Measures of Economic Activity PART II

Measures of Economic Activity PART II

Microeconomics: - the branch of economics that studies the economy of consumers or households or individual firms VS. Macroeconomics: - The Study of the economy as a whole in contrast to microeconomics, which studies its parts.

GDP: The total value of all final goods and services produced by and economy in a given year. - The most commonly used measure of a country s output. - GDP can be calculated in two different ways : * Expenditure approach - Add up the total that is spent on all goods and services in one year. * Income approach Add up all income that is earned by the different factors of production (wages, rent, interest, profit) - The GDP in each case should be the same.

GDP Income Approach How are revenues received for products and services used? 1. Pay for the labour used (wages + income of self employed proprietors) 2. Pay for the use of fixed resources, such as land and building (rent) 3. Pay a return to capital employed (interest) 4. Remaining revenues go to...replenishing capital assets (depreciation)

GDP Income Approach What are some income components of GDP? Wages and Salaries Corporate Profits Interest Income Proprietor s Income Indirect Taxes Depreciation Stat Discrepancy

Wages and Salaries Represent the largest income category Includes pmts to workers, employee benefits and contribution to employee pension funds Anything that is considered a taxable income and taxable benefit Corporate Profits Dividends Corporate income tax Re-investing into the business (profits back into the business) Retained earnings

Interest Income Interests paid on business loans and bonds Royalty Payments DOES NOT include interest payments made by consumers and governments (ie: personal line of credit/ late CC bill) Proprietors Income and Rents Earnings of sole proprietorships and partnerships Income from self-employed professionals and farmers Rental income

Indirect Taxes PST charged on products Depreciation PPE Assets losing value -> can be written off A cost of doing business Statistical Discrepancy GDP figures are ESTIMATES.. Why? Business/individual records might not be accurate

To calculate the GDP using this approach, the final value of goods and services produced in Canada is tabulated by Statistics Canada through gathering expenditure information on a nationwide basis. The formula below is used to arrive at the GDP: GDP = C + G + I + (X M)

GDP = C + G + I + (X M) C = Consumption: - What households spent on goods and services. - total spent on durable goods, semi-durable goods, nondurable goods and services G = Government Purchases': - contains value of expenditures on all goods and services by all levels of Government. - Includes spending on wages to employees, office supplies, and public capital goods (schools hospitals)

I = Investment: - A business s purchase of capital goods, construction of new buildings, or changes to inventories, with a view to increasing production and profit. -Not purchase of stocks/bonds but purchase of CAPITAL GOOD that are used to produce goods and services (X M) = the value of net exports in Canada M = imports: - Purchases of all items, some of which are produced outside of Canada X = Exports: - Production that originated in Canada but is purchased by Individuals, businesses and governments in other countries.

GDP - Expenditure Approach The expenditure approach is the sum of purchases in product markets is based on value added (net product) at each production stage to avoid double counting excludes financial exchanges and second-hand purchases

Why does Value Added concept matter? Stages of a Product Raw Materials Intermediate Phase (WIP) Final Product The value in all of the above stages are included in the GDP, but if we include the book value of all products in all phases, we run the risk of double-counting We must use the concept of value added in order to avoid double-counting Some products will be sold many times in product markets first as intermediate products and then as final products. If the values of ALL products final and intermediate were included in GDP calculations, we would be double counting

How exactly does Canada deal with this? Stat Canada subtracts the value of ALL purchases of intermediate goods by business from the value for which intermediate and final products are sold

Value Added in Making Paper Production Stage Total Value Paid/Received Value Added Business That Adds Value 1. Wood is cut and transported to paper mill $1.00 $1.00 logging company 2. Paper is processed and sold to retailer 2.75 1.75 (2.75 1.00) paper company 3. Paper is sold by retailer to consumer 4.00 1.25 (4.00 2.75) retailer $7.75 $4.00

Exclusions for Expenditure-based GDP What are some things that are not related to current production? 1. Financial Exchanges Gift of money between family members is no a transaction because the transaction just shifts purchasing power from one party to another Depositing and purchase of stocks are not included Payments for a financial service (bank charges/commission to a stockbroker) DO count TOWARDS GDP 2. Second-Hand Purchases Products have already been counted at their first sale to a consumer

GDP and Living Standards How do we compare Canadian Economic performance compare to other countries? GDP per capita Canada s GDP in 1999 was 957 911 million and its population was30,493 million, what was Canada s per Capita GDP? GDP / Population = 957 911 million / 30, 493 million = $31,414 per person

