THE MEASUREMENT AND STRUCTURE OF THE CANADIAN ECONOMY 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 $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 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 out- migration 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: Private saving is used in 3 ways: Investment ( ) The government budget deficit ( ) The current account balance ( )

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 Domestic physical assets Net foreign assets How to increase a country’s national wealth? Increase in the value of the existing assets 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)