Transcript 1). Product Approach

CHAPTER 2
THE MEASUREMENT AND
STRUCTURE OF THE
CANADIAN ECONOMY
Lecture Outline:
I. Three Measurement Approaches & The
Fundamental Identity
II. Savings & Wealth
III. Nominal vs. Real Variables
IV. Interest Rates
I. 3 Measurement Approaches
1). Product Approach:
Output produced – output used up in the
intermediate stage
2). Income Approach
Total income generated by production
3). Expenditure Approach
Total spending by purchasers
Example: 2 Businesses Economy
Stelco (produces steel):
Revenues received from the sales
Steel sold to public
Steel sold to Ford
Wages paid to Stelco employees
Taxes paid to government
After tax profits
Ford (produces cars)
Revenues received from the sales
Wages paid to Ford employees
Taxes paid to government
Steel purchased from Stelco
After tax profits
$70k
20k
50k
30k
10k
30k
$80k
20k
4k
50k
6k
Why are the 3 approaches
equivalent?
→ Any output produced (production) is
purchased by someone (expenditure) and
results in someone’s income (income).
II. Gross Domestic Production
1). Product Approach
GDP = market value of final goods and
services newly produced within a
nation during a fixed period of time
1) Product Approach
i) Market Value:
→ allows adding different items by valuing
in common units
- Non-market Items
- Underground Economy
- Government Services
1) Product Approach
ii) Final Goods and Services:
- Don’t count Intermediate goods and
services
- Capital Goods: goods used to produce other
goods
- Inventories: unsold finished goods, goods in
process & raw materials
1) Product Approach
iii) Newly Produced:
- Counts only things produced in the given
period
- Excludes things produced earlier
1) Product Approach
iv) GDP vs. GNP:
GDP = output produced within a country
GNP = output produced by domestic
factors of production
NFP = net factor payments from abroad
Question:
Does a country with lots of outmigration have bigger GNP or GDP?
II. Gross Domestic Production
2). Expenditure Approach
GDP = Total spending on final goods
and services produced within a nation
during a specified period of time
2) Expenditure Approach
i) Consumption (56.5 %):
includes 4 categories:

Consumer durables: >3 yrs (cars, TVs,
not houses)

Semi-durable goods: 1-3 yrs (clothing)

Nondurable goods (food, utilities, fuel)

Services (rent, health care)
2) Expenditure Approach
ii) Investment (20 %):

Fixed Investment
a). Residential construction
b). Nonresidential investment
c). Machinery and equipment investment
Inventory Investment
 Government Investment

2) Expenditure Approach
iii) Government purchases (19.5 %):

Government expenditure (all levels) on
goods or services

Excludes transfers & debt interest
payments
2) Expenditure Approach
iv) Net Exports (3.9 %):
= Exports - Imports

Why are imports subtracted from GDP?
II. Gross Domestic Production
3). Income Approach
GDP = Total incomes generated by
production
3) Income Approach

Net National Income
a). Labour income
b). Corporate profits
c). Interest and investment income
d). Unincorporated business income

Indirect taxes - subsidies

Depreciation
3) Income Approach

Private and Government sector income

Private disposable income:
The amount of income the private sector has
available to spend.

Net government income
→ What do you get when you add these up?
III. Savings and Wealth
1). Important Concepts:

Wealth = assets – liabilities

Saving = current income – current spending

Private Savings
= private disposable income – consumption

Gov’t Savings
= net gov’t income – gov’t purchases

National Savings = Private + Gov’t Savings
2). Uses of Private Savings
 Uses-of-saving
Identity:
S pvt  I  (  S govt)  CA

Private saving is used in 3 ways:
Investment ( I )
ii. The government budget deficit (  S govt)
iii.The current account balance ( CA )
i.
3). Relating Saving and Wealth
 Stocks
vs. Flows
- Flow variables:
measured per unit of time
- Stock variables:
measured at a point in time
 Wealth
is a stock, while saving is a flow.
3). Relating Saving and Wealth
 National
wealth has two parts
1) Domestic physical assets
2) Net foreign assets
 How
to increase a country’s national wealth?
1) Increase in the value of the existing
assets
2) Increase in national saving
IV. Real vs. Nominal GDP

Nominal variables (in dollar terms):
Problem: Do changes in nominal values
reflect changes in prices or quantities?

Nominal GDP (current-dollar GDP):
uses current market prices

Real GDP (constant-dollar GDP):
uses the prices of a base year
Price Indexes

Price Index: a measure of average level of
prices for some specified set of goods and
services, relative to some base year.

GDP Deflator ( Quarterly): measures the
overall level of prices for ‘economy’.

Consumer Price Index (Monthly):
measures the prices of consumer goods.
Price Indexes
 Concerns
with using the CPI:
• The base year should be updated
occasionally.
• CPI may overstate inflation:
i). Quality adjustment bias
ii). Substitution bias
 Inflation:
growth rate of the price level
V. Interest Rates
An interest rate is a rate of return promised
by a borrower to a lender.

Nominal interest rate:
nominal return to an asset

Real interest rate:
real return to an asset

Expected real interest rate
= nominal interest rate – expected inflation
Chapter 2 Summary


What we have learned from Ch.2:
- Measurement of GDP
- Savings and Wealth
- Nominal vs. Real GDP
- Interest Rates
Next: What determines the amount of
output produced in an economy? (Ch.3)