Chapter 2. Overheads. 303. F2016

Chapter 2: Measure and Structure of Canadian Economy
Economics 303: OVERHEADS - D. McClintock
Chapter 2
The Measure and Structure of the Canadian Economy
Table of Contents
2.1 National Income Accounting
-
2.2 Gross Domestic Product

-
2.3 Saving and Wealth

-
2.4 Real GDP, Price Indexes and Inflation
Intellectual property of Douglas McClintock and authors cited above Page 1

2.1 National Income Accounting
National income accounts are an accounting framework used in measuring current

economic activity.
Some of the accounts that we talked about in Econ 203 are Gross Domestic
Product (GDP), Gross National Product (GNP), Net Domestic Income, (NDY),
Personal Income (PY) and Personal Disposable Income (PDY)
There are 3 measurements used by Stats Canada to measure the national accounts.
1) Value added or Product Approach

2) Expenditure Approach
3) Income Approach
When we measure GDP (the value of total production in the economy), we are
simultaneously measuring the value of total income.

Expenditure Approach to Measuring GDP
Statistics Canada divides its statistics on GDP into four major categories of
expenditures:
• Consumption, C
• Investment, I
• Government purchases, G
• Net exports, NX = X - M
+ Statistical discrepancy
Economists use these categories to understand why GDP fluctuates and to forecast
future GDP.
Consumption Spending, C

Gross Private Domestic Investment or

“Investment”
Investment Spending by firms on new factories, office

buildings, machinery, and additions to inventories, plus
spending by households and firms on new houses.
Spending on gross private domestic investment, or simply

investment, is divided into three categories:
1. Business gross fixed capital formation is spending
by firms on new factories, office buildings, and
machinery used to produce other goods.
2. Residential structures are spending by households

and firms on new houses.
3. Business investment in inventories is also
included in investment.

Government Consumption and Gross Investment,

or “Government Purchases”
Spending by federal, provincial and local governments
on goods and services, such as teachers’ salaries,
highways, and hospitals.
Again, government spending, when referring to GDP,

does not include transfer payments to individuals
because such payments do not represent the
production of a new good or service.
Transfer payments include employment insurance,

pensions and welfare payments.
Net exports: Exports minus imports.
We add exports to expenditures to include all spending on

new goods and services domestically produced and we
subtract imports from total expenditures to exclude
spending that does not result in this production.

A simple equation sums up the components of GDP:
Y  C  I  G  NX
The equation tells us that GDP (denoted as Y) equals

consumption (C) plus investment (I) plus government
purchases (G) plus net exports (NX).
Table 4.2 (2012)

The table in Figure 4.2 provides a more detailed

breakdown of the components of GDP and shows several
interesting points:
• Consumer spending on services is greater than the

sum of all other types of consumer spending.
• Business fixed investment is the largest component

of investment. (and the most volatile)
• Purchases made by government accounts for just

over one-quarter of every dollar spent in Canada.
• The majority of government spending is classified

as spending on goods and services rather than
investment.
• In 2012, imports were larger than exports, so net

exports were negative (a trade deficit). We discuss
in Chapter 14 why imports are larger than exports
in Canada.

Do we spend too much?

Examples for year 2011 (see page 25)
GDP Expenditure Approach (Year 2011)
Billions of Dollars
Personal Consumption 982.6
Fixed Business Investment 320.4
Business Inventory Investment 4.7
Government Investments 67
Government Purchases 367.6
Net Exports -21.1
Exports (535.7)
Imports ((556.7)
Statistical Discrepancy -0.5
GDP (market prices) 1720.7
GDP Income Approach (Year 2011) (Truncated version)
Billions of Dollars
Labour Income (wages and salaries) 889.5
Gross Corporate Profits* 225.1
Unincorporated business income** 111.6
Indirect taxes less subsidies 180.0
Capital Consumption Allowance 241.7
Statistical discrepancy 0.5
GDP 1720.7
* includes government enterprise profit.

** Includes net farm income

Income Approach to Measuring GDP

1) Wages and Salaries1
 Include gross wages, salaries, commissions and bonuses.
2) Interest and Miscellaneous Income

 Interest earned on bank deposits, interest on loans to firms,
other deposits (e.g. Credit Unions), bond interest and misc.
investment income (e.g. interest earned on whole life
policies)
3) Net farm income

 This is income generated to farmers after expenses
1
The category of Wages and Salaries does not include transfer payments (i.e. employment insurance or welfare
payments to individuals) since no production was derived from these payments.