Adjustments to Per Capita GDP otwo adjustment types 1. Inflation adjustment Prices changes over the years Real GDP: GDP expressed in constant dollars from a given year 2. Exchange-rate adjustment Adjusting to the STANDARD monetary currency ($USD)

Remember GDP is a measure of the total money value of all final goods and services produed in an economy over a given period GDP indicates economic activity

Limitations of GDP 1. Exclude Activities 2. Product Quality 3. Composition of Output 4. Income Distribution 5. Leisure 6. The environment

1. Excluded Activities onon market activities o Household o Unpaid child care o DIY ounderground economy o Market trxns that are unreported o smuggling o Illegal activity o under the table trxns

2. Product Quality Items whose quality have increased significantly with little or no rise in price GDP can only add up the selling prices, but cannot capture these quality improvements

3. Composition of Output The allocation of GDP While GDP s may be the same for certain countries, how another country dedicates the same GDP to different categories can affect the countries living standards

4. Income Distribution GDP does not reflect how output is distributed among a country s citizens North Korea vs Canada

5. Leisure We love leisure and we consider that a requirement in order to enjoy life; it is a standard Leisure is not bought and sold in the market therefore it cannot be accounted for by GDP Even though the average Canadian work week has gradually become shorter (half of what it was a century ago), GDP has no way of representing this change GDP understates economic well-being

6. The Environment Since GDP quantifies economic activity in terms of its money value, it does not represent the environment GDP does not differentiate between economic activities that are harmful to the environment It does not show /represent spillover costs and benefits While clean-up of an oil spill would be added to GDP, the creation of a new nature preserve would likely not be added

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Gross National Product (GNP) next class GNP is the total income acquired by Canadians both within Canada and elsewhere GNP focuses on the earnings of Canadians Gross Domestic Product measures the value of final goods and services produced within a country s borders, while Gross National Product measures the value of final goods and services produced by a country s residents, regardless of where in the world that production takes place. How do we calculate GNP? GDP + net income inflow from abroad (Trade Balance, Interest of external loans, Private Remittance) - net income outflow to foreign countries = GNP

GNP continued GNP not only captures the value of the economy within a country s borders, but adjusts the value of a country s citizens GNP differs from GDP by the net balance on factor incomes: adding the income received by domestic residents for their contribution to production that takes place in other countries, while subtracting the income paid to foreign residents for their contribution to production that takes place within home country GNP measures what we as a nation make, but overseas as well If GNP> GDP Corporations are producing more elsewhere than they are here IE: US is $250 billion greater than its GDP If GDP> GNP IE: China s GDP is $300 billion due to the large number of foreign companies manufacturing in the country Country is producing more within the country than the world

Extra Information on GNP Now, what is Gross national product(gnp)? GNP is the GDP of a country added with its 'income from abroad'. Here, trans boundary economic activities of an economy is also taken into account. The items which are counted in segment 'Income from Abroad are- 1. Trade balance: the net outcome of the year end of total exports and imports of a country may be positive or negative accordingly added with GDP( in India's case it has always been negative except the three consecutive years 2000-03 when it was positive, due to high levels of 'service sector export during the years.2. Interest of external loans: the net outcome on front of interest payments, i.e., balance of the inflow ( on the money lend out by the economy ) and the outflow (on the money borrowed by the economy) of the external interest. Again, in India's case it has always been negative as economy has been a 'net borrower' from world economies. 3. Private Remittances: the net outcome of money which inflows and outflows on account of 'private transfers' by Indian nationals working outside India ( to India) and the foreign nationals working in India ( to their home countries).on this front India has always been a gainer basically from USA and other European nations. Ultimately, balance of all the three components of ' Income from Abroad ' segment may turn out to be positive or negative.

Net Domestic Income NDI: income earned by households supplying resources in Canada NDI = GDP amounts that are not earning from current production NDI = GDP (indirect taxes + dep n, stat discrepanc)

Personal Income Personal Income income actually received by households Transfer payments (+) They are excluded from NDI but still part of a household s personal income Other Payments to Persons (+) Gov t to households; still part of personal income even though it is not part of NDI Earnings not paid out to persons (-) Net Investment Income to the Rest of the World (-)

Disposable Income Disposable income household income minus personal taxes and other personal transfers to gov t DI = Income personal taxes personal transfers to gov t