Module 5 Reading Flashcards
what are national income accounts
An accounting framework most countries have that is used in measuring economic activity
what idea are the national income accounts based on
the idea that the amount of economic activity that occurs during a period of time can be measured in terms of:
1. The amount of output produced, excluding output used up in intermediate stages of production (the product approach)
2. Incomes received by the producers of output (the income approach)
3. The amount of spending by the ultimate purchasers of output (the expenditure approach)
what does each national income approach give
a different perspective of the economy
what is the fundamental principal of national income accounting
that all 3 approaches give identical measurements of the amount of current economic activity (except for if there are problems like incomplete or misreported data)
what is the product approach
- Measures economic activity by adding the market values of goods & services produced, excluding any goods & services used up in intermediate stages of production
- Uses the value added concept
what is the value added of any producer
The value of its output - the value of the inputs purchased from other producers
how does the product approach calculate economic activity
by adding the value added of all producers
what is the income approach
- Measures economic activity by adding all income received, including wages, taxes, and after-tax profits (to get total income)
- total income = total value added from product approach
what is the expenditure approach
Measures activity by adding the amount spent by all ultimate users of output
who are the ultimate users of output
- those who consume the output
- not those that use it up in production to sell
why must the 3 approaches always be the same answer?
- The market value of goods and services produced in a given period = the amount buyers must spend to purchase them
- What the seller receives must equal what the buyers spend
what does it mean: The market value of goods and services produced in a given period = the amount buyers must spend to purchase them
- the market value of a good is a certain amount because its the amount people are willing to spend on it
- Market value of a good or service and spending on that good or service are always the same, so the product approach (which measures market values) and the expenditure approach (which measures spending) must give the same measure of economic activity
what does it mean: What the seller receives must equal what the buyers spend
- Seller’s receipts = total income generated by the economic activity (aka revenue)
- Total income/revenue is what the company made before salaries paid to workers and suppliers, taxes paid to the government, and profits (whatever is left over)
- Therefore, total expenditure must = total income generated, meaning expenditure and income approaches must also produce the same answer
what is gross domestic product
- GDP
- Broadest measure of aggregate economic activity
how are the 3 approaches equal
Because product value = expenditure, and income = expenditure
what is the fundamental identity of national income accounting
Total Production = Total Income = Total Expenditure
- where production, income, and expenditure are all measured in the same units (ex. dollars)
what are market values
they are the prices goods/services are sold for
how can GDP be measured
- by any of the approaches from earlier
- All 3 approaches gives the same value for GDP, but sees GDP differently
- Using all 3 gives a complete picture of an economy’s structure
what is an issue with using market values to measure GDP
that some useful goods and services are not sold in formal markets since they are hard to measure
what is a capital good
- A good that is produced (except for natural resources like land) to be used to produce other goods, but are not used up in the same period that its produced in
- Ex. factory equipment, office equipment, factories, office buildings
- For example, you built a factory in one year
- The factory was built so you can make other goods
- But you’re not done using the factory in the same year you built it, you plan to use it for a long time, making more goods for the years to come
how does the product approach measure/define GDP
Defined as the market value of final goods and services newly produced within the nation during a fixed period of time
with the product approach, how are goods and services counted in GDP
they’re counted in their market values
why are market values used in GDP
- because it’s adding the production of different goods and services together based on their prices, not their quantity
- it takes into account differences in the relative economic importance of different goods and services (more expensive = more important)
- ex. the total output in an economy is 7 cars and 100 pairs of shoes
- can’t say total output = 107, (7 + 100) since the two have different prices
- it should be the value of each good added
which types of goods and services are included in GDP
only final goods
what are examples of non-market goods/services that aren’t included in GDP
- Ex. unpaid homemaking and childcare services performed in a family are not included, but paid homemaking and childcare services (ex. Professional housecleaners, private daycare centres) are included
- Ex. we don’t buy and sell the benefits of clean air and water in markets, so money spent to reduce pollution or improve environmental quality isn’t included in the GDP
what are some non-market goods/services that are partially incorporated in the GDP
Ex. Activities that happen in the underground economy
- Includes legal activities hidden from the government to do things like avoid taxes or comply with regulations
- Also includes illegal activities like drug dealing, prostitution, gambling, etc.
how are activities that happen in the underground economy included in the GDP
these activities usually use cash, so Statistics Canada estimates the size of the underground economy by calculating the possible amount of cash in circulation and add it to the GDP
what are other important parts of economic activity that isn’t sold in markets
- ones the government provides
- like national defence, police and fire protection, public education, etc.
