of GDP because GNP adds items such as the earnings of Canadian companies abroad and subtracts items such as interest payments on bonds owned by the residents of say, China and Japan Question One In 1995 GDP was $780B $16B in income (interest and dividends) was paid to Canadians by foreigners $49B of income (interest and dividends) was paid to foreigners by Canadians a) What is the value of net investment income paid to foreigners? $33B
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
To calculate this, we subtract the amount paid to Canadians from the amount paid by Canadians b) What is the value of GNP? $747B To obtain this value, we subtract the net investment income paid to foreigners from the GDP
Question Two Suppose a worker is a Canadian and an American citizen. If that worker works for Stelco in Sudbury, which of the following does his production get counted in: Canadian GDP – YES Canadian GNP – YES American GDP – NO American GNP – YES Question 3 Suppose Toyota built a new automobile plant in Mexico using Japanese management practices, Canadian capital, and Mexican labour. Which of the following statements would be true at least conceptually? a) The portion of the output contributed by Canadian capital would be included in Canadian GDP b) The portion of output contributed by Japanese management would be included in both Japanese GNP and GDP c) The protion of output contributed by Japanese management would not be included in Japanese GNP and GDP d) The portion of output contributed by Mexican labour would be included in both Mexican GDP and GNP
Prof: Angela Trimarchi
Chapter 5: Measuring a Nation’s Income Gross Domestic Product – GDP Is the market value of all final goods and services produced It is strictly a measure of PRODUCTION (And income earned) within a country In a given period of time (such as a year) Valued at market prices Domestic means within the borders of a country Important Facts about GDP: GDP is basically a production concept GDP is a flow variable (through time) – ie not Stock variable Market Value – see following example Example: Item
Price
Quantity
Price * Quantity
CDs
$15
1000
15000
Tapes
$5
2000
10000
Calculate GDP by multiplying P * Q for each good and then adding your results together GDP = (15 * 1,000) + ($5 * 2,000) = $25,000 Important Facts about GDP continued… In the national accounts, firms and the government are the units which produce output in the domestic economy GDP includes only final goods not intermediate goods o (input into the production process) Items not included in GDP: Used or second hand goods Non-marketed goods and services Financial assets
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
How do we actually measure GDP? Three Methods: Value-added (production) Approach o Measures items included in GDP by measuring value added at each stage of production Expenditure Approach o Calculates GDP by adding together spending by all the sectors (groups) in the economy Income Approach o Measures GDP by adding together the incomes of the factors of production used to produce domestic product
Col (i) Stage of Production
Sheep Ranch
Value-Added Example Col (ii) Col (iii) Col (iv) = Col (ii – iii) Total Value Cost of Value Added = Intermediate Total Value - Cost of Products Intermediate Products $60 $0 $60
Wool Processor Suit Manufacturer Retail Outlet
$100
$60
$40
$175
$100
$75
$250
$175
$75
Total
$585
$335
$250
Contribution to GDP:
$250
Total value of all transactions: $585
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Income Approach
Factors Land Labour Capital Entrepreneurship
Compensation (Income) Rent Wages Interest & Dividends Profits
Income Approach to Measuring GDP First determine: Net Domestic Income at Factor Cost Wages, salaries and supplementary labour income Corporate profits before taxes Government enterprise profits before taxes Interest and miscellaneous investment income Accrued net income of farm operators Net income of non-farm unincorporated business, including rent Inventory valuation adjustment Add the following to Net Domestic Income at Factor Cost to obtain GDP: o Indirect taxes less subsidies o Capital Consumption Allowance: • Also known as depreciation o Statistical Discrepancy
Expenditure Approach C - Consumption I – Business Gross Investment Residential construction Non-residential construction Machinery Inventory investment
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
