Measures of Economic Activity

Measures of Economic

ActivityBy: May Leung, Kenif Tse, Kent Yip, Alvan Au & Carol

Lam

What is Gross Domestic Product?

Total dollar value at current prices of all

final goods and services produced in Canada over given period (typically 1

year)

The Importance of GDP• national income

accounts: accounts showing levels of total income and expenditures in Canadian economy– Allow us to evaluate

performance of economy

What is Gross Domestic Product?

• Total dollar value at current prices of all final goods and services produced in Canada over given period (typically 1 year)

What is Gross Domestic Product?

• Total dollar value at current prices of all final goods and services produced in Canada over given period (typically 1 year)

• Calculated with two approaches:– Income approach: sum of all

incomes in economy– Expenditure approach: sum

of all spending in economy

Calculation of GDP

The GDP Identity

• GDP expressed as total income ≡ GDP expressed as total expenditures

• Expressions on either side are identical

The Income Approach• GDP expressed as total

Canadian income = sum of 4 income categories and 3 balancing categories

• Income: Wages, Profit, Interest, Rent

• Balances: Indirect Taxes, Depreciation, Statistical Discrepancy

Wages (Income)• Wages and salaries represent

close to 60% of GDP; includes direct payments to workers in both business and gov’t, as well as employee benefits such as pension funds

Profit (Income)• All corporate profits

declared to the gov’t, including profits paid as corporate income tax, profits paid out to shareholders as dividends, and profits put back into business (retained earnings)

Interest (Income)

• Income made from interest paid on business loans, bonds, royalties, etc.

Rent (Income)• Proprietor’s incomes

include earnings of sole proprietorships and partnerships; received by owners for supplying various types of resources to their businesses

Indirect Taxes (Balance)

• Charged on products rather than levied against households or businesses, included in expenditure approach; therefore must be added to income approach

Depreciation (Balance)

• Shows up in expenditure approach, and must therefore be added to income approach

Statistical Discrepancy (Balance)

• To balance income and expenditure figures, half of the difference is added to the lower amount and half of the difference is subtracted from the higher amount

The Expenditure Approach

GDP found using the expenditure approach is the sum of purchases in product

markets

Categories of Products• Final Products: products

that will not be processed further and will not be resold

• Intermediate Products: products that will be processed further or will be resold

Double Counting

• If values of final and intermediate products are added double counting occurs.

• To avoid double counting, the concept of value added is applied (the extra worth of a product at each stage in its production) Refer to figure 10.4

Categories of Purchases

• These purchases are NOT included in the calculation of GDP:

• There are two types: financial exchanges and second-hand purchases. They are excluded because they are not related to current production.

Financial Exchanges

• A simple transaction that shifts purchasing glower from one party to another. Ex.) Gifts of money from family, bank deposits, purchases of stocks

• Note: payments for financial services such as bank service charge etc are included in GDP

Second-Hand Purchase

• Second-hand or used goods are excluded to avoid overstatement, because they were already counted at first sale

Categories of Products

• Purchases which are INCLUDED in the calculation of GDP:

• Expenditure Equation: GDP= C + I + G+ (X-M)

(C) Personal Consumption

• Household spending on goods and services.

• Non-durable goods (use up) and Durable goods (repeated use)

• Make up largest component (about 60%) of GDP

(I) Gross Investment

• Purchases of assets that are intended to produce revenue

• Usually between 15-25 % of GDP

• Includes inventory (intended to be sold)

• Construction of buildings (including houses etc) are included because they could be rented

(I) Gross Investment ctn’d

• Capital stock (total value of productive assets that provide a flow of revenue) – Annual depreciation = Net Investment (gross investment- depreciation) See Figure 10.5 pg 289

• Source of investment could be businesses’ retained earnings or households’ personal savings (S). See Figure 10.6

(G) Government Purchases

• Include current spending by all levels of government on goods and services. Ex) Road repairs

• Typically 20% of GDPDoes NOT include expenditures by government-owned agencies on income producing assets because already counted in gross investment

(X-M) Net Exports

• Net Exports = Exports (X) – Imports (M)

• Exports INCLUDED- products purchased by foreigners were still made in Canada

• Imports EXCLUDED- money spent by Canadians on foreign products that were not made in Canada does not reflect Canadian production.

