Module 14.1: GDP, Income, and Expenditures

Gross Domestic Product (GDP)

-(GDP) is the total market value of the goods and services produced in a country within a certain time period. -Measure of the size of a nation's economy. -Includes only purchases of newly produced goods and services. -The sale or resale of goods produced in previous periods is excluded. Transfer payments made by the government (e.g., unemployment, retirement, and welfare benefits) are not economic output and are not included in the calculation of GDP.

Professor's note

Candidates should be aware that different countries' economic reporting bureaus may use their own terminology. For example, Statistics Canada defines gross domestic income as "net domestic income + consumption of fixed capital + statistical discrepancy," where net domestic income is "compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production + taxes less subsidies on products and imports."

Per-capita real GDP

Defined as real GDP divided by population and is often used as a measure of the economic well-being of a country's residents.

Value added at stages of production

Under the sum-of-value-added method, GDP is calculated by summing the additions to value created at each stage of production and distribution. An example of the calculation for a specific product is presented in Value Added at Stages of Production. Page 53

Net exports (exports- imports)

Using the expenditure approach, the major components of real GDP are consumption, investment, government spending, and net exports (exports minus imports). These components are summarized in the equation: GDP = C + I + G + (X - M) where: C = consumption spending I = business investment (capital equipment, inventories) G = government purchases X = exports M = imports We may also express this equation as: GDP = (C + Gc) + (I + Gi) + (X - M) where: GC = government consumption GI = government investment (capital goods, inventories)

The values used in calculating GDP market

-Are market values of final goods and services, meaning WONT be resold or used in the production of other goods and services. -->ex: the value of the computer chips that Intel makes is not explicitly included in GDP; their value is included in the final prices of computers that use the chips. The value of a Rembrandt painting that sells for 10 million euros is not included in the calculation of GDP, as it was not produced during the period. -Goods and services provided by government are INCLUDED in GDP even though they are not explicitly priced in markets. ex: the services provided by police and the judiciary, and goods such as roads and infrastructure improvements, are included. Because these goods and services are not sold at market prices, they are valued at their cost to the government. GDP: value of owner-occupied housing, rental housing services. Because the value of owner-occupied housing is NOT REVEALED in market transactions, the value is estimated for inclusion in GDP.Home repair is not GDP By-products of production, such as environmental damage, are not included in GDP.

Household disposable income or personal disposable income

-Income after taxes -The amount household have available to either save or spend on goods/services -An important economic indicator of the ability of consumer to spend and save.

Personal income

-Measure of the pretax income received by households -Determinant of consumer purchasing power and consumption -Different from national income, it includes all income that households receive: govt transfer payment (unemployment or disability benefits)

Example: Calculating and using the GDP deflator

1- GDP in 20X2 is $1.80 billion at 20X2 prices and $1.65 billion when calculated using 20X1 prices. Calculate the GDP deflator using 20X1 as the base period. GDP deflator = 1.80 / 1.65 × 100 = 109.1, reflecting a 9.1% increase in the price level. 2-Nominal GDP was $213 billion in 20X6 and $150 billion in 20X1. The 20X6 GDP deflator relative to the base year 20X1 is 122.3. Calculate real GDP for 20X6 and the compound annual real growth rate of economic output from 20X1 to 20X6. Real GDP 20X6 = $213 / 1.223 = $174.16. FUrther explain /54

Value of final output method

GDP under the expenditure approach as summing the values of all final goods and services produced. This expenditure method is termed the value-of-final-output method.

Professor's Note

In the topic review of International Trade and Capital Flows, we will see that a trade deficit (current account deficit) must be associated with an inflow of foreign investment (capital account surplus). So we can interpret this equation as saying a fiscal deficit must be financed by a combination of domestic and foreign capital.

Professor's Note

In this equation and the ones we will derive from it, a positive value for (G - T) is a government budget deficit and a negative value for (G - T) is a budget surplus. On the other hand, a positive value for (X - M) is a trade surplus and a negative value for (X - M) is a trade deficit. If we solve this equation for the fiscal balance, we get: (G - T) = (S - I) - (X - M) From this equation, we can see that a government deficit (G - T > 0) must be financed by some combination of a trade deficit (X - M < 0) or an excess of private saving over private investment (S - I > 0).

A capital consumption allowance (CCA)

Measures the depreciation (i.e., wear) of physical capital from the production of goods and services over a period. CCA can be thought of as the amount that would have to be reinvested to maintain the productivity of physical capital from one period to the next. --The statistical discrepancy is an adjustment for the difference between GDP measured under the income approach and the expenditure approach because they use different data.

National income is the sum of the income received by all factors of production that go into the creation of final output:

National income= compensation of employees (wages and benefits)+ corporate and government enterprise profits before taxes+ interest income+ unincorporated business net income (business owners' incomes)+ rent+ indirect business taxes - subsidies (taxes and subsidies that are included in final prices)

The GDP deflator

Nominal GDP/Real GDP x 100 -A price index to convert nominal GDP into real GDP, taking out the effects of changes in the overall price level. The GDP deflator is based on the current mix of goods and services, using prices at the beginning and end of the period. The GDP deflator is calculated as: page 54

Fiscal balance and Trade balance

Note that (G - T) is the fiscal balance, or the difference between government spending and tax receipts. Recall that (X - M) is net exports, or the trade balance. This equation shows that private savings must equal private investment, plus government borrowing or minus government savings, and minus the trade deficit or plus the trade surplus.

Real GDP

Output of the economy using BASE YEAR PRICES, removing the effect of changes in prices so that INFLATION IS NOT COUNTED as economic growth. Real GDP is calculated relative to a base year. By using base-year prices and current-year quantities, real GDP growth reflects only increases in total output, not simply increases (or decreases) in the money value of total output. Assuming the base year prices are those for five years ago, real GDP can be calculated as:PAGE 53

GDP Calcuation

The sum of spending on newly produced goods/services, or as the sum of the income received as a result of producing these goods and services. Under the EXPENDITURE APPROACH, GDP is calculated by summing the amounts spent on goods and services produced during the period. Under the INCOME APPROACH, GDP is calculated by summing the amounts earned by households and companies during the period, including wage income, interest income, and business profits. For the whole economy, total expenditures and total income must be EQUAL. In practice, measurement issues result in different values under the two methods.

Total expenditure can be GDP=C + I + G + (X - M)

Total income EQUAL total expenditures, can be stated as: GDP = C + S + T C = consumption spending S = household and business savings T = net taxes (taxes paid minus transfer payments received) Total income EQUALS total expenditures, we have the equality: C + I + G + (X - M) = C + S + T Rearranging this equation and solving for S (household and business savings), we get the following fundamental relationship: S = I + (G - T) + (X - M)

Nominal GDPt for year t

Under the expenditures approach: the total value of all goods/services produced by an economy, valued at current market prices. For an economy with N different goods and services, we can express nominal GDP as: Page 53 Because nominal GDP is based on current prices, inflation will increase nominal GDP even if the physical output of goods and services remains constant from one year to the next.

Gross Domestic Income (GDI)

Under the income approach, we have the following equation for GDP, or gross domestic income (GDI): GDP = national income + capital consumption allowance + statistical discrepancy