G – Government Expenditure on Goods and Services Can be divided into two categories: o Current expenditures o Investment expenditures Does not include: o Transfer payments o Interest payments on national debt NX – Net Exports (X-M) = Exports – Imports Exports are included in GDP o Goods produced domestically and sold to foreigners Imports are not included in GDP o Goods produced by foreigners and sold to domestic residents Equation for GDP expenditure based: C+I+G+X-M GDP vs GNP Anything that happens within the borders of Canada is GDP, and anything that happens in the rest of the world is GNP Gross National Product (GNP) Measures the income earned by a country’s domestic residents The income could have been earner domestically or abroad First define: Investment Income: Payment of interest and dividends for the ownership of capital
o
GNP = GDP Net investment income paid to foreigners Foreign owned companies among Canada’s current largest companies: General Motors Canada Owned by Detroit-based, General Motors Wal-Mart Canada Wholly owned by Wal-Mart of the US Honda Canada
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Owned by Honda of Japan Costco Based in Seattle Labatt Brewing Company Purchased by Belgian brewer Interbrew in 1995 Other Key National Accounts Concepts Personal Disposable Income Consumption (C) + Savings (S) Personal (Private) Saving The difference between Personal Disposable Income and Consumption Question: What is another word for personal disposable income? Take home pay. Nominal GDP vs. Real GDP Nominal GDP aka “Current Dollar GDP” Current production expressed in current dollars or current prices Real GDP Consider the following: Five years ago: computer prices were high and computer production was low Today: Computer prices are low (decreased by 25%) and computer production is high If we express today’s production in terms of the prices of five years ago GDP will be (underestimated/overestimated) If we express the production of five years ago in terms of the prices of today GDP will be (overestimated/underestimated) Example: Price and Quantity Data for a Hypothetical Economy Year 1
Year 2
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Price
Quantity
Price
Quantity
Apples
$1.20
60
$1.25
80
Bread
$1.00
90
$1.30
100
Find Nominal GDP for Year 1 and Year 2 Apples (Price * Quantity) + Bread (Price * Quantity) – for year year Year 1 NGDP = ($1.20*60) + ($1.00*90) = $72 + $90 = $162 Year 2 NGDP = ($1.25*80) + ($1.30*100) = $100 + $130 = $230 To calculate real GDP, first calculate the Fisher Volume Index using three steps: Step 1: o Calculate the Laspeyres Volume Index for Year 2: = Year2 GDP at Year1 prices = (1.2*80 + 1.0*100) = $196 = Year1 GDP at Year1 prices $162 $162
$1.2099
Year2 GDP is the output produced in Year 2 Year1 GDP is the output produced in Year 1 Laspeyres Volume Index Step 2: o Calculate the Paasche Volume Index for Year2: = Year2 GDP at Year2 prices = $230 = $230 = $1.1979 Year1 GDP at Year2 prices (60*1.25)+(90*1.3) $192
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Step 3: o Calculate the Fisher Volume Index for Year2: = √(Laspeyres Index) (Paasche Index) = √ (1.2099)(1.1979) = 1.2039 The Fisher Volume Index can now be used to calculate real GDP: Calculation of Real GDP Using Year 1 as the Base Year: Year
Index of Real GDP (Fisher Volume Index)
1
1
2
1.2039
Real GDP $162 $162*1.2039 = $195.03
Note: the index of real GDP = 1 in the base year Note: real GDP = Nominal GDP in the base year Calculation of Real GDP using Year 2 as the Base Year: Year
Index of Real GDP
1
1/1.2039
2
1
Real GDP 230/1.2039 = 191.05 $230
GDP Deflator A price index that indicates how much prices rise from one year to the next Includes prices of all the goods and services in GDP GDP Deflator in Yeart: = Nominal GDP in Yeart * 100% Real GDP in Yeart From the previous example, using Year1 as the base year, calculate the GDP deflator for Year1:
GDP deflator in Year1: = $162 * 100% = 100% $162
From the previous example, using Year1 as the base year
Econ 102 Chapter 5 Notes
calculate the GDP deflator for Year2: GDP deflator in Year2: = $230 $195.03
Prof: Angela Trimarchi
* 100% = 117.93%
Inflation Rate Percent change in the GDP deflator from one year to the next Formula for Percent Change: [Final value – Initial value]/ [Initial value] * 100% [117.93 – 100]/ [100] * 100% = 17.93% Formula for Percent Change can also be used for real GDP in current and real GDP in base year growth rates [195.03 – 162]/ [162] * 100% = 20.39% [230 – 191.05]/ [191.05] * 100% = 20.39% GDP and Economic Well Being GDP ignores: The Size of The Population Consumption Of Leisure Non-Marketed Economic Activities Environmental Quality GDP Per Capita Output per person Is a better measure of economic well-being than real GDP Example: Suppose the economy of Denmark had a real GDP of $40B and China had a real GDP of $220B. But suppose the population of China was much larger than the population of Denmark . The economy of Denmark would be much better off