GDP and Living Standards

Per capita GDP: GDP per personPer capita GDP is frequently used as a measure to evaluate the living standards in Canada today compare with the past

living standards. It also shows how Canadian economics’ performance compares with other countries’.

Per capita GDP = GDP Population

Adjustments to Per Capita GDP

• Depending on how per capita GDP is to be used, either of two adjustments can be made to it: inflation adjustment or exchange-rate adjustments.

Inflation Adjustments

• This adjustment is done by using real GDP, which is GDP expressed in constant dollars from a given year.

• When a country’s real GDP is divided by its population, the result is per capita real GDP, which is GDP per person expressed in constant dollars from a given year.

Inflation Adjustments ctn’d

• Inflation adjustments allow comparisons to be made between per capita GDP despite changes in price.

• Per capita real GDP = Real GDP

Population

Exchange-Rate Adjustments

• To compare various countries’ per capita GDP for a given year, we must adjust for the different currencies.

• This is done by expressing all countries’ GDPs in one currency, the standard being this American dollar

Limitations of GDP

• GDP does indicate economic activity and to some extent, living standards. Like all indicators, it has quantitative and qualitative limitation.

Excluded Activities

• GDP does not include some types of productive activities. Excluding these activities means that GDP can understate economic activity and living standard

• Nonmarket activities: productive activities that take place outside the marketplace.

• Underground economy: all the productive transactions that go unreported.

Product Quality

• GDP can only add up selling prices, cannot fully capture the quality improvements

Composition of Output

• The dollar value basis of GDP is that it tells us nothing about what is produced and purchased

Income Distribution

• Citizens in two countries with the same per capita GDP may have very different living standards if one country’s income is equally distributed

Leisure & Environment

• Leisure is not bought and sold in the market, so it can’t accounted for by GDP

• GDP does not adequately represent another factor: the environment

Other Economic Measures

• Gross National Product (GNP)

• Gross Domestic Product focuses on incomes made in Canada

• Gross National Product is the total income acquired by Canadians internationally

Gross National Product

• Two adjustments to GDP in order to have GNP:

Deduct (a) income earned from Canadian investments by foreigners

Add (b) income earned from foreign investments by Canadians

Net investment income to foreigners

Net Domestic Income (NDI)

• It represents what is earned by household supplying resources

• To obtain NDI, subtract those amounts that are not earned currently

• E.g. (I) indirect taxes, (II) depreciation allowances and the (III) statistical discrepancy

Personal Income (PI)

• This is the income actually earned by the households

• Several adjustments to NDI are needed to get PI:

Add (1) Government transfer payments (2) Other payments to persons

Deduct (3) Earnings not paid out to persons (4) Net investment income to foreigners

PI

Disposable Income (DI)

• This is the income that household can actually spend

• To get DI, personal taxes and other personal transfers to government have to be subtracted

Discretionary income

This income is either being saved or spent on nonessential items

Deriving Other Income Measures

• Gross Domestic Product (GDP) 710.7

• Deduct: Indirect taxes (-)89.4

• Depreciation (-)84.5Statistical discrepancy (-)2.4

Net Domestic Income 534.4 Add: Gov’t transfer payments 112.8

Other payments to persons 72.7Deduct: Earnings not paid

out to persons (-)59.8Net investment income to

foreigners (-)24.7

Net Domestic Income (NDI)

Personal Income (PI)

Personal Income 635.4

Deduct: Personal taxes

& other personal

transfer to government (-)145.6

Disposable income (DI) 489.8

Deduct: Purchases of necessities (-)XX.X

Discretionary income XXX.

Article

Hazel Henderson

Game – Who wants to be the millionaire?

