The Measurement of National Income: Slide 20-1

Chapter 20
The Measurement of
National Income
Slide 20-1
Copyright © 2002 Pearson Education Canada Inc.
Learning Objectives
• Recognize the problem of “double counting” and how the
concept of value added solves this problem when
measuring national income.
• Understand that the circle flow of income implies three ways
of computing national income -- total value added, total
expenditure, and total income.
• Explain the basic methods of measuring national income,
using either the income approach or the expenditure
approach.
• Understand the difference between real and nominal GDP,
and why GDP per worker is a better measure of living
standards than just GDP itself.
• Recognize that many things affecting our well-being are
omitted from official measures of GDP.
Slide 20-2
National Output and Value Added
Production occurs in stages. Many firms produce outputs that

are used as inputs by other firms.
Intermediate products are outputs of some firms that are used

as inputs by other firms.
Final products are outputs that are not used as inputs by

any other firms.
Each firm’s contribution to total output is its value added,

which is the gross value of the firm’s output minus the value of
all intermediate goods and services that it uses.
Slide 20-3
Copyright © Pearson Education Canada Inc.
The total value added produced in the economy is called
Gross Domestic Product (GDP). GDP is a measure of all final
output that is produced in the economy.
Adding up value added avoids the statistical problem of

double counting. If we simply
APPLYING added up each
ECONOMIC firm’s gross20-1
CONCEPTS
output we would vastly overestimate GDP.
Value Added Through Stages of
Production
The term final demand refers to the purchase of final goods
for consumption, for investment (including inventory
accumulation), for use by governments, and for export.
Slide 20-4
National Income Accounting: The Basics
There are three different ways of measuring national income.
• adding up the total value added from domestic production

• adding up the total flow of expenditure on domestic
output Practice with Study Guide Chapter 20,
Exercise
• adding up 3. of income generated by domestic
the total flow
production.
Because of the circular flow of income, these three measures

yield the same total, which is called Gross Domestic Product
(GDP).
Slide 20-5
GDP from the Expenditure Side
Consider adding up the expenditures needed to purchase the
final output produced in any given year. There are four broad
expenditure categories:
Actual consumption expenditure, denoted as Ca, includes

expenditure on all final goods during the year.
Actual investment expenditure, denoted as Ia, is expenditure

on the production of goods not for present consumption,
including:
inventory accumulation;
new plant and equipment; and
new residential construction.
Slide 20-6
Actual government purchases of goods and services, denoted
as Ga, are purchases of currently produced goods and
services by government and, therefore, does not include
transfer payments.
Actual net exports, denoted as NXa, is the difference between

exports and imports. NXa = (Xa - IMa)
Exports are purchases of Canadian-produced goods and

services by foreigners. They are part of the total expenditure
on Canadian output.
Imports are the purchases of foreign-produced goods by

Canadians. This does not represent spending on Canadian
output and so it is subtracted from total expenditure.
Slide 20-7
From the circular flow of income, we know that total output
equals total expenditure. Calculated from the expenditure
side, GDP is therefore given by:
GDP = Ca + Ia + Ga + (Xa - IMa)
What were aggregate expenditures in 1998?
Category $billion % of GDP

Consumption $536.1 59.7
Government purchases 191.8 21.4
Investment 155.8 17.4
Net exports 12.8 1.4
Statistical discrepancy 0.8 0.1
Total 897.3 100.0
Slide 20-8
GDP from the Income Side
When calculated from the income side, GDP is the sum of
factor incomes and other claims on the value of output. Factor
incomes include wages, rent, interest, and profits. These
factor incomes are combined to be net domestic income.
For the most recent data on
Canadian
Other claims on the value national
of output include:income, see
Statistics Canada’s
- indirect taxes (net of subsidies)
website:
www.statcan.ca.
- depreciation of existing physical capital
GDP from the income side is therefore equal to:

GDP = Net domestic income +
indirect taxes + depreciation
Slide 20-9
Category $billion % of GDP
Wages, salaries and extra income 471.3 52.5
Interest and miscellaneous
45.8 5.1
investment income
Business profits (including net
income of farmers and 144.6 16.1
unincorporated businesses)
Net Domestic Income at factor cost 661.7 73.7
Capital consumption allowance 116.2 12.9
Indirect taxes less subsidies 120.2 13.5
Statistical discrepancy -0.8 -0.1
Total 897.3
$897.3 100.0
100.0
Slide 20-10
National Income Accounting: Some
Extra Issues
GDP and GNP

A measure of EXTENSIONS
national output closely related to 20-1
IN THEORY GDP is Gross
National Product (GNP). The difference between GDP and
Arbitrary
GNP is the difference Decisions
between incomein produced
National and income
received. Income Accounting
GDP measures the total output produced in Canada and the
total income generated as a result of that production.
GNP measures the total amount of income received by

