5.2 National Income Accounting: The Basics

Question 1

What is the value of domestic output equal to?

Answer 1

The value of domestic output is equal to the value of the expenditure on that output and is also equal to the total income generated by producing that output.

Question 2

Memorize The Circular Flow of Income and Expenditure

Answer 2

Question 3

What is national income equal to?

Answer 3

National income is equal to national product.

Question 4

What are the three ways of measuring national income?

Answer 4

-The first is simply to add up the value of all domestic output—the goods and services produced in the economy. (This requires the concept of value added, which we discussed above.)
-Add up the total flow of expenditure on domestic output.
-Add up the total flow of income generated by domestic production.

All three measures yield the same total, which is called** gross domestic product** (GDP).

Question 5

What is GDP?

Answer 5

Gross domestic product (GDP)

      The total value of goods and services produced in the economy during a given period.

Question 6

What is GDP on the expenditure side?

Answer 6

When GDP is calculated by adding up total expenditure for each of the main components of output, the result is called GDP on the expenditure side.

Question 7

What is GDP on the income side?

Answer 7

When GDP is calculated by adding up all the income generated by the act of production, it is called GDP on the income side.

Question 8

How do we calculate GDP from the expenditure side for a given year?

Answer 8

By adding up the expenditures needed to purchase the output produced in that year. Total expenditure on output is the sum of four broad categories of expenditure:

-Consumption
-Investment
-Government purchases
-Net exports

Question 9

What is important to remember when considering the four categories of expenditure?

Answer 9

it is important to remember that these four categories of expenditure are exhaustive—they are defined in such a way that all expenditure falls into one (and only one) of the four categories.

Question 10

What is Consumption expenditure?

Answer 10

Consumption expenditure

      Expenditure on all goods and services for final use. Represented by the symbol C.

It includes services, such as haircuts, dental care, legal advice, and

Actual measured consumption expenditure is denoted by the symbol G(subscript)a.

Question 11

What is Investment expenditure?

Answer 11

Investment expenditure

      Expenditure on the production of goods not for present consumption. Represented by the symbol I.

Inventories of goods made but not yet sold and of inputs purchased but n

Question 12

What are the three catagories of investment goods?

Answer 12

Changes in Inventories

New Plant and Equipment

New Residential Housing

Question 13

What are Inventories?

Answer 13

Inventories

      Stocks of raw materials, goods in process, and finished goods held by firms.

Question 14

Difference between inventories of input and output.

Answer 14

Inventories of inputs and unfinished materials allow firms to maintain a steady stream of production despite interruptions in the deliveries of inputs bought from other firms.

Inventories of outputs allow firms to meet orders despite fluctuations in the rate of production.

Question 15

In regards to inventories, what counts and positive investment and what counts as negative investment (disinvestment)?

Answer 15

The accumulation of inventories during any given year counts as positive investment for that year because it represents goods produced but not used for current consumption. These goods are included in the national income accounts at their current market value.

The drawing down of inventories, often called decumulation, counts as disinvestment (negative investment) because it represents a reduction in the stock of finished goods available to be sold.

Question 16

What is Capital stock?

Answer 16

Capital stock

      The aggregate quantity of capital goods.

This is often called “plant and equipment,” although the term refers to

Counts as “New Plants and Equipment”

Question 17

What is a fixed investment?

Answer 17

Fixed investment

      The creation of new plant and equipment.

Adding to the existing stock of capital goods is an act of investment an

New Plants and Equipment

Question 18

When is housing counted as an investment expenditure?

Answer 18

Because such an asset meets the definition of investment that we gave earlier, housing construction—the building of a new house—is counted as investment expenditure rather than as consumption expenditure. However, when an individual purchases an existing house from a builder or from another individual, the ownership of an existing asset is simply transferred, and the transaction is not part of national income. Only when a new house is built does it appear as residential investment in the national accounts.

Question 19

What is the total amount of investment the sum of?

Answer 19

The total amount of investment in any given year is the sum of the changes in inventories, the additions to the stock of plant and equipment, and the new construction of residential housing units.

Actual total investment expenditure is denoted by the symbol I(subscript

Question 20

What is Depreciation?

Answer 20

Depreciation

      A rise in the exchange rate—the domestic currency has become less valuable so that it takes more units of domestic currency to purchase one unit of foreign currency.

Question 21

Is investment occuring during the year to replace depreaciated product counted towards GDP?

Answer 21

Note that some of the investment occurring during a year is used to replace some physical capital that wears out through use in a process called depreciation. But all of the investment—whether for replacement or for expansion of the capital stock—represents expenditures. And all of the investment generates income, so all of it is included in the calculation of GDP.

Question 22

What counts as government purchaces?

Answer 22

Government purchases

      All government expenditure on currently produced goods and services, exclusive of government transfer payments. Represented by the symbol G.

Actual government purchases of goods and services are denoted G(sub)a

Question 23

How do we value Government output?

Answer 23

Government output is typically valued at cost rather than at market value. In many cases, there is really no choice. What, for example, is the market value of the law courts or of police protection or of the economic analysis done by economists at the Department of Finance? No one knows. But since we do know what it costs the government to provide these services, we value them at their cost of production.

Question 24

What is the potential consequence of valuing government purchase at cost?

Answer 24

Although valuing at cost is the only possible way to measure many government activities, it does have one curious consequence. If, because of an increase in productivity, one civil servant now does what two used to do, and the displaced worker shifts to the private sector, the government’s measured contribution to national income will fall (but the private sector’s contribution will rise). Conversely, if two workers now do what one worker used to do, the government’s contribution will rise.

Question 25

What types of government purchases are included as part of the GDP?

Answer 25

Only government purchases of currently produced goods and services are included as part of GDP. As a result, a great deal of government spending does not count as part of GDP. For example, when the government makes payments to a retired person through the Canada Pension Plan, there is no market transaction involved as the government is not purchasing any currently produced goods or services from the retiree. The payment itself does not add to total output. The same is true of payments for employment insurance and welfare, and interest on the national debt (which transfers income from taxpayers to holders of government bonds).

Question 26

What is a transfer payment?

Answer 26

Transfer payments

      Payments to an individual or institution not made in exchange for a good or service.

Question 27

What are the two variables of Net Exports?

Answer 27

Imports are domestic expenditure on foreign-produced goods and services; exports are foreign expenditure on domestically produced goods and services.

Question 28

What are imports?

Answer 28

Imports

      The value of all goods and services purchased from firms, households, or governments in other countries.

Question 29

What are Exports?

Answer 29

Exports

      The value of all domestically produced goods and services sold to firms, households, and governments in other countries.

Question 30

What are the conditions that must be met in order for something to be considered an export?

Answer 30

If Canadian firms sell goods to German households, the goods are part of German consumption expenditure but constitute expenditure on Canadian output. Indeed, all goods and services produced in Canada and sold to foreigners must be counted as part of Canadian production and income; they are produced in Canada, and they create incomes for the Canadian residents who produce them.

Question 31

Consumption, investment and government purchase all have an import componenet. How do we balence that to reflect the actual value of imports?

Answer 31

Consumption, investment, government purchases, and exports all have an import component. To arrive at total expenditure on Canadian products, we need to subtract from total Canadian expenditure the economy’s total expenditure on imports. The value of actual imports is given the symbol IM(subscript)a

Question 32

What are Net exports?

Answer 32

Net exports

      The value of total exports minus the value of total imports. Represented by the symbol NX.

Question 33

What is the formula for GDP on the expenditure side?

Answer 33

Measured from the expenditure side, GDP is equal to the total expenditure on domestically produced output. GDP is equal to…

Question 34

What is an example of the calculations of sums of expenditure for GDP

Answer 34

Question 35

What does the calculation of GDP from the income side involve?

Answer 35

The calculation of GDP from the income side involves adding up factor incomes and other claims on the value of output until all of that value is accounted for.

From the income side, GDP is the sum of factor incomes plus indirect taxes (net of subsidies) plus depreciation.

Question 36

What are the two main variables that are calculated for GDP income side?

Answer 36

Factor Incomes
-Wages and Salaries
-Interest
-Business Profits
-Net Domestic Income

Non-factor Payments
-Indirect Taxes and Subsidies
-Depreciation

Question 37

What are wadges in saliaries in terms of GDP income side calculations

Answer 37

Wages and salaries are the payment for the services of labour and they include all pre-tax labour earnings—that is, the payment to workers before deductions for income taxes, employment-insurance contributions, pension-fund contributions, and other employee benefits. In total, wages and salaries represent the part of the value of production that is paid to labour.

Question 38

What is interest in terms of GDP income side?

Answer 38

Interest includes interest that is earned on bank deposits, interest that is earned on loans, and miscellaneous other investment income. (Not included is interest income earned from loans to Canadian governments).

Question 39

What is included in buisness profits in terms of GDP income side caluclations?

Answer 39

For accounting purposes, total profits include corporate profits, incomes of unincorporated businesses (mainly small businesses, farmers, partnerships, and professionals), rent paid on land and buildings, and profits of government business enterprises and Crown corporations (such as Canada Post and Hydro-Québec).

Question 40

What is the difference between dividends and retained earnings?

Answer 40

Some profits are paid out as dividends to owners of firms; the rest are held by firms and are called retained earnings.

Question 41

What do profits and interest represent?

Answer 41

Profits and interest together represent the payment for the use of capital—interest for borrowed capital and profits for capital contributed by the owners of firms.

Question 42

What is net domestic income in terms of GDP income side calculation?

Answer 42

The sum of wages and salaries, interest, and profits is called net domestic income at factor cost.
It is “net” because it excludes the value of output that is used as replacement investment.
It is “domestic income” because it is the income accruing to domestic factors of production.
It is “at factor cost” because it represents only the part of the value of output that is paid to factors for their services.

Question 43

When a consumer buys something, why dose part of the expenditure spent not get paid as income to factors of production?

Answer 43

Every time a consumer spends $10 on some item, some part of this $10 expenditure does not get paid as income to factors of production. This shortfall is due to the presence of indirect taxes and depreciation.

Question 44

What are indirect taxes?

Answer 44

An important claim on the market value of output arises out of indirect taxes, which are taxes on the production and sale of goods and services.

In Canada, the most important indirect taxes are provincial sales taxes,

Question 45

How do we account for government subsidies to firms when determing GDP income side?

Answer 45

Sometimes the government gives subsidies to firms, which are like negative taxes. When these occur, it is necessary to subtract their value, since they allow factor incomes to exceed the market value of output.

Question 46

What is depreciation?

Answer 46

Some of the investment spending in any year is required to replace capital that has worn out in a process we referred to earlier as depreciation.

Question 47

Why do we account for depreaciation as a non-factor payment?

Answer 47

For national accounting purposes, we need to include this part of investment spending in its own separate category as a “non-factor payment” because its value does not accrue to any factor of production.

Question 48

What is statistical discrepancy and why do we use it?

Answer 48

statistical discrepancy, a term that appears with equal magnitude but opposite sign. This is a “fudge factor” to make sure that the independent measures of income and expenditure come to the same total. Statistical discrepancy is a clear indication that national income accounting is not error-free. Although national income and national expenditure are conceptually identical, in practice both are measured with slight error.

Question 49

Example of calculations of GDP from the income side…

Answer 49