4) Business Profits
i) Unincorporated Business Income (UBY) – this includes

profits from small businesses, partnerships, professionals
and self-employed businesses.
ii) Gross Corp Profits – these are gross profits (before tax)
of corporations.
iii) Profits from Government enterprises, such as Canada
Post, Export Development Corporation and Alta Treasury
Branch.
Note: Gross corporate profits (earnings) are the sum of

retained earnings, dividends and taxes.

5) Indirect Taxes and Less Subsidies

 Indirect taxes include GST and PST. (We must add these
since we pay these taxes when goods are purchased.)
A subsidy must be subtracted so that the expenditure side = income side.
This relates mostly to agricultural products were a farmer may earn more
(due to the subsidy) than the market value of the good). Therefore the
subsidy must be subtracted.
6) Depreciation (Capital Consumption Allowance)

Because firms are allowed to deduct depreciation to calculate
gross profits (profits before tax), we must add the depreciation
back so that the expenditure side equals the income side.
7) Statistical Discrepancy

National Accounts
Income Approach Expenditure Approach
Depreciation Exports minus

(Consumption Minus FDD = GDP minus Imports
of fixed Dep Net Exports minus Xn = X - M
capital) Minus Business
Statistical Discrepancy Inventories
minus
Indirect
Taxes
Indirect Tax
(less subsidies)
(less subsidies)
Gross Government
Corporate Government
Corporate Spending
Profits Spending
Profits Gov’t Net of
(before tax) Net of transfers
(before tax) Transfers transfers
(G)
(G)
Gov’t
Gov’t Enterprise Dividends (minus
Enterprise
profits personal
profits
tax)
Unincorporated
Business **Gross
(U.B.Y) (U.B.Y)
Income Investment
(U.B.Y) Ig = In +D
Gross (D = Depreciation
Investment (In = Net Investment))
Net Farm Y Ig = In +D
Net Farm Y Net Farm Y
a) Bus Fixed
Personal Investment
Savings b) Residential
(PS) Structures
Interest & Interest &
Interest & misc c) Investment in
misc misc
Investment Bus Inventories
Investment Investment
Y
Y Y
Consumption Consumption Consumption

Wages, (C) (C) (C)
Wages, salaries Wages,
and salaries salaries
supplementary & &
labour income Suppl. Suppl.
Y Y Y
GDP NDY PY PDY FDD GDP

(at Basic (Final
(C + PS) Domestic
Prices)
Household Income Demand)

New Changes to National Accounts (2016)

Douglas McClintock Revised National Accounts
Statistics Canada 2016
Gross Domestic Product (2014)

Income Approach Expenditure Approach
($ millions) ($ millions)
Statistical -388 Statistical

+388
Discrepancy Discrepancy
Taxes
NX = Exports
(less subsidies)
Taxes minus
on production, NX
(less subsidies) Imports
products and (-$18,615)
$209,549 ($624,594 -
imports
$643,209)
$209,549
Consumption of Investment In Investment in
fixed capital: Inventories Inventories
Unicorporated ($8,488) ($8,488)
Businesses Gross
$54,607 Income
$222,245
General
governments
Net Mixed
gross fixed
Income
capital
$167,638
formation
($76,688)
Consumption of
fixed capital: Gross Fixed
Government and Capital Non-profit
non-profit Formation Institutions
Institutions ($469,739) serving
$66,381 households fixed
Gross capital formation
Operating ($3,044)
Surplus
Consumption of
$543,051
fixed capital:
Corporations Business
$204,261 Gross
Capital
Formation
Net Operating ($390,007)
Surplus
Corporations
$272,409 General
Governments
final consumption
Employers’ expenditure
social ($406,340)
Contributions
$139,102
Non-profit
institutions
serving
Final housholds
Wages, salaries
Compensation Consumption final
&
Of Expenditure consumption
Supplementary
Employees ($1,513,043) ($27,294)
Income
$998,586
Household
Final
$859,484 Consumption
(Durable,
non-durable
goods and
services)
($1,079,409)
GDP $1,973,043 $1,973,043 GDP
Source: Cansim Table 380-0063 and

Note: Not to scale
Table 380-0064

Calculating GDP from Income side: Example 1 - Table 2.1
Category Current Values

($)
Wages, Salaries and Supplementary Income $100

Exports 55
Personal Income Taxes 40
Government Transfer Payments X
Government Expenditures on Goods and Services 120
Net Investment 32
Personal Savings 47
Interest and Miscellaneous Investment Income 42
Undistributed Corporate Profits (Retained Earnings) 20
Imports 65
Investment Income paid to Non-Residents (Foreign 18
sources)
Unincorporated Business Income 48
Dividends 20
Depreciation X
Total Corporate Profits X
Indirect Taxes net of subsidies 26
Government Business Enterprise Profits 5
Investment Income received from foreign sources 16
Corporate Income Taxes 20
Gross Investment 40
Consumption X
Net Farm Income 33
Statistical Discrepancy 0
Note: An “X” opposite an item means that its value is unknown and that it may or may not
be asked for.
1) What is the value of GDP?

