5: Income and Expenditure
Gross Domestic Product: the total income of everybody in the economy and the total expenditure on the economy’s output of goods and services. All the income produced within the border of a country.
For an economy as a whole, income must equal expenditure on the economy’s goods and services because every transaction has a buyer and a seller.
GDP equals the total amount spent by households in the market for goods and services. It also equals the total wages, rent, and profit paid by firms in the markets for the factors of production.
GDP can be computed by adding up the total expenditures by households, or adding up the total income paid by firms.
Add up all the income, add up all the expenditure in the economy, the value added approach. Income must equal expenditure.
Official definition of GDP
The market value of all final goods and services produced within a country in a given period of time. Based on geography.
GNP: the amount of goods produced by citizens of a country, both internally and abroad. Based on citizenship.
GDP adds together many different kinds of products into a single measure of the value of economic activity. Uses market prices. Reflects the value of all goods in the economy.
GDP tries to be comprehensive. All items produced in the economy and sold legally. Also includes market value of housing services, by adding in the price of rent and estimating the rental value of owned homes.
Excludes illegal products and those that will never enter the marketplace. GDP can underestimate the true amount of productive activity taking place in the economy, like items produced and consumed at home.
Black markets aren’t a part of GDP — can’t put a value on them.
Includes only the value of final goods because the value of intermediate goods are already included in the price of final goods.
Except when intermediate goods are produced and added to inventory of goods to be used or sold at later. Taken to be “final” for the moment, and its value as inventory investment added to GDP. When the intermediate good is later used, the inventory investment is negative, thus subtracting from GDP.
Includes both tangible goods and intangible services that are at their final price.
Includes goods and services currently produced inside a country, does not include transactions involving items produced in the past. e.g. sale of used cars.
Measures the value of production within the geographic bounds of a country.
GDP measures value of production in an interval, usually a year or a quarter. Usually presents GDP at an “annual rate” — quarterly GDP multiplied by 4. Equivalent to an income statement.
Seasonal adjustment: adjust quarterly data to take out the seasonal cycle, e.g. Christmas.
Components of GDP
GDP = Y
Consumption: C
Spending by households on goods and services. (2/3rds of the economy)
Includes household spending on durable goods, e.g. automobiles and non-durable goods, e.g. food and clothing.
Services include intangible items like haircuts.
Also includes spending on post-secondary education.
We always want GDP to grow.
Investment: I
(1/6th of the economy). Most volatile component of GDP, creates booms and busts. Strong economy = spending in investment. Weak economy = loss of confidence = recession because of lower investment.
Governments should spend in recessions, save in recessions. Should go in opposite directions to government spending.
The purchase of goods that will be used in the future to produce more goods and services. Sum of purchases of capital equipment, inventories, and structures (including new housing).
Therefore, the purchase of a new house is categorized as investment.
If a firm produces a widget and adds it to its inventory, the firm is assumed to have purchased the computer for itself. Therefore, it is part of investment spending.
Investment: purchase of goods used to produce other goods.
Government Purchases: G
Spending on goods and services by all levels of government; including government salaries and spending on public works.
Payment of benefits are considered transfer payments because it is not made in exchange for a currently produced good or service. Alters household income, but not economic production.
also known as what governments tax.
Net Exports: NX
The purchases of domestically produced goods by foreigners (exports) minus the domestic purchases of foreign goods (imports.)
When a domestic household, firm or government buys a good or service from abroad, the purchase reduces net exports, but because it raises consumption, investment, or government purchases, it does not affect GDP.
Exports - Imports.
Real & Nominal GDP
Economists want to differentiate between an increase in production and an increase in prices. We want to focus on the tangible output increases.
Nominal GDP: GDP as calculated using current prices. Stay away!!
Real GDP: what would be the value of goods and services produced this year if we valued these goods and services at the price that prevailed in some specific year in the past? Constant base year prices to place a value on the economy’s production of goods and services. Factors out inflation. Normalizes prices.
Fixed prices show how the economy’s overall production of goods and services change over time.
Real GDP is calculated with a base year price, which allows us to discern changes in production.
GDP deflators are the nominal GDP / real GDP * 100.
Measures the current level of price relative to the level of prices in the base year.
Actual production, net of inflation.
Real GDP is a better indicator of the economy’s production of goods and services.
Calculating Inflation
Inflation: the economy’s overall price level is rising. There is a basket of goods that the BoC thinks an average household consumes in the year. Creates a base year — says the basket is worth $100. Following years, the BoC asks what the price change is with the basket of goods.
Inflation rate: the percentage change in some measure of the price level from one period to the next.
Inflation rate in year 2 = (GDP deflator in year 2 - GDP deflator in year 1) / GDP deflator in year 1.
(102 - 100) / 100 = 2% inflation.
Basically the percent change formula.
Recession: two or more consecutive quarters of falling real GDP. GDP growth is not steady.
GDP and Economic Wellbeing
GDP does not include factors like the qualities of health or education. Many dispute the validity of GDP as a measure of wellbeing.
GDP does in fact help us measure wellbeing. Nations with larger GDP can afford better healthcare and other systems. GDP measures our ability to obtain the inputs into a worthwhile life.
GDP also excludes the quality of the environment and activity that takes place outside of markets, nor does it say anything about the distribution of income.
We end the lecture with this bizarre anecdote about Andrew Tate. Definitely on the exam.