what are intermediate goods and services
- Those used up in production of other goods & services in the same period that they themselves were produced
- Ex. you made flour, and in the same year, you made bread with the flour, so the flour is an intermediate good
- The trucking company that delivered the flour to the bakery would also be an intermediate service
what are final goods and services
- Those goods & services that are not intermediate
- They are the end products of a process
- Ex. the bread from the earlier example would be the final good
- The bus ride home from the bakery is the final service
why aren’t the government activities included in the GDP
Because its not sold in markets/doesn’t have a market value, the GDP they wouldn’t show the government’s contribution to the GDP
what kind of economic activity does GDP measure
- current economic activity
- only goods/services that are newly produced in the current period and not any purchases or sales that were done in previous periods
- Ex. the price paid for a newly built house would be included in the GDP, but not the price paid for an already existing house
- The value for the existing house would’ve been included in the GDP for the year it was built
- But the value for the service of a real estate agent that sold the existing house would be included in the GDP
how are government contributions added to the GDP
- the cost of production for these contributions are added into the GDP
- Ex. the contribution of national defence to the GDP = the wages of the soldiers’ salaries, costs of military equipment, etc.
what are inventories
Stocks of unsold finished goods, goods in process, and raw materials held by firms
what is a way to differentiate between an intermediate and final goods
based on the treatment of inventory investment
what are capital goods considered as
- capital goods are considered final goods
- so new capital goods that are made are included in the GDP
what is inventory investment
- the amount inventories increase during the year (not just the amount purchased, since some of it could’ve been used up)
- Ex. a baker had $1k worth of flour in the beginning of the year, and ended the year with $1.1k worth of flower
- The difference between the beginning and the end of $100 ($1.1k - $1k) is the inventory investment during the year
- Even though the purpose of flour is to make bread, an increase in inventory represents flour produced that isn’t used in the year
what are inventory investment considered as
- final goods, so they are included in the GDP
what is gross national product
- GNP
- The market value of final goods and services newly produced by domestic factors of production during the current period
what does factors of production include
capital and labour
what is the difference between GDP and GNP
- GDP is anything that is produced in the country (including foreign capital/labour used in Canada)
- the foreign capital/labour wouldn’t be in the Candian GNP, but the foreign GNP
- Ex. Ex. Japanese cars made in Canada
The value of the cars made would be counted in the Canadian GDP and the Japanese GNP - GNP is anything that is produced by the country’s factors of production (labour, capital, etc.)
- ex. A road in Saudi Arabia is built by a Canadian construction company
- The value of the road that is paid by the Saudi government to the company would be in the Canadian GNP but not the Canadian GDP
why are the GDP and GNP numbers different
When foreign firms invest in a country, the interest and profits they earn are goes into GDP not GNP
What is net factor payments from abroad (NFP)
Income paid to domestic factors of production by the rest of the world - income paid to foreign factors of production by the domestic economy
how does the expenditure approach measure GDP as
as total spending on final goods and services produced within a nation during a specified period of time
what are the four major categories of spending that are added to get GDP in the expenditure approach
- Consumption = C
- Investment = I
- Government purchases of goods and services = G
- Net exports of goods and services = NX
what is consumption
Spending by domestic households on final goods and services, including those produced abroad
what are the 4 categories in consumption expenditure
- Durable goods: Long-lived items
- Ex. motor vehicles, furniture, and appliances
- Don’t include houses - Semi-durable goods: Shorter-lived goods
- Ex. clothes - Nondurable goods: Ex. foods & utilities
- Services
- Ex. health care, financial services, rent, restaurant meals
what is investment
Both spending for new capital goods (fixed capital investment) and increases in firms’ inventory holdings (inventory investment)
who makes fixed capital investments
- the governments and the private sector
- this type of government spending is under I instead of G
what is the fixed capital investment done by the private sector like
physical structures and products that are from intellectual property and research and development
what else is also included in investment
- spending on foreign-produced goods
- Increases in inventories
what are government purchases of goods and services
- Include any expenditure by the government for a currently produced good (other than capital goods) or service, foreign or domestic
- They include purchases made by the federal, provincial, municipal, and territorial governments
what are transfers
- a form of spending that isn’t for making purchases of currently produced goods or services
- A category that includes transfers between levels of government, and government payments to individuals from public pensions, unemployment insurance benefits, welfare payments, etc.
