1. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 0

2. C H A P T E R 2 Measuring the Performance of the Canadian Economy PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa Copyright 2005 © McGraw-Hill Ryerson Ltd. äUnderstand what is Gross Domestic Product (GDP). äUnderstand that we assume that goods are produced through a production function. äUnderstand that what is produced must be sold. äUnderstand that in an economy, total savings is composed of private savings plus the government budget deficit. äUnderstand that the dollar value of Gross domestic product can change if the level of physical production changes or if the price level changes. Learning objectives

3. C H A P T E R 2 Measuring the Performance of the Canadian Economy PowerPoint® slides prepared by Marc Prud’Homme, University of Ottawa Copyright 2005 © McGraw-Hill Ryerson Ltd. âUnderstand that the real interest rate is equal to the nominal interest rate minus the inflation rate. âUnderstand that the unemployment rate can change if the participation rate changes or if the number of people employed changes. Learning objectives (cont’d)

4. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 3 Measuring Gross Domestic Product oNational Income and Expenditure Accounts: oNational Income and Expenditure Accounts: A measure of current activity in the Canadian economy, published quarterly by Statistics Canada. oGross Domestic Product (GDP): oGross Domestic Product (GDP): The dollar value of all final goods and services produced in the economy over some specified period of time, usually one year. oThe measurement of GDP is based on a simple principle: Whatever is produced in the economy must be sold (Supply = Demand). oGDP can be measured by adding the value of final goods produced (supply) or by adding the final value of goods purchased. Chapter 2: Measuring the Economy

5. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 4 Measuring Gross Domestic Product oFactors of production oFactors of production: inputs such as labour and capital. oFactor payments oFactor payments: Payments made to factors, such as wages and interest payments. oProduction function oProduction function: Technological relation showing how much output can be produced for a given combination of inputs. Chapter 2: Measuring the Economy Measuring Supply

6. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 5 Measuring Gross Domestic Product oFinal goods and services oFinal goods and services: Goods and services that are sold to firms, the public, or the government for any purpose other than use as an input to production; all goods excluding intermediate ones. oIntermediate goods oIntermediate goods: Goods used to produce other goods and services. oValue added oValue added: The increase in value of output at a given stage of production OR the value of outputs minus value of inputs. Chapter 2: Measuring the Economy Measuring Supply (cont’d)

7. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 6 Farmer Value of Wheat$0.10 Miller Cost of Wheat 0.10 Plus GST 0.007 Value added 0.30 Total $0.407 Baker Cost of flour $0.407 Less GST rebate -0.007 Value added 0.20 Total $0.628 Plus GST 0.028 Final Consumer Cost of Bread $0.628 Less GST rebate -0.028 Final cost $0.642 Plus GST 0.042 Value Added and the GST BOXBOX 2-1

8. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 7 Measuring Gross Domestic Product oNet domestic product at factor cost oNet domestic product at factor cost: The total payments to the factors of production. oNet domestic product at market prices oNet domestic product at market prices: Indirect taxes (net of subsidies) are added to net domestic product at factor cost. oGross domestic product oGross domestic product: By adding depreciation to Net domestic product, the result is Gross domestic product. oDepreciation oDepreciation: The wearing out of capital as it is being used to produce output. oGross national product oGross national product: Measure of the value of all final goods and services produced by domestically owned factors of production. Chapter 2: Measuring the Economy Measuring Supply (cont’d)

9. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 8 Measuring Gross Domestic Product Chapter 2: Measuring the Economy Table 2-1: Income Approach to Measuring GDP, 1961 and 2002

10. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 9 Measuring Gross Domestic Product oTotal demand oTotal demand is made up of four components: oConsumption spending by households (C) oInvestment spending by businesses and households (I) oGovernment purchases of goods and services (G) oForeign demand for our net exports (NX) oThe National Income Identity oThe National Income Identity: Chapter 2: Measuring the Economy Measuring Demand (3) Y = C + I + G + NX

11. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 10 Measuring Gross Domestic Product Chapter 2: Measuring the Economy Table 2-2: Measuring GDP by Components of Demand, 1961 and 2002

12. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 11 Measuring Gross Domestic Product oConsumption spending: oConsumption spending: Total current spending by consumers. oInvestment spending: oInvestment spending: Additions to the physical stock of capital. oHuman capital oHuman capital: Knowledge and ability to produce that is embodied in the labour force. oGross investment oGross investment: Depreciation is not deduced. oNet investment oNet investment: Gross investment minus depreciation. Chapter 2: Measuring the Economy Measuring Demand (cont’d)

13. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 12 Measuring Gross Domestic Product oGovernment purchases: oGovernment purchases: Government purchases of goods and services. oGovernment expenditure: oGovernment expenditure: Government purchases plus transfers. oTransfer payments: oTransfer payments: Payments that are made to people without their providing a current service in exchange. oNet exports: oNet exports: The difference between exports and imports. Chapter 2: Measuring the Economy Measuring Demand (cont’d)

14. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 13 Problems in Measurement of GDP oNot all output is produced in the market (e.g. domestic production and government services). oActivities that represent the use of resources to prevent certain “bads” (e.g. crime prevention and national security). oNew and improved products (e.g. computers and cars). BOXBOX 2-2

15. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 14 Allocation of Income and Savings (4) Y = C + I Y: National income C: Consumption spending I: Investment spending (5) S = Y - C S: Savings 4) into 5): (6) S = I Chapter 2: Measuring the Economy … no government or foreign trade: In an economy with…

16. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 15 Allocation of Income and Savings Chapter 2: Measuring the Economy (3) Y = C + I + G + NX G: Government purchases NX: Net exports (7)YD = Y + YNR + TR - TA YD: Disposable income YNR: Income from non-residents TR: Transfer payments TA: Taxes (8)S P = YD - C S P : Private savings … government and foreign trade: In an economy with…

17. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 16 Allocation of Income and Savings Chapter 2: Measuring the Economy 7) into 8): (9)S P = (Y + YNR + TR - TA) - C 3) into 9): (10) S P = C + I + G + NX + YNR + TR - TA - C … government and foreign trade (cont’d): In an economy with… (11) S = S P + S G = I + CA Government budget deficit - S G Current account balance CA = (G + TR - TA) + (NX + YNR) + I

18. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 17 Measuring Gross Domestic Product Chapter 2: Measuring the Economy Figure 2-1: Investment, Savings, and the Current Account 1961 and 2002

19. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 18 Federal Government Fiscal Balance Action Policy in Action

20. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 19 Real and Nominal GDP and Inflation oCurrent dollar (or nominal) GDP oCurrent dollar (or nominal) GDP: Measuring GDP between two periods while allowing the price level to change between the two periods. oConstant dollar (or real) GDP oConstant dollar (or real) GDP: Measuring GDP between two periods holding the price level constant. oChain weighted GDP oChain weighted GDP: Calculated by averaging the base over two years, the current and the preceding year, and so the averaging moves over time as the current year moves over time. Chapter 2: Measuring the Economy

21. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 20 Calculating Real GDP: Different Base years Table 2-4 $15,000 10 computers 15 reports 5 computers 10 reports Quantity $25,000 2002 GDP measured in 1995 Dollars $10,000 $1,000 per computer $15,000 $1,000 per report 2002 1995 GDP measured in 1995 Dollars $5,000 $1,000 per computer $10,000 $1,000 per report 1995 Value in 1995 Dollars PriceYear 1. Real GDP Calculated Using 1995 Base Year Prices Growth rate of real GDP = ($25,000/$15,000) = 66.67%

22. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 21 Calculating Real GDP: Different Base years Table 2-4 (cont’d) $13,500 10 computers 15 reports 5 computers 10 reports Quantity $21,500 2002 GDP measured in 2002 Dollars $5,000 $500 per computer $16,500 $1,100 per report 2002 1995 GDP measured in 2002 Dollars $2,500 $500 per computer $11,000 $1,100 per report 1995 Value in 1995 Dollars PriceYear 2. Real GDP Calculated Using 2002 Base Year Prices Growth rate of real GDP = ($21,500/$13,500) = 59.2%

23. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 22 Price Indexes and Inflation oPrice index oPrice index: A measure of prices in any one year compared to the level of the same prices in some base year (base value = 100). oInflation oInflation: The rate of change in prices. P t t P t-1  t oIf P t represents the price index in period t and P t-1 represents the price index In the previous year, the the annual rate of inflation,  t is: Chapter 2: Measuring the Economy (13)(13)

24. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 23 Price Indexes and Inflation oGDP deflator oGDP deflator: The price index that pertains to the goods produced in GDP. It is the ratio of nominal GDP in a given year to real GDP of that year. (14) (14) GDP deflator = Nominal GDP/Real GDP inflation rate oDeflator based inflation rate: (15) (15)  t = %  nominal GDP - %  real GDP oConsumer Price Index (CPI) oConsumer Price Index (CPI): Measures the cost of a fixed bundle of goods that is representative of the purchases of the average consumer. Chapter 2: Measuring the Economy

25. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 24 GDP deflator, the CPI, and Inflation BOXBOX 2-3 Inflation as measured by the GDP deflator and the Consumer Price Index, 1962-2002

26. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 25 Inflation and Nominal and Real Interest Rates oNominal interest rate: oNominal interest rate: Measures how much money you received above the amount that you initially invested, expressed as a percentage. Chapter 2: Measuring the Economy (16) oBond: P B t P B t +1 oBond: Contract between a lender and a borrower. If P B t is the current price of the bond and P B t +1 is the price of the bond at t + 1, then the nominal interest rate is: oReal interest rate: oReal interest rate: Nominal interest rate minus the inflation rate. (17)

27. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 26 Inflation and Nominal and Real Interest Rates Chapter 2: Measuring the Economy Figure 2-2: Nominal and real interest rates and inflation, 1961 and 2002

28. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 27 The Unemployed and the Unemployment Rate oLabour force: oLabour force: The total number of individuals who are employed, plus the number of individuals who are actively seeking employment but who do not have jobs. oUnemployment rate: oUnemployment rate: The percentage of the labour force that is unemployed. Chapter 2: Measuring the Economy Measuring the unemployment rate Unemployment rate = Number of unemployed persons Total labour force X 100

29. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 28 The Unemployed and the Unemployment Rate oLabour force participation rate: oLabour force participation rate: Number of persons in the labour force as a percentage of the adult population. Chapter 2: Measuring the Economy Measuring the unemployment rate (cont’d) Participation rate = Labour force Adult population X 100 oNatural rate of unemployment: oNatural rate of unemployment: Rate of unemployment at which the flows into and out of the unemployment pool balance; also, the point on the augmented Phillips curve at which expected inflation equals actual inflation.

30. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 29 The Unemployed and the Unemployment Rate oFrictional unemployment: oFrictional unemployment: The unemployment that exists when the economy is at full employment. oStructural unemployment: oStructural unemployment: Long-term unemployment that arises because of a lack of matching between the skills of workers and the needs of employers. oDiscouraged workers: oDiscouraged workers: Individuals who have been in the labour force, could not find employment and have now given up looking for a job. They are not in the labour force and therefore are not counted among the unemployed. Chapter 2: Measuring the Economy Measuring the unemployment rate (cont’d)

31. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 30 The Unemployed and the Unemployment Rate oOkun’s law: oOkun’s law: The hypothesized relationship between changes in the unemployment rate and changes in real GDP. Chapter 2: Measuring the Economy Okun’s law

32. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 31 The Unemployed and the Unemployment Rate Chapter 2: Measuring the Economy Figure 2-3: Okun’s law, 1962 and 2002

33. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 32 Chapter Summary GDP is the value of all final goods and services produced in an economy within a given period. GDP can be measured from the supply side as payments to factors of production or on the demand side as components of spending. Total savings in an economy is composed of private savings plus government savings. Nominal GDP is also called current dollar GDP. Real GDP is also called constant dollar GDP. Chain weighted GDP is an alternative measure of real GDP. Chapter 2: Measuring the Economy

34. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 33 Chapter Summary (cont’d) A price index is a measure of prices in any one year compared to the level of the same prices in some base year. Inflation is the rate of change in prices. Nominal interest rates give the return on bonds in current dollars and real interest rates give the return in constant dollars. The unemployment rate is defined as a percentage of the labour force that is unemployed. The labour force participation rate is defined as a percentage of the adult population that is in the labour force. Chapter 2: Measuring the Economy

35. Copyright 2005 © McGraw-Hill Ryerson Ltd.Slide 34 The End Chapter 2: Measuring the Economy