1. Discretionary income may either be saved or spent on _______ items.

A. fun

D. worthless

B. non-essential

C. stinky

2. According to a United Nations report which country is the best place to live in?

C. Japan

B. SwitzerlandA. Canada

D. Norway

3. Per Capita GDP is frequently used as a measure of ___________.

C. Weight

B. Temperature A. Living Standards

D. Shoe Size

4. Gross National product is the total income acquired by Canadians in ______.

A. Canada only B. Markham

C. Canada and elsewhere

D. Ontario

5. Products that will not be further processed is called a ____ product

C. good

B. resoldA. final

D. intermediate

6. Henderson’s metaphor for economics is _____.

A. A pie B. A sandwich

C. A cake D. Scoop of icecream

7. GDP stands for :

A. Good Delicious Peas

D. None of the above

B. Gross Domestic Product

C. Gross Deductible Percentage

8. What is Henderson’s favorite motto?

A. Think locally, act globally

D. Act Locally, Think Globally

B. Think globally, act locally

C. Act Globally, Think Locally

9. What type of income may be spent on nonessential items?

A. Disposable Income

D. Personal Income

B. Discretionary Income

C. Net Domestic Income

10. According to the “human development index” (HDI), what average life expectancy do we have?

A. 79.2

D. 80.2

B. 77.2

C. 78.2

11. Goods and services that are only consumed once are called ____.

A. durable goods B non-durable goods

C. None of these D. Perishable goods

12.Which of the following is a type of transfer payments?

A. Stock interest B. wages

D. Unemployment compensation

C. None of the above

13. What is an example of indirect tax

A. Income tax

D. All of the above

B. Provincial sales tax

C. Property tax

14. GDP can be calculated using these approaches:

A. Income and depreciation

B. Expenditure and balance

C. Income and expenditure

D. Balance and depreciation

15. Gross Investment makes up about ____ of the GDP.

A. 60% B. Less than 5%

D. 15-25%C. 80%

1. Statistics Canada is a _____ agency.

A. Provincial B. International

C. Federal D. Charity

2. GDP identity is when:

A. Income approach > depreciation approach

C. Income approach < depreciation approach

B. Income approach = depreciation approach

D. None of the above

3. If all products – final and intermediate- were included in GDP calculations we will have the problem of ________.

A. No problem at all

C. Multiple counting

B. Double counting

D. Understatement of GDP

4. Financial exchanges include:

A. Bank deposits

D. Purchase of stocks

C. All of these

B. Gifts of money

5. Per Capita GDP is also known as _______.

A. GNP per person B. GNP per country

D. GDP per personC. GDP per country

6. What does Henderson feel should be added in the economic accounting system?

B. GST and PST

D. Corporate Tax and Research Costs

A. Environmental and social costs of development

C. Income and Property Tax

7. What is the expenditure equation?

A. GDP = C + K + I + (X-M)

D. GDP= C + I + G +(M-K)

C. GDP= C + I + G+ (X-M)

B. GDP = C + K + G + (M-K)

8. Why do we need inflation adjustments?

A. To compare it with population

B. To find GDP

D. To compare economic conditions in different years

C. To compare with different countries

9. In 1978, Hazel Henderson published which book?

A. The Hobbit B. The Bible

C. Creating Alternative Futures: The End of Economics

D. People and Economics

10. Which of the following is not a limitation of GDP?

A. Excluded Activities

D. Leisure

B. Populaton

C. Product Quality

11. Who does Henderson believe should pay for pollution cleanup?

A. taxpayers B. George Bush

D. The pollutersC. government

12. What is not included in calculating GDP using income approach?

A. wages B. Corporate profitsD. Gross investments

C. depreciation

13. What is the current base year (real GDP)

B. 1987

D. 1988

A. 1986

C. 1980

14. Which income is actually received by households?

A.

D. C.

B.

15. According to Henderson, power is defined by money, the control of capital and ______.

A. Popularity of your business

B. Biceps

D. Ability to control political processes

C. Ability to control cash flow