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