chapter 7

The national accounts

• All countries calculate national income and product accounts (national accounts)

  • More reliable the accounts, more economically advanced the country

  • Calculated by stats canada here

  • Keeps track of consumer spending, producer sales, and many other flows of funds

• The expanded circular flow diagram

  • “Real” economy on left side of diagram (“financial” economy on right)

    • Flows of funds associated with production and sales of goods

    • Spending on goods and services (money into market for goods) comes from 4 buyers:

      • Governments

        • Education, defense, etc.

      • Households

        • Consumer spending(consumption)

      • Firms

        • Investment spending (investment)

          • Spending on productive capital(ie. machines)

      • Rest of the world

        • Exports sold to other countries

    • Purchase of imports leads to a flow of funds out of market for goods and out of economy

    • GDP = consumer spending + investment spending + govt purchase of goods + exports - imports

• Gross Domestic Product

  • Final goods and services

    • goods/services sold to the final/end user

  • Intermediate goods/services

    • Goods/services that are  inputs for production of final goods

    • purchaser(another firm) not final user

  • GDP

    • Total value of all final goods/services produced in an economy during some time period

    • Ways to calculate

      • surveying firms and adding up total value of production of final goods/services

      • Add up aggregate (total) expenditure on domestically produced final goods and services in the economy

        • Since Gdp must equal flow of funds received by firms from sales in goods/services market

        • Based on total spending on final goods/services

      • Sum total factor income earned by household from firms

        • Total value of factor income paid by firms to households

        • Based on total income earned

        • Each sale in economy must accrue to someone as an income

          • Wages, profit, interest or rent

    • Not included

      • Intermediate goods

      • Inputs

      • Used goods

      • Financial assets

      • Goods produced abroad

      • Volunteered work, illegal/underground work

      • Household production

      • Environmental damage

• Calculating GDP

  • Value added approach

    • Value added at each step of production minus cost of intermediate goods for each step

    • Adding up total value of all final goods/service produced

    • Excludes intermediate goods/services

      • Including causes us to count same items several times and inflate calculation

    • Only count each producers value added 

      • Difference between value of sales and value of intermediate goods it purchased from other firms

        • Subtract cost of inputs at each stage of production process

  • Expenditure approach

    • Adding up spending on all domestically produced final goods/services

      • The flow of funds into firm

    • Don't want to double count

      • Only count value of sales to final buyers

        • Consumers, firms that purchase investment goods, govt., foreign buyers

      • Omit sales of inputs from one business to another

    • GDP = C + I + G + X - IM

      • C = consumption (household)

      • I = investment (by firms)

      • G = govt. Expenditure

      • X = exports

      • IM = imports

    • X - IM = net exports

  • Income approach

    • Adding up total factor income earned by household from firms

    • Add two sources of income:

      • Factor incomes

        • Income earned by factors of production or inputs

        • Eg. wages, interest, rent, dividends, etc.

      • Non-factor payments

        • Income earned by federal govt. As a result of production of goods/services

        • Difference between prices final products sold in market and amount received (and kept) by the factors of production before income tax

        • Eg. net tax = taxes - subsidies, capital depreciation (value of capital(ex. machines) going down)

    • Sum total wages, interest, rent, etc. and profit

• What gdp tells us

  • Measure of the size of the economy

  • Good to compare economies

Real GDP: a measure of aggregate output

• Aggregate output

  • Total quantity of final goods/service the economy produces

• Helps to avoid price changes (inflation/deflation) distorting GDP

• Calculating real GDP

  • How much would GDP increase if prices didn’t change

  • Real GDP def

    • Total value of final goods/service produced during a year, calculated as if prices stayed constant at level of some given base year

  • Nominal gdp

    • Gdp at current prices with no adjustment

  • Govt. economists use chain linking to measure change in real gdp

    • Avg between gdp growth rate calculate using early and late base year

• What real GDP doesn’t measure

  • Gdp per capita

    • Gdp divided by size of population

  • Real gdp per capita not sufficient measure of std. Of living in a country

    • Increase in real gdp means expansion of economies ppf

      • Economy has greater productive capacity and can achieve more things

      • But society doesn’t always use that increase potential to improve living standards

Price indexes and the aggregate price level

• Aggregate price level

  • Single number representing overall level of prices

• Market baskets and price indexes

  • Consumption bundle

    • Typical basket of goods/service purchased by customers before the price changes

  • Market basket

    • A hypothetical consumption bundle used to measure changes in overall price level

  • Price index

    • Normalized measure of overall price level

      • Normalized means price index for base year set to 100

        • 84% increase in price basket will mean PI = 184 for new year

    • Price index in given year = (cost of market basket in given year) / (cost of market basket in base year) * 100

    • Basis for measuring inflation

      • Inflation rate is annual percent change in an official price index

      • Inflation rate = (PI in year 2 - PI in year 1) / PI in year 1 * 100

• Consumer price index(CPI)

  • Most widely used measure of prices in canada

    • Intended to show how cost of purchases by typical canadian family changed over time

    • Calculated by surveying market prices for a market basket to represent consumption of average family

  • CPI in a year = (cost of (fixed) market basket in a given year) / (cost of (fixed) market basket in base year) * 100

  • Market basket recalculated every 4 years with survey data

• Other price measures

  • PPI

    • Producer price index

    • Measures changes in prices of goods purchased by producers

  • Industrial producer price index (IPPI)

    • Measures cost of typical basket of goods/services containing raw commodities(steel, electricity, etc.) purchased by producers

    • Responds to inflation/deflation quicker than CPI

  • GDP deflator

    • A current weighted price index

    • Ratio of nominal to real gdp

    • = nominal gdp for a year / real gdp for a year * 100

  • These metrics tend to move together