Measure We measure our income by measuring how much we produce, how much a country produces is GDP

Welfare of
Country Gross Domestic Product = the market value of all final goods and services produced within a country in a
given period of time.

GDP is Market GDP measures value of goods produced in an economy by taking quantity produced and multiplying by
Value the price ( the value we give the good )

All goods have different measurements: ( 50 kg meat + 30 liter of milk = ??? ) ( 50 x 10 + 30 x 1 ) (530)

Of All & Final All goods and services produced in the economy are included ( services make our lives better too )
Final : Do not include intermediate goods, or these goods will be double counted

However, if an intermediate good is produced but not sold, it is included in the GDP as a final product in
the inventories category until it is sold (then it will be subtracted from inventories and therefor also
subtracted from GDP). • E.g. If $2000 worth of steel is made in 2007 but not sold, include in 2007 GDP. If
sold in 2008 to car company that sells $20000 worth of cars, decrease the $20000 by $2000 (the value of
the steel produced last year) ( GDP 2007 = 2000 ) ( GDP 2008 = 20000 - 2000 = 18000 )

Produced All goods must be produced recently, it does not include transactions involving items produced in the
past. GM produces and sells a new car, it is included in GDP, someone sell their old car, it is not included

Within a Need the value of production within the geographic confines of a country.
Country
• E.g. if a British citizen works temporarily in Canada, his production is part of Canadian GDP. When a
Canadian citizen owns a factory in Haiti, the production of her factory is not part of Canadian GDP (but it
is part of Haiti’s GDP)

In a Given It is usually reported annually or quarterly.

Period
What contributes more to GDP—the production of a kilogram of hamburger or the production of a
kilogram of caviar? Why? ( Caviar is more expensive, therefore GDP will be bigger )

National Output Production occurs in stages – most firms produce outputs that are other firm’s inputs
& Value Added EG: Intermediate product is lumber and final product is furniture

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

- To find value added, just take the revenues minus the costs for that producer.

Example Canadian Ore Inc. produces and sells $4200 of iron to a steel company. The steel company sells $7000
of steel to consumers and $3000 of steel to a car company. The car company sells $25,000 in cars.
Purchase of Factors Amount Revenue Made Value Added (RevCost)

Canadian Ore 4,200 4,200

Steel Company 4,200 10,000 5,800

Car Company 3,000 25,000 22,000

( Total Value added is 32,000 ) ( 32,000 is the Gross Domestic Product )
Expenditure Closed Economy = No exports or imports
Approach Households = person or group that share an income
Government = Represent the people
Firms = organizations that produce goods/services to sell
Value Added = the value of goods produced
Expenditure = the money spend on the goods purchased
( When we trade our expenditures on goods must be equal to the value of those goods )

GDP from The components of GDP in Closed Economy = C + I + G

Expenditure Consumers buy 25,000 in cars, 7000 in steel, which is 32,000 total
Side
(Spending
Approach)

Open Economy The circular Flow of Expenditure ( includes government, rest of world, households & fiirms
( Four Components of GDP = C + I + G + NX )

1: Consumptions ( C ) = Spending by households on goods & services (except for expenditure on house)
( Cars, clothes and Food )

2: Investments ( I ) = Purchase of goods that are used to make a company more productive in future
( goods that contribute to future sales of goods ) ( Purchase of machines, not intermediate goods )
factories, houses, inventories until they are sold ( investment is not stocks or money )

3: Government Purchases ( G ) = spending on salaries and public work ( teacher gets paid, government )
( a payment to a person receiving a pension is not government spending ) (transfer payment, not in GDP)

4: Net Exports ( NX = X - M ) Spending on domestically produced goods by foreigners (exports X), less
spending on foreign produced goods by domestic residents (imports M )

GDP vs GNP GDP = ( Plus = production by citizens outside of Canada ) ( Less = Production by Foreigners in Canada )
GNP = Income received by nationals of a country

