Primary Deck

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 1

 NOMINAL GDP AND REAL GDP

GDP concepts measure the value of all final products

and services produced annually in a country; nominal
GDP combines changes in prices and quantities, real
GDP measure only changes in quantities, and real
GDP per person is the best measure of material
standard of living.
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 2
 NOMINAL GDP AND REAL GDP

• Nominal GDP
value at current prices of all final products and
services produced annually in a country

– Nominal PA1935 QA1935 + PB1935 QB 1935

GDP1935 =
+ PC1935 QC 1935 +… PZ1935 QZ 1935

PA2013 QA 2013 + PB2013 QB 2013

– Nominal =
GDP2013 + PC2013 QC 2013 +… PZ2013 QZ 2013

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 3

 • Differences in nominal GDP between years due to
price changes or quantity changes
• GDP includes products and services produced within
a country’s borders, no matter what the nationality of
the business doing the producing
• GDP is a flow
amount per unit of time
• Stock
fixed amount at a moment in time

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 4

 • Real GDP
value at constant prices of all final products and
services produced annually in a country.

– Real = PA QA
1935 + P 2002 Q 1935
B B
2002
GDP1935
+ PC2002 QC 1935 +… PZ2002 QZ 1935

= P A
Q A
+ P B
Q B
– Real 2002 2013 2002 2013

GDP2013 + PC2002 QC 2013 +… PZ2002 QZ 2013

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 5

 • Real GDP uses constant prices for one year to
value quantities produced in different years
• Differences in real GDP between years show only
changes in quantities
• Real GDP per person
real GDP divided by population
– Real GDP per person is the best measure of
material standard of living

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 6

 Nominal GDP, Real GDP, and Real GDP per
Fig. 6.1
Person, 1926–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 7

Fig. 6.2 Nominal and Real GDP, 2002–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 8

 VALUE ADDED AND
THE ENLARGED CIRCULAR FLOW

Value added solves the problems of double counting

and distinguishing final and intermediate products and
services, and shows how aggregate spending equals
aggregate income in circular flow diagrams.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 9

 VALUE ADDED AND THE ENLARGED
CIRCULAR FLOW
• Value added
value of output minus the value of intermediate
products and services bought from other businesses
• Value added solves the problems of double counting
and of distinguishing between final and intermediate
products and services
– Value of final products and services =
value added
– Value of final products and services (GDP) =
input’s income

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 10

 Value Added Equals Value
Fig. 6.3 of Final Products and Services

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 11

 • Value of final products and services =
value added
• Value of final products and services (GDP) =
input’s income

• GDP can be calculated using either half of the

circular flow
– Aggregate spending (GDP) =
aggregate income (Y)
– Spending on final products and services =
payments to input owners

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 12

 Simple GDP Circular Flow of
Fig. 6.5
Income and Spending

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 13

 • Flows of spending on the enlarged circular flow
– C — consumption spending by consumers
– I — business investment spending on factories
and machines made by businesses
– G — government spending on products and
services
– X — spending by the rest of the world (R.O.W.)
on Canadian exports of products and services.
– IM — Canadian spending on imports of products
and services produced by the rest of the world

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 14

 Enlarged GDP Circular Flow of
Fig. 6.6
Income and Spending

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 15

 Enlarged GDP Circular Flow of Income
Fig. 6.7
and Spending with Banking System

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 16

 • Consumer choices
– Spend or save
– Disposable income
aggregate income minus net taxes
– Net taxes
taxes minus transfer payments
• Business choices
– Hiring inputs and producing
products and services
– Investment spending
(often financed by borrowing)

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 17

 • Government choices
– Collect taxes, make transfer payments
– Spending on products and services
– Policy choices in Chapter 12
• R.O.W. choices
– Buy Canadian exports or products and
services from elsewhere
– Sell imports to Canada or elsewhere
– Invest and borrow money in Canada or
elsewhere
• Bank choices
– Take deposits and make loans

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 18

 POTENTIAL GDP AND ECONOMIC GROWTH

By increasing the quantity and quality of inputs,

economic growth increases productivity and potential
GDP per person, raising maximum possible living
standards.
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 19
 POTENTIAL GDP AND ECONOMIC GROWTH

• Potential GDP
real GDP when all inputs fully employed —
labour, capital, land/resources, entrepreneurship
– Short-run goal for economic performance
– Outcome if invisible hand works perfectly
• Potential GDP per person
potential GDP divided by the population
– Short-run maximum possible living standards
for an economy

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 20

 Potential GDP per Person and Real GDP per
Fig. 6.8
Person, 1926–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 21

 Potential GDP per Person and Real GDP per
Fig. 6.9
Person, 1980–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 22

 • Economic growth
expansion of economy’s capacity to produce
products and services; increase in potential GDP
(per person)
• Macro production possibilities frontier (PPF)
shows maximum combinations of products and
services a country can produce when all inputs
fully employed
– On macro PPF, all inputs fully employed;
economy producing at potential GDP
– Inside macro PPF, some inputs unemployed;
economy producing below potential GDP
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 23
Fig. 6.10a Macro Production Possibilities Frontier

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 24

 • Economic growth increases potential GDP
(per person)
– Shifts macro PPF outward
– Caused by increases in the quantity or quality of
a country’s inputs, including technological
change

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 25

Fig. 6.10b Economic Growth

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 26

 • Increases in labour
– Quantity — population growth, immigration,
labour force participation rate
– Quality — increases in human capital —
increased earning potential from work
experience, on-the-job training, education
• Increases in capital
– Quantity — more factories and equipment
– Quality — technological change —
improvements in quality of capital through
innovation, research, development