Other Measures of National Income
1) Gross National Product (GNP)
Is the income received (earned) by Canadians regardless of where they

were located when the income was produced (e.g. Canadian companies
operating overseas or Canadians working in foreign countries)
To Calculate GNP
1) Gross National Product (GNP) is
GDP
Plus (+)
[(Investment income received by Canadians from non-residents)
+ (compensation of Canadians working abroad)]
Minus (-)
[(Investment income paid to non-residents)
+ (Compensation of employees, non-residents)]
Net investment Income (and compensation) is called Net Factor

Payments (NFP).

GDP to GNP Example: An illustrative example

Recall:
GDP measures the value of output and income produced in Canada.
GNP measures the total amount of Income received by Canadian
residents, no matter where the income was generated.
Part #1 (Year 2013)
 Suppose the TD Bank operates a call center outside Canada.

(Say India).
 It generates $10 million in revenue in that country, so GDP

(India) increases by $10 million.
 Suppose $1 million in profits are remitted back to its

Canadian owners, those profits will be part of Canada’s GNP.
(Investment income received by Canadians from foreign sources) = +

$1 million

Part #2
 Toyota has a factory located in Cambridge Ontario.
 Suppose the value (revenues) generated at that plant was

$100 million. GDP in Canada would increase by $100
million.
 Now suppose $5 million of the profits (part of value added)

was sent back to the owners in Japan, only $95 million of
value added generates income for Canadians.
(Investment income paid to non-residents) = $5 million

Net factor payments (NFP) = + $1 million - $5 million = - $4 million
From these two examples,
GNP = GDP + (-$4 million)……………….

Therefore
GNP = GDP - $4 million
(GNP = GDP + NFP)

2) Net Domestic Demand (NDD) = GDP minus net exports minus

Investment in inventories.
Note: Investment in inventories has sometimes been referred to as changes in inventories
3) Net Domestic Income (NDY) or (Net Domestic Product) at market

prices is =
GDP – (Depreciation + Statistical Discrepancy)
4) Net Domestic Income (NDY) at basic prices is =
GDP – (Depreciation + Stat Discrepancy) – Indirect Taxes (less

subsidies)
(NDY at basic prices is sometimes referred to as National Income

at factor prices or factor costs)
5) Personal Income (PY) =
Consumption + Personal Savings + Personal Taxes
6) Personal Disposable Income (PDY) =
Consumption + Personal Savings

National Savings
Remember from Econ 203 that national savings is the sum of private (household)
saving and public. (government saving)
Personal (Private) Disposable Income is how much money people have left to
spend after they pay taxes.
Therefore PY = C + Personal Savings (S) + Taxes
and PDY = C + Spvt
From the Income side
Total Personal Income to household
PY = Y + NFP + TR + Int
Where Y = income
NFP = net factor payments from abroad
TR = Transfers (EI, Pension income, welfare etc.)
Int = interest payments
PDY = Y + NFP + TR + Int – Taxes
By substitution
C + Spvt = Y + NFP + TR + Int – Taxes
Personal (private) Savings (Spvt)
Spvt = Y + NFP + TR + Int – Taxes - C

Public or Government Savings
Recall that T is the income for the government and G is the spending
Government savings = Net government income – government purchases (G)
Net government income = T – TR – Int
Therefore, government (public) savings:
Sgovt = T – TR – Int – G
National Savings = Spvt + Sgovt
So: Y + NFP + TR + Int – Taxes – C + = Taxes – TR – Int – G
Cancelling taxes, TR, Int
We get:
Y + NFP – C – G
*Therefore national savings is Y (GDP) + net factor payments minus

consumption minus government spending.*

Uses of Private Savings
How is private savings put to use? Here we show that private savings is used to
fund new capital investment, provide funds to governments and acquire assets
from foreigners.
Recall that:
Y = C + I + G + X – M (1)
And
National savings is equal:
S = Y + NPF – C – G (2)
Substituting equation (1) into equation (2)
S = C + I + G + X – M + NPF – C – G
S = I + NPF + X – M
Where X – M = NX
S = I + (NX + NFP)
If you recall from economics 203, NX + NPF is called the current account balance
CA
NX + NFP = CA
Therefore,
S = I + CA

