Macro 102 Chpater 20

20. The Measurement of National Income
[20.1 National Output and Value Added] Production occurs in stages Some firms produce outputs that are used as inputs by other firms, and these other firms, in turn, produce outputs that are used as inputs by yet other firms Double counting (multiple counting) is the error that would arise in estimating the nation’s output by adding all sales of all firms Could be solved by distinguishing between two types of output
Intermediate Goods: all outputs that are used as inputs by other producers in a further stage of production
Final Goods: goods that are not used as inputs by other firms but are produced to be sold for consumption, investment, government, or exports during the period under consideration Extremely difficult to distinguish final goods from intermediate goods Economists use the concept of value added
Value Added: the value of a firm’s output minus the value of the inputs that it purchases from other firms
(Value Added = Revenue – Cost of intermediate goods (purchased from other firms)) Payments made to factors of production (such as wages and profits) are NOT purchases from other firms, and therefore are not subtracted But the firm’s revenue must equal the cost of intermediate goods plus these payments to factors of production
(Value Added = Payments to factors of production) Value added is the correct measure of each firm’s contribution to total output – the amount of market value that is produced by that firm Value added is the net value of a firm’s output The sum of all values added in an economy is a measure of the economy’s total output
[20.2 National Income Accounting: The Basics] Measures of national income and product derive from an accounting system called the National Income and Expenditure Accounting (NIEA) The value of domestic output is equal to the value of the expenditure on that output and is also equal to the total income claims generated by producing that output 3 ways of measuring national income are: Add up the value of all goods and services produced in the economy (which gives GDP by value added) Requires the concept of value added Add up the total flow of expenditure on final domestic output (which gives GDP on the expenditure side) Add up the total flow of income generated by the flow of domestic production (which gives GDP on the income side) All three give the same total called gross domestic product (GDP)
Gross Domestic Product (GDP): the total value of goods and services produced in the economy during a given period
GDP from the Expenditure Side Given by adding up the expenditures needed to purchase the final output produced in one year Sum of four broad categories of expenditure: consumption, investment, government purchases, and net exports Define all expenditure on final outputs so it falls into one of the four categories
1. Consumption Expenditure
Consumption Expenditure (C): household expenditure on all goods and services Includes expenditure on all goods including services, non-durable goods, and durable goods Actual measured consumption expenditure is Ca
2. Investment Expenditure
Investment Expenditure (I): expenditure on goods not for present consumption Includes expenditure on investment goods Changes in Inventories
Inventories: stocks of raw materials, goods in process, and finished goods held by firms to mitigate the effect of short-term fluctuations in production or sales Decumulation (drawing down of inventories) counts as disinvestment (negative investment) because it is a reduction in the stock available to be sold New Plant and Equipment
Capital Stock: the aggregate quantity of capital goods
Fixed Investment: the creation of new plant and equipment (also called business fixed equipment) New Residential Housing Only when a NEW house is built ( a durable asset over a long period of time), it appears as residential investment Gross and Net Investment Total investment in the economy (gross investment) is divided into two parts: Replacement investment Amount of investment required to replace that part of the capital stock lost through the process of depreciation
Depreciation: the amount by which the capital stock is depleted through the production process Net investment = gross investment – depreciation Net investment is positive => economy’s capital stock is growing Net investment is negative => economy’s capital stock is shrinking Actual total investment expenditure is Ia
3. Government Purchases ONLY include government purchases on goods and services
Government Purchases (G): all government expenditure on currently produced goods and services, exclusive of government transfer payments Actual government purchases of goods and services are Ga Cost versus Market Value Government output valued at cost not the actual market value (Ex. value of law courts impossible to determine) Government Purchases vs. Government Expenditure ONLY government purchases on goods and services count; and therefore a great deal of government expenditure – transfer payments – (such as pension plans and welfare) does not count
Transfer Payment: a payment to an individual or institution not made in exchange for a good or service
