CHAPTER 2CHAPTER 2

THE MEASUREMENT AND

STRUCTURE OF THE

CANADIAN ECONOMY

Lecture Outline:Lecture Outline:

I. Three Measurement Approaches & The Fundamental Identity

II. Savings & Wealth

III. Nominal vs. Real Variables

IV. Interest Rates

I. 3 Measurement I. 3 Measurement ApproachesApproaches1). 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 Example: 2 Businesses EconomyEconomyStelco (produces steel): Revenues received from the sales $70k

Steel sold to public 20k Steel sold to Ford 50k

Wages paid to Stelco employees 30k Taxes paid to government 10k After tax profits 30k

Ford (produces cars) Revenues received from the sales $80k Wages paid to Ford employees 20k Taxes paid to government 4k Steel purchased from Stelco 50k After tax profits 6k

Why are the 3 approaches Why are the 3 approaches equivalent?equivalent?

→ Any output produced

(production) is purchased by

someone (expenditure) and

results in someone’s income

(income).

II. Gross Domestic II. Gross Domestic ProductionProduction

1). Product Approach

GDP = market value of final

goods and services newly

produced within a nation

during a fixed period of time

1) Product Approach1) Product Approach

i) Market Value: → allows adding different items by

valuing in common units

- Non-market Items

- Underground Economy

- Government Services

1) Product Approach1) 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 Approach1) Product Approach

iii) Newly Produced:

- Counts only things produced in the given period

- Excludes things produced earlier

1) Product Approach1) 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:Question:

Does a country with lots of out-

migration have bigger GNP or

GDP?

II. Gross Domestic II. Gross Domestic ProductionProduction

2). Expenditure Approach

GDP = Total spending on final

goods and services produced

within a nation during a

specified period of time

2) Expenditure Approach2) 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 Approach2) Expenditure Approach

ii) Investment (20 %): Fixed Investment a). Residential construction

b). Nonresidential investment

c). Machinery and equipment investment

Inventory Investment Government Investment

2) Expenditure Approach2) Expenditure Approach

iii) Government purchases (19.5 %): Government expenditure (all

levels) on goods or services

Excludes transfers & debt interest payments

2) Expenditure Approach2) Expenditure Approach

iv) Net Exports (3.9 %):

= Exports - Imports

Why are imports subtracted from GDP?

II. Gross Domestic II. Gross Domestic ProductionProduction

3). Income Approach

GDP = Total incomes

generated by production

3) Income Approach3) Income ApproachNet National Income

a). Labour income

b). Corporate profits

c). Interest and investment income

d). Unincorporated business incomeIndirect taxes - subsidiesDepreciation

3) Income Approach3) 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 WealthIII. Savings and Wealth1). 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 Savings2). Uses of Private Savings

Uses-of-saving Identity:

Private saving is used in 3 ways:

i. Investment ( )ii.The government budget deficit ( ) iii.The current account balance ( )

CA)S(I S govtpvt

I

govtS

CA

3). Relating Saving and 3). Relating Saving and WealthWealthStocks 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 3). Relating Saving and WealthWealthNational wealth has two parts1) Domestic physical assets2) 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 GDPIV. Real vs. Nominal GDPNominal 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 IndexesPrice IndexesPrice 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.

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

Price IndexesPrice Indexes

V. Interest RatesV. Interest RatesAn 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

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)

Chapter 2 SummaryChapter 2 Summary