Recall
S = I + CA
S = Spvt + Sgovt
Therefore,
Spvt + Sgovt = I + CA
Private Savings:
Spvt = I + (- Sgovt) + CA equation 2.11
Where – Sgovt is the government balance deficit

Equation 2.11 is called the uses of savings identity.
1. Investment: Firms borrow from private savers to finance the construction

and purchase of new capital, new residential construction and inventory
investments.
2. The government budget deficit (-Sgovt)

If the government runs a deficit, this term turns positive, which means that
the government must borrow from private savers to cover the difference
between spending (G) and revenue. (T)
If (-Sgovt) is positive, this term is negative, which men’s that the

government is providing savings to the economy.
3. The current account balance (CA)

When the current account is positive, foreigner payments are insufficient
from Canada are insufficient to cover the payments they make to Canada.
To make up the difference, foreigners must be borrowing from Canadians or
sell to Canadian foreign assets.

Real GDP, Price Indexes and Inflation

Real GDP measures how production is changing over time.
Real GDP = (Nom GDP/CPI) x 100
Price Index: CPI – the CPI measures the change in expenditure of a basket that a
typical Canadian family would purchase.
Inflation: Is a rise in the general price level, as measured by the CPI or the GDP
deflator.

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Chapter 2. Overheads. 303. F2016

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Chapter 2: Measure and Structure of Canadian Economy

Economics 303: OVERHEADS - D. McClintock

2.2 Gross Domestic Product

2.3 Saving and Wealth

2.4 Real GDP, Price Indexes and Inflation

Intellectual property of Douglas McClintock and authors cited above Page 1

2.1 National Income Accounting

National income accounts are an accounting framework used in measuring current

1) Value added or Product Approach

Intellectual property of Douglas McClintock and authors cited above Page 2

Expenditure Approach to Measuring GDP

Intellectual property of Douglas McClintock and authors cited above Page 3

Gross Private Domestic Investment or

Investment Spending by firms on new factories, office

Spending on gross private domestic investment, or simply

2. Residential structures are spending by households

Intellectual property of Douglas McClintock and authors cited above Page 4

Government Consumption and Gross Investment,

Again, government spending, when referring to GDP,

Transfer payments include employment insurance,

Net exports: Exports minus imports.

We add exports to expenditures to include all spending on

Intellectual property of Douglas McClintock and authors cited above Page 5

A simple equation sums up the components of GDP:

The equation tells us that GDP (denoted as Y) equals

Table 4.2 (2012)

Intellectual property of Douglas McClintock and authors cited above Page 6

The table in Figure 4.2 provides a more detailed

• Consumer spending on services is greater than the

• Business fixed investment is the largest component

• Purchases made by government accounts for just

• The majority of government spending is classified

• In 2012, imports were larger than exports, so net

Intellectual property of Douglas McClintock and authors cited above Page 7

Do we spend too much?

Intellectual property of Douglas McClintock and authors cited above Page 8

Examples for year 2011 (see page 25)

GDP Expenditure Approach (Year 2011)

GDP Income Approach (Year 2011) (Truncated version)

* includes government enterprise profit.

Intellectual property of Douglas McClintock and authors cited above Page 9

Income Approach to Measuring GDP

2) Interest and Miscellaneous Income

3) Net farm income

Intellectual property of Douglas McClintock and authors cited above Page 10

i) Unincorporated Business Income (UBY) – this includes

Note: Gross corporate profits (earnings) are the sum of

Intellectual property of Douglas McClintock and authors cited above Page 11

5) Indirect Taxes and Less Subsidies

6) Depreciation (Capital Consumption Allowance)

Intellectual property of Douglas McClintock and authors cited above Page 12

Depreciation Exports minus

Consumption Consumption Consumption

GDP NDY PY PDY FDD GDP

Intellectual property of Douglas McClintock and authors cited above Page 13

New Changes to National Accounts (2016)

Gross Domestic Product (2014)

Statistical -388 Statistical

GDP $1,973,043 $1,973,043 GDP

Source: Cansim Table 380-0063 and

Intellectual property of Douglas McClintock and authors cited above Page 14

Calculating GDP from Income side: Example 1 - Table 2.1

Category Current Values

Wages, Salaries and Supplementary Income $100