4. Net Exports A country’s national income is the total value of final goods produced in that country
Imports: the value of all domestically produced goods and services purchased from firms, households, or governments in other countries
Exports: the value of all goods and services sold to firms, households, and governments in other countries Imports Consumption, investment, and government expenditures all have an import content To arrive at total expenditure on Canadian products, we need to subtract from total Canadian expenditure any expenditure on imports Actual import is IMa Exports To arrive at the total value of expenditure on Canadian output, we need to add in the value of Canadian exports of goods and services Actual export is Xa
Net Exports (NX): the value of total exports minus the value of total imports IMa > Xa => negative NXa IMa < Xa => positive NXa
Total Expenditures
(GDP = Ca + Ia + Ga + (Xa – IMa))
GDP from the Income Side National income = national output
1. Factor Incomes Wages and Salaries Payment for the services of labour (including pre-tax labour earnings) Interest Interest earned on bank deposits, loans to firms, and other investment income Business Profits Dividends (profits paid out to owners of firm) and retained earnings (held by the firm) Net Domestic Income The sum of wages & salaries, interest, and profits = net domestic income at factor cost
2. Non-factor Payments Indirect Taxes and Subsidies Indirect taxes are taxes on the production and sale of goods and services Subsidies act like negative taxes – must subtract, because they allow factor incomes to exceed the market value of output Depreciation Depreciation is the value of capital that has been used up in the process of producing final output. Needed to compensate for capital used in the process of production – NOT part of net profits (NOT income earned by any factor of production)
3. Total National Income
(GDP = factor incomes + indirect incomes (net of subsidies) + depreciation) Statistical discrepancy indicates that although national income and national expenditure are conceptually identical, in practice both are measured with slight error
[20.3 National Income Accounting: Some Further Issues]
GDP and GNP
Gross National Product: the value of total incomes earned by domestic residents GDP measures the value of all production located in Canada, no matter who receives the income from that production GNP measures the income received by Canadian residents, no matter where the production occurred to generated that income Canada a net debtor; GDP < GNP yet a small difference by 3-4%
Which Measure is Better? GDP is a better measure of domestic economic activity Ex) when finding a job GNP is a better measure of the income of domestic residents
Disposable Personal Income Disposable personal income the most important measure for individual households
Disposable Personal Income: the part of national income that accrues to households and is available to spend or save Calculated by:
(Disposable Personal Income = GNP – parts of GNP not available to households (such as taxes, depreciation, retained earnings, and interest) + transfer payments) In recent years, has been about 60% of GDP
Real and Nominal GDP Total GDP valued at current prices is called nominal GDP Changes in nominal GDP reflects the combined effects of changes in quantities & changes in prices GDP valued at base-period prices is called real GDP – measured in constant dollars Changes in real GDP reflects the effect of changes in quantities ONLY
The GDP Deflator Comparing nominal and real GDP over the same period implies the existence of a price index measuring the change in prices over that period
(GDP deflator = x 100 = x 100)
GDP Deflator: an index number derived by dividing nominal GDP by real GDP; its change measures the average change in price of all the items in the GDP
GDP Deflator versus the CPI GDP deflator =/ CPI CPI measures the change in the average price of consumer goods GDP deflator measures the change in the average price of goods produced in Canada
Omissions from GDP
Illegal Activities Illegal activities sometimes get included in national income measure but are mostly excluded
The Underground Economy Legal activities not reported for tax purposes (often paid in cash)
“Home Production” and Other Non-market Activities Production goods and services in the home is called home production; includes all of the “ordinary” work required to keep a household functioning Volunteer work Leisure Total economic well-being has increased even though measured GDP has fallen
Economic “Bads” To the extent economic growth brings with it increases in pollution, congestion, and other disamenities of modern living, measurements of national income will overstate improvement in living standards
Do the Omissions Matter? Unless the importance of unmeasured market activity changes rapidly, changes in GDP will probably do a satisfactory job of measuring changes in economic opportunities
GDP and Living Standards Depends on the definition of “living standards” Purchasing power & real income Not necessarily GDP per capita a better measure of average material living standards Productivity an important measure Intangible factors