• GDP is used to measure the overall health of the economy

• GDP is used to compare across countries
• GNP is used to measure the productivity of the citizens of the country
• GNP is used to measure the wellbeing of the citizens of a country

Honda owns a plant in Canada, its Output will be included in GDP since it is produced in Canada. Since
the Factory is owned by Japan, the output will be included in GNP

GDP & Well rGDP or GDP per capita reflect how well off people are in a country
Being • But, there are several reasons why GDP does not accurately reflect well-being in a country

1: Goods and Services produced but not sold do not get counted into GDP
( Cleaning your own house ( not counted ) or hiring a housekeeper ( included in GDP )

2: Underground Economy / Black Markets ( Goods and services produced and sold illegally )
( In BC, Marijuana sales were estimated to be around $7.5 billion in the black market before it was legal )
( Under the table services such as babysitters or paying cash for repair services ( no record, not in GDP )
 3: More Expenditure on some good and services does not mean people are better off
( GDP will be higher for a country that has to spend a lot on health care than for a country with healthy
residents do need as much healthcare

4: Government Spending is valued at cost rather than the actual value the government good or service
provides.--> E.g. ( A vaccination program )
• Each needle costs $2, which is the value that is counted into GDP • But the needles save lives, so the
actual value is much higher than $2

5: Environmental quality not accounted for—value of production added to GDP but costs of
pollution are not subtracted → ( eg: an oil spill will add to GDP since cost of clean up is
included, but environmental cost is not

6: Cross-country comparisons are difficult because of differences in lifestyles. Higher GDP does not
necessarily mean that people are happier.
( Eg: Canada’s GDP is higher than Mexico’s because we spend more on heating )

Possible Solutions: Have a better measure for living standards. An alternative used is the human
development index (HDI), which includes measures of health and life expectancy

But it is not just GDP that has problems with accuracy

Limitations 1: Discouraged workers: those who are not actively looking for work are not counted as unemployed
( They are not counted in the labor force, the understated UR )

2. People looking for full-time work who Grudgingly settle for a part-time job are counte as “fully”
employed, yet they are only “partly” employed.
( Shouldn’t be in LF, this understates U.R )

3. There are a number of jobs in the underground economy that are not reported at all
( should be in LF, this understates UR )

4: People may claim they are actually seeking work so that they can continue to collect employment
insurance or receive other government benefits. ( shouldn’t be in LF, this overstates UR )

Nominal & Real Real GDP is adjusted for inflation, nominal GDP is not adjusted for location
GDP GDP = Sum of Price x Quantity for all goods and services ( G & S )
( GDP can increase if the quantity of G & S produced increases, if prices of G & S increases, or both. But
only an increase in quantity produced will make people better off )
Example An economy with goods A to X, over 2 years, 2014 and 2015

Nominal GDP 2014 = P14a x Q14a + P14b x Q14b + P14x + Q14x

Nominal GDP 2015 = P15a x Q15a + P15b x Q15b + P15x + Q15x
Prices for that year multiplied by the quantity of the same year, Don’t know if quantity or price is changing

Real GDP 2014 = P14a x Q14a + P14b x Q14b + P14x + Q14x

Real GDP 2015 = P15a x Q15a + P15b x Q15b + P15x + Q15x
Keep Prices the same, only quantity changes, so changes only due to increased production

Real GDP = Nominal GDP / Price Index x 100

( Economic Growth = GDP growth over time is measured as a % change
( EG = GDP growth in 2015 = GDP15 - GDP14 / GDP14 x 100% )

Calculate GDP 1. Find nominal GDP (price now times quantity now)
Deflator 2. Find real GDP (price old (base price) times quantity now)
3. Divide Nominal GDP by Real GDP and multiple by 100
• The deflator uses all goods in the economy to get a measure of the price level

