Economic Analysis of Business: Introduction

Question 1

Macroeconomics

Answer 1

The study of the economy as a whole.

Question 2

Economic Recoveries

Answer 2

V Shaped: Economy recovers as quickly as it contracted.

U Shaped: Economy spends some time at the bottom of the trough before it recovers.

W Shaped: Economy begins to recover but falls back, perhaps with a second or third wave of the virus.

L Shaped: Economy remains below trend – never fully recovers

K Shaped: High skilled/High income groups recover, while low skilled/ low-income groups continue to do poorly

Question 3

Model of the Economy:

Answer 3

The IS-LM-BP model allows us to analyze the impact of alternative policies on the Canadian economy. Designed to think about trade-offs between monetary and fiscal policy and the economy.

Question 4

National Income Accounting

Answer 4

A government bookkeeping system that measures a country’s economic activity— and performance.

Question 5

Gross Domestic Product (as defined in the National Income Accounting)

Answer 5

GDP (Gross Domestic Product): Measures the production of all goods and services in Canada over a period of time. This includes production with both Canadian and foreign-owned factors of production.

GDP depends on location, not ownership.

Question 6

Gross National Product (as defined in the National Income Accounting)

Answer 6

GNP (Gross National Product): Measures the production of goods and services produced with Canadian-owned factors of production, including production by Canadian firms abroad.

GNP depends on ownership, not location.

Question 7

Comparing Gross Domestic Product & Gross National Product

Answer 7

Whereas GDP measures the total income produced domestically, GNP measures the total income produced by nationals (residents of a nation).

Question 8

Gross Domestic Product

Answer 8

Note: “gross” domestic product does not consider the depreciation of the machinery (the so-called capital stock) used in producing the output.

GDP is used as a proxy for wealth.

Question 9

GDP: Market Value

Answer 9

GDP is the market value (prices) of all final goods and services produced within Canada in a given period of time.”
Market value is informed by market price, because price indicates how much people are willing to spend on a good or service.

Question 10

GDP Measurement

Answer 10

Gross domestic product (GDP) measures total income, and equivalently, the total expenditure on the economy’s output of goods and services.

For the economy as a whole, expenditure and income are always the same.

Question 11

GDP Limitations

Answer 11

Does not account for the fact that some of the value created is accrued to foreign companies, who naturally aim to eventually move their returns to investment back home (e.g., Walmart – a U.S. company that operates in Canada).

Domestic also doesn’t account for value created by local firms abroad

Question 12

The Digital Economy (Bias in Measuring GDP)

Answer 12

The measurement of GDP was designed for an economy producing goods and some market services. Both have well-defined prices, so their value can be “easily” computed.

Question 13

Goods with Price “Zero”

Answer 13

Using GDP as a proxy can be unsatisfactory because elements of value are difficult/impossible to measure. In the digital economy, many of the goods in consumer baskets have a price “zero”. In effect, measurements of GDP undercount the value added from digital goods.

Question 14

Net Domestic Product

Answer 14

Unlike GDP, NDP also considers the decrease in the value of fixed assets (e.g. computers, buildings, transport equipment, machinery, etc.) used in the production process.

Net domestic product is gross domestic product (GDP) minus the consumption of fixed capital (CFC).

Note: Only consider costs associated with depreciation (machine breakdown), not productivity costs.

Question 15

Consumption of Fixed Capital

Answer 15

Depreciation (depletion of the capital stock).

Question 16

Nominal GDP

Answer 16

Market value of goods and services at current prices.

Limitation: if Nominal GDP increases, it is unclear if supplies also increased.

Question 17

Real GDP

Answer 17

The value, in base year prices, of goods and services.

Values goods and services at constant prices.

Advantage: Real GDP rises only when the amount of goods and services has increased, whereas nominal GDP can rise either because output has increased or because prices have increased.

Question 18

Real GDP: Base Year

Answer 18

The base year is identified by the intersection between nominal and real GDP.

Note base years do not matter when we are considering only one good.

Question 19

Calculating Gross National Product (GNP)

Answer 19

Note: Gross National Product does not consider depreciation.

Question 20

Net National Product

Answer 20

GNP minus depreciation

Question 21

Measuring Economic Activity:

Answer 21

Two ways to measure GDP:
1. Incomes-based approach: Payments to labour and capital

2. Expenditure-based approach: C + I + G + X where X are exports - imports

Question 22

Measuring GDP: Income-Based Approach

Answer 22

Note: Wages and salaries represent the largest share of GDP (Primary target for taxation).

Question 23

Measuring GDP: Expenditure Approach

Answer 23

GDP is the sum of consumption, investment, government purchases, and net exports. Each dollar of GDP falls into one of these categories. This equation is an identity—an equation that must hold because of how the variables are defined. It is called the national income accounts identity.

The national income accounts divide GDP into four broad categories of spending:
■ Consumption (C )
■ Investment (I )
■ Government purchases (G)
■ Net exports (NX ).

Thus, letting Y stand for GDP,

Y = C + I + G + NX

NX = exports – imports.

Question 24

Consumption (C)

Answer 24

Consumption (C): Spending by households on goods and services. “Goods” include household spending on durable goods, such as automobiles and appliances, and nondurable goods, such as food and clothing. “Services” include such intangible items as haircuts and dental care. Household spending on postsecondary education is also included in consumption of services.

Question 25

Investment (I)

Answer 25

Investment (I): Spending on capital equipment, inventories, and structures. The purchase of goods will be used in the future to produce more goods and services. NOT financial investments.

Question 26

Government Purchases

Answer 26

Government Purchases (G): Spending on goods and services by local, territorial, provincial, and federal governments. It includes the salaries of government workers and spending on public works.

Question 27

Net Exports

Answer 27

Net Exports (NX): The value of a nation’s exports minus the value of its imports. It equals the purchases of domestically produced goods by foreigners (exports) minus the domestic purchases of foreign goods (imports).

Question 28

Personal Assessment

1. How many approaches are there to measuring economic activity? Describe
2. Why is it useful to measure economic activity?
3. What is the difference between real and nominal variables?
4. Why it is important to differentiate between GDP and GNI?

Answer 28

1. Income-based approach and Expenditure-based approach.
2. To have a “thermometer” of the activity in the economy, important for policy design and responses, as well as for business planning.
3. Nominal variables scale with prices, so even if quantities are fix, their value may change because prices changes.

Real variables hold prices fixed (e.g. fix a base year) and are design to measure changes in quantities.

4. GDP measures what is produced within a country while GNP is a measure of production from Canada’s owned factors. In economies that are opened to capital flows these two might be very different.