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 27

 Labour Force Participation Rates or Men and
Fig. 6.11
Women, 1951–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 28

 • Increases in land and resources
– Quantity — bringing land and resources not
connected to markets into the circular flow
– Quality — due to increases in capital used with
land
• Increases in entrepreneurship
– Quantity and quality interrelated
– Better management techniques, organization,
worker/management relations

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 29

 • Economic growth rate
annual percentage change in real GDP per person

• Canada’s average annual economic growth rate, 1926-

2008, was 2.1%

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 30

 Annual Growth Rates of Canadian Real GDP
Fig. 6.12
per Person, 1926–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 31

 Growth in Real GDP per Person, Industrialized
Fig. 6.13
Countries, 1870–2017

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 32

 • Rule of 70
number of years it takes for initial amount to double
is roughly 70 divided by annual percentage growth
rate
– Because of compounding, small differences in
annual growth rates have large consequences over
time

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 33

 • Productivity
quantity of real GDP produced by an hour of
labour
– Increases in productivity increase living
standards
– More can be produced
– Reduced amount of work time required to buy
products and services
• Creative destruction
competitive business innovations generate profits
for winners, improving living standards for all, but
destroy less productive or less desirable products
and production methods
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 34
 BUSINESS CYCLES

Business cycles — fluctuations of

real GDP around potential GDP —
are periods of real GDP expansion
and contraction. Output gaps
measure the difference between real
GDP and potential GDP, and “closing
the gap” is an important target for
policymakers.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 35

 BUSINESS CYCLES

• Language of business cycles

up and down fluctuations of real GDP around
potential GDP
– Expansion
period during which real GDP increases
– Peak — highest point of an expansion
– Contraction
period during which real GDP decreases
– Trough
lowest point of a contraction
– Recession
2+ successive quarters contraction of real GDP
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 36
 Most Recent Complete Canadian
Fig. 6.15
Business Cycle

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 37

 • Output gap
real GDP minus potential GDP
– Recessionary gap
real GDP below potential GDP;
gap is a negative number
– Inflationary gap
real GDP above potential GDP;
gap is a positive number

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 38

 WHAT’S WRONG WITH GDP AS A
MEASURE OF WELL-BEING

Real GDP per person is a limited measure of well-

being because it excludes non-market production,
underground economy, environmental damage, leisure,
and political freedoms and social justice.
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 39
 WHAT’S WRONG WITH GDP AS A
MEASURE OF WELL-BEING
• Real GDP per person is a limited measure of well-
being; does not include
– Non-market production — household production
is not counted but improves the quality of life
– Underground economy — hides activities that are
illegal, or legal but avoiding taxes (cash payments
for services, unreported tips)
– Environmental damage — does not subtract costs
of environmental damage and resource depletion

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 40

 – Leisure — lowers real GDP, but may be desirable
– Political freedoms and social justice —
countries with high real GDP per person can have
limited political freedoms, unequal distributions
of income
• Growth rates of real GDP per person useful for
judging economic progress if no major changes in
the limitations
• United Nations Human Development Index (HDI)
measures quality of life by combining life
expectancy, educational achievement, and income

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 41

 Secondary Deck
Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 42
 Alternate Graph Slides

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 43

Fig. 6.4 Simple Circular Flow without Government

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 44

 A Macro Production Possibilities Frontier
Fig. 6.10
and Economic Growth

a) Macro Production
b) Economic Growth
Possibilities Frontier

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 45

Fig. 6.14 Rule of 70

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 46

 Refresh Questions

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 47

 Refresh 6.1
1. What is the definition of nominal GDP? What one
word is different in the definition of real GDP How
does that word change affect the accuracy of the
measurement?
2. In Figure 6.1, explain why the graphs of nominal
GDP and real GDP intersect at the year 2002.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 48

 Refresh 6.1
3. In your own words, explain why real GDP per
person is a more accurate measure of standard of
living than nominal GDP. List two factors that
could increase real GDP per person and explain
why.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 49

 Refresh 6.2
1. Explain value added and how it solves the double-
counting problem in calculating GDP.
2. Make a list of the imported products or services
you bought last month. Of all of the money you
spend in a year, what percentage of it do you think
you spend on imported products or services?

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 50

 Refresh 6.2
3. Explain to a friend who is not taking an
economics course why understanding GDP and
how to measure it is important in her life.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 51

 Refresh 6.3
1. In your own words, define potential GDP per
person.
2. In your own words, explain how economic growth
occurs and how it is measured.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 52

 Refresh 6.3
3. A country can increase labour force participation,
which increases potential GDP, by allowing child
labour and reducing vacation time. Do you think
such choices should be allowed? Explain why or
why not. What questions do such choices raise
about the quest for profits and improved standards
of living?

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 53

 Refresh 6.4
1. Describe the sequence of a typical business cycle,
beginning with an expansion and ending with an
expansion.
2. In the first quarter of 2009, real GDP was $1292
billion and potential GDP was $1331 billion. What
kind of gap existed and what was its size?

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 54

 Refresh 6.4
3. Go to www.statcan.gc.ca to find the quarterly data
for real GDP starting with 2012. Do the data show a
contraction or a recession since 2012? If so, identify
the quarters involved.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 55

 Refresh 6.5
1. In your own words, explain what the underground
economy is. Why is it not included in GDP?
2. More and more people are eating their meals in
restaurants instead of cooking at home. Explain
how this social trend affects real GDP. How might
it affect their quality of life?

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 56

 Refresh 6.5
3. Of the five factors not included in real GDP as a
measure of well-being, which makes the most
difference to your personal quality of life? Explain
why.

Copyright © 2021 Pearson Canada Inc. Chapter 6 Slide 57