Canadian residents, no matter where the income was
generated.
Slide 20-11
GDP is superior to GNP as a measure of domestic economic
activity.
GNP is superior to GDP as a measure of the economic well-

being of domestic residents.
Disposable Personal Income (DPI) is GNP minus:

- any part of it that is not actually paid to households
- personal income taxes paid by households
- plus transfer payments received by households.
Slide 20-12
RealDoand
theNominal
CPI and the
GDP GDP Deflator Move Together?
Broadly,
Total GDPthe two
that is price
valuedindexes move
at current together,
prices due to
is a nominal
underlying inflationary forces. But because one tracks
measure, often called nominal national income.
consumer prices and the other tracks the prices of goods
produced
GDP that isinvalued
Canada, there will base-period
at constant be some differences.
prices is aFor
real
example, suppose the world price of coffee rises. This will
measure,
push up thereferred to asCPI.
Canadian real But
national
sinceincome.
Canada produces no
coffee, there will be a negligible effect on the Canadian
implicit GDP deflator. GDP at current prices x 100
Implicit GDP Deflator =
GDP at base-year prices
APPLYING ECONOMIC CONCEPTS 20-2
The implicit GDP deflator is the most comprehensive available
index of theCalculating Nominal
price level because and Real
it includes theGDP
prices of all
goods and services produced in the country.
Slide 20-13
Output and Productivity
The rise in real GDP over the past century has had two main
causes:
1. The increase in the amount of land, labour, and capital
used in production; and
2. An increase in the with
Practice amount of output
Study produced
Guide per unit
Chapter 20,of
input. Extension Exercise 1.
Per capita output is the amount of output per person -- it is
computed by dividing GDP by total population. It measures
the average output (and income) per person.
For studying changes in average living standards, per capita

output is a better measure than total GDP.
Slide 20-14
A better way of assessing average living standards is to
consider measures of productivity. For example, GDP divided
See chapter
by the number of employed persons20 of us the average
tells
output per employedpearsoned.ca/lipsey
person. This is one measure
for a of labour
productivity. discussion of “Computers and
Productivity
GDP divided by the total number ofinhours
the Information
worked measures
Economy”.
output per hour of labour input and provides a second
measure of labour productivity.
Changes in overall living standards are better reflected by

changes in productivity than by changes in GDP per capita.
GDP and related measures of national income must be

interpreted with their limitations in mind. What are these
limitations?
Slide 20-15
Omissions from GDP
National income and expenditure accounts cannot measure
economic activity that takes place outside of regular and legal
markets. Some of these activities are:
See chapter 20 of
• illegal activities pearsoned.ca/lipsey
(drugs, prostitution, etc.)for a
• the undergrounddiscussion of “If Canada
economy (tax-avoided is Number
transactions)
• home production One, Why Would Anyone Leave?”
(housework, do-it-yourself projects)
• economic “bads” (pollution)
Hence, GDP does not measure everything that contributes to

(or detracts from) human welfare.
Slide 20-16
This is an important point – GDP is not a complete measure
of economic well-being. However, income is a very
important part of well-being and GDP is a very good
measure of income.
Unless the unmeasured economic activity changes rapidly,

changes in GDP will do a quite satisfactory job of measuring
changes in economic well-being.
LESSONS FROM HISTORY 20-1

GDP and Economic Growth
Slide 20-17
Slide 20-18

The Measurement of National Income: Slide 20-1

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Chapter 20

Production occurs in stages. Many firms produce outputs that

Intermediate products are outputs of some firms that are used

Final products are outputs that are not used as inputs by

Each firm’s contribution to total output is its value added,

Adding up value added avoids the statistical problem of

• adding up the total value added from domestic production

Because of the circular flow of income, these three measures

Actual consumption expenditure, denoted as Ca, includes

Actual investment expenditure, denoted as Ia, is expenditure

Actual net exports, denoted as NXa, is the difference between

Exports are purchases of Canadian-produced goods and

Imports are the purchases of foreign-produced goods by

What were aggregate expenditures in 1998?

Category $billion % of GDP

GDP from the income side is therefore equal to:

GDP and GNP

GNP measures the total amount of income received by

GNP is superior to GDP as a measure of the economic well-

Disposable Personal Income (DPI) is GNP minus:

For studying changes in average living standards, per capita

Changes in overall living standards are better reflected by

GDP and related measures of national income must be

Hence, GDP does not measure everything that contributes to

Unless the unmeasured economic activity changes rapidly,

LESSONS FROM HISTORY 20-1

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