GDP Deflator 2015 = Nominal GDP 2015 / Real GDP 2015 ( Base Year ) x 100

Base Year is 2014

Year P Hotdog Q Hotdog P Burger Q Burger

2014 1 100 2 50

2015 2 150 3 100

2016 3 200 4 150

Nominal GDP:
2014 = ( 1 x 100 ) + ( 2 x 50 ) = 200
2015 = ( 2 x 150 ) + ( 3 x 100 ) = 600
2016 = ( 3 x 200 ) + ( 4 x 150 ) = 1,200

Real GDP
2014 = ( 1 x 100 ) + ( 2 x 50 ) = 200
2015 = ( 1 x 150 ) + ( 2 x 100 ) = 350
2016 = ( 1 x 200 ) + ( 2 x 150 ) = 500

GDP Deflator
2014 = 200 / 200 x 100 = 100
2015 = 600 / 350 x 100 = 171.42
2016 = 1,200 / 500 x 100 = 240

Rate of Inflation = Price Index2 - Price Index1 / Price Index1

2014 and 2015 ( 171.42 - 100 / 100 ) x 100 = 71.42%
CPI 1. Determine a representative basket of goods that Canadians consume in a specific year
2. Find the prices of those goods
3. Compute the costs of the basket of goods in each year by finding the total expenditure for each year
(price x quantity of each good).
The quantity of the goods always stays the same, but the prices change in each year

CPI = (Cost of typical bundle of good in given year prices /cost of same bundle in base year prices) x 100

Suppose the typical Canadian consumer only consumes three products: apples, beer, and
toques. 1. Choose a base year → 2014.
2. Identify the typical basket of goods in the base year.
Suppose the typical Canadian in 2014 consumed 10kg apples, 20 l beer, 3 toques

So the Expenditure Equation = Pa(10) + Pb(20) + Pt(3)

Year 2014 2015 2016

P ( apples ) 3 4 5

P ( beer ) 8 9 9

P ( toques ) 10 12 13
2014 is base year

Compute value of basket for 2014, using 2014 prices = 3(10) + 8(20) + 10(3) = 220
Compute value of basket for 2014, using 2015 prices = 4(10) + 9(20) + 12(3) = 256
Compute value of basket for 2015, using 2016 prices = 5(10) + 9(20) + 13(3) = 269

CPI 2014 = 220 / 220 x 100 = 100

CPI 2015 = 256 / 220 x 100 = 116
CPI 2016 = 269 / 220 x 100 = 122

Rate of Inflation = CPI 2016 - CPI 2014 / CPI 2014 x 100

( 122 - 100 / 100 ) x 100 = 22%

CPI vs Deflator 1. What kind of goods do you want to measure?

• The Deflator reflects the prices of all goods and services produced domestically
• The CPI represents the change in prices of ANY goods or services bought by consumers, as long as
they are goods typically purchased by consumer

EG: The price of an airplane sold by Bombardier will affect the deflator but not CPI, since it is not typically
purchase by consumers

Suppose that the price of Volkswagen increases and they are part of a typical basket of consumption
goods. CPI will increase but deflator will not

2: The CPI does not reflect changes in price or preferences. • CPI compares the price of a FIXED
 BASKET of goods. These baskets do not change for 4 years.

EG: 20 years ago, it included CDs in typical basket, but aren’t relevant today

Also it will not reflect how increases in prices affect consumer’s behaviour. If prices go high for one good
we will purchase less, but the CPI does not make that adjustment, making the inflation higher it should
be.

Cost of Inflation If wages rise at the same rate as prices of G&S, real income (in terms of how much you can buy) remains
constant ( • However, high inflation means that financial savings will lose purchasing power )

1: People have incentive to take money out of banks and buy things that will hold value better, such as
real estate or gold ( slow economic growth, firms can not borrow since bank has less money to loan out )

2: 2. High inflation makes people uneasy about the future of the economy (will the economy take a
downturn? ( people are less likely to invest in the economy slows down economic growth )

3: Menu costs: the costs to a firm for changing prices ( reprinting catalogs or menus )
( shoe leather costs = costs of running back to the bank to keep taking out money )