GNP When considering the production (income) included in GNP, remember GNP is the production (income earned) by a country’s residents or nationals. It does not matter if that production (income earned) took place in the residents’ own country or in another country Problem:
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
Suppose a person is a Canadian citizen and an American citizen. This person produces wine in Montreal, Quebec. Does the output of this person contribute to: a) Canadian GNP b) Canadian GDP c) American GNP d) American GDP Which of the following gets counted in GDP? a) b) c) d)
The tires on a brand new car (NO) The new tires on a used car (YES) The sale of an old pair of shoes (NO) A transaction involving financial assets (NO)
Next question… Which adds more to GDP? A pound of ground beef or a pound of caviar? Question One An art collector recently sold a piece of pottery for $300. He had purchased it for $200 two years earlier. Definitions: Subsidy: Payment by the government to a producer Not included in GDP – Income based Capital Consumption Allowance Also called depreciation Is wear and tear and obsolescence of capital equipment It is also a fall in the market value of a capital asset Ex. Jan 1, 2010 $20,000
Dec 31, 2010 $15,000
Depreciation = $5,000 Gross Investment = Net Investment + Depreciation Net Investment = Gross Investment – Depreciation
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
GNP vs GDP – Some Key Points Definition of GNP The total market value of all final goods and services produced by the citizens of a country, regardless of the location of production Key Point # 1 - GNP versus GDP o GNP would include some of the income/output from an Apple Computer factory in Singapore but would exclude some of the income produced by a Honda factory in Ontario Key Point # 2 - Size of GNP and GDP o The relative size of GDP and GNP depends on the balance between income from Canadian investments abroad and income from foreign investments in Canada o For most of Canada’s history Canada has been a net debtor country o Therefore, the value of foreign-based assets owned by Canadian residents has been less than the value of Canadian based assets owned by foreigners o This makes Canadian GNP less than Canadian GDP o But the difference is small o Alternatively, because there are many foreign owned firms in Canada (compared to Canadian-owned firms abroad) GNP is less than GDP o Canadian GNP for 2005 totaled $1274.0 billion whereas GDP was $1368.7 billion Key Point # 3 – GNP, Interest on Bonds and Earnings of Companies o Estimates of Canadian GNP differ slightly from estimates of GDP because GNP adds items such as the earnings of Canadian companies abroad and subtracts items such as interest payments on bonds owned by the residents of say, China and Japan Question One In 1995 GDP was $780B $16B in income (interest and dividends) was paid to Canadians by foreigners $49B of income (interest and dividends) was paid to foreigners by Canadians a) What is the value of net investment income paid to foreigners? $33B
Econ 102 Chapter 5 Notes
Prof: Angela Trimarchi
To calculate this, we subtract the amount paid to Canadians from the amount paid by Canadians b) What is the value of GNP? $747B To obtain this value, we subtract the net investment income paid to foreigners from the GDP
Question Two Suppose a worker is a Canadian and an American citizen. If that worker works for Stelco in Sudbury, which of the following does his production get counted in: Canadian GDP – YES Canadian GNP – YES American GDP – NO American GNP – YES Question 3 Suppose Toyota built a new automobile plant in Mexico using Japanese management practices, Canadian capital, and Mexican labour. Which of the following statements would be true at least conceptually? a) The portion of the output contributed by Canadian capital would be included in Canadian GDP b) The portion of output contributed by Japanese management would be included in both Japanese GNP and GDP c) The protion of output contributed by Japanese management would not be included in Japanese GNP and GDP d) The portion of output contributed by Mexican labour would be included in both Mexican GDP and GNP