what are not included in government purchases
- transfers
- Interest payments on the national debt
what are exports
goods/services produced in a country that are purchased by foreigners
what are imports
goods/services produced abroad that are purchased by a country’s residents
what is negative net exports
when exports < imports
what is positive net exports
when exports > imports
why are exports added to total spending (GDP)
because its money foreigners spend on final goods and services produced in a country
why are imports subtracted from total spending
because consumption, investment, and government purchases already include imported goods and services
how does the income approach measure GDP
Calculates GDP by adding the incomes received by producers, including profits, and taxes paid to the government
what are the components of the income approach
- Compensation of Employees
- Gross Operating Surplus
- Gross Mixed Income
- Taxes Less Subsidies on Production
- Taxes Less Subsidies on Products and Imports
- these are all added up to get an estimate of income-based GDP
what is the compensation of employees
- Total amount in cash or payable a company needs to pay an employee
- Usually one of the largest component of the income approach to measuring GDP
what is gross operating surplus
- Income earned from the production of goods/services that is paid to the owners of incorporated companies
- Owners can be: corporations, governments, households, non-profit institutions
- Ownership is usually stocks that they can earn dividends or other investment income one
- This is the second-largest component of the income approach
what is gross mixed income
- Income paid to unincorporated companies
- For these companies it’s hard to separate the payments made to employees and payments made to owners, they are just combined and put under this, called “mixed income”
what are taxes less subsidies on production
Taxes minus any subsidies received, that companies pay for the use of labour, machinery, buildings or other assets used in the production of goods/services
what are taxes less subsidies on products and imports
Taxes payable after a product is produced and sold in Canada or imported from abroad
what is statistical discrepancy
- a final category of the income approach that is the difference between between the averaged Statistics Canada’s estimates of GDP from an expenditure approach and its estimate from the income approach
- the difference is added to the income approach to make the income approach = expenditure approach
why would the total income need to be split up into the private sector and the government sector
Ex. if you want to predict the demand for consumer goods, looking at the income available to the private sector (where consumers are) is better than looking at the income of the whole economy (which includes the governments)
who is considered in the private sector
households and businesses
what is private saving
Saving of the private sector
who is considered in the government sector
federal, provincial, territorial, and municipal governments
what is private disposable income
(Income of the private sector) Measures the amount of income the private sector has available to spend
what do you need to know to know how well off a household is and why?
- their current income, what they own (assets), and what they owe (liabilities)
- because someone can make a lot of money but have a lot of debts, vs someone could make no money but have no debts and a lot of expensive assets
what are 3 important measures of saving
- Private saving
- Government saving
- National saving
what is really important in determining wealth
- The rate of saving
- Ex. a family that puts aside money will accumulate wealth must faster than a family that’s spends all of theirs
what is wealth (net worth)
The difference between assets and liabilities
how are the rates of saving and wealth closely related
The rate at which national wealth increases also depends on the rate individuals, businesses, and governments in the economy save
how is the saving rate of an economic unit calculated
saving / income
how is saving (of any economic unit) calculated
= Is unit’s current income - its spending on current needs
what is government budget surplus
Another name for government saving
what is budget deficit
- If government revenue < government expenditure (they don’t have enough revenue to cover their spending)
- When there is a budget deficit, government saving is negative
what is national saving
- The saving of the economy as a whole (private saving + government saving)
- also the total income of the economy
what is private saving used for
- Fund new capital investment
- Provide resources the government needs to finance its budget deficits
- Acquire assets from or lend to foreigners
what is current account balance (CA)
= payments received from abroad in exchange for currently produced goods and services (including factor services) - Analogous payments made to foreigners by the domestic economy
what is the uses of saving identity
States than an economy’s private saving is used in 3 ways:
1. investment (I)
2. government budget deficit (-Sgovt)
3. current account balance (CA)
how is private saving used in investment
Firms borrow from private savers to finance constructions and purchase of new capital (including residential capital) and inventory investments
how is private saving used in the government budget deficit
When a government has budget deficits and needs to borrow from private savers to cover the difference
how can you tell if there is a budget deficit or not
- budget deficit = Sgovt (negative)
- no budget deficit = -Sgovt (positive)
how is private saving used in the current account balance
- When its positive it means the money foreigners get from Canada is not enough to cover the money they give to Canada
- To make up the difference, foreigners must either borrow from Canadian private savers or sell some of their assets to Canadian savers (assets can be land, factories, stocks, and bonds)
- Therefore, financing the current account balance is a use of a country’s private savings
- If CA is negative (such as during the post-war period) Canada got more money from foreigners and couldn’t cover the payments to foreigners
- To make up the difference, Canada needs to borrow from foreigners or sell assets to them
- In this case, foreigners use their saving to lend to Canada or to acquire Canadian assets
what are flow variables
- Variables that are measured per unit of time
- They can be per quarter or per year
- Ex. annual GDP measures the economy’s production per year
what are stock variables
- Variables that are defined at a point in time
- Ex. the amount of money in your bank account on a specific date
- Many times, a flow variable is the rate of change in a stock variable
what kind of variables are wealth and saving
- saving is a flow variable
- wealth is a stock variable
what is national wealth
the total wealth of the residents of the country
what are the 2 parts of national wealth
- The country’s domestic physical assets
- Net foreign assets
what are the country’s domestic physical assets
Like stock of capital goods and land
what are the net foreign assets of a country
= country’s foreign assets - foreign liabilities
what are foreign assets
like foreign stocks, bonds, and factories owned by domestic residents
what are foreign liabilities
domestic physical and financial assets owned by foreigners
why are domestic financial assets not part of national wealth but net foreign assets are
- Net foreign assets are a part of national wealth because it shows if there is a difference between foreign assets and liabilities
- Domestic financial assets held by domestic residents aren’t part of national wealth because the asset is offset by the liability
- ex. having an account at the bank
- A Canadian putting money into a Canadian bank = an asset for the Canadian and a liability for the bank (it cancels out)
- Vs. A Canadian putting money into a foreign bank = an asset for the Canadian and a liability for the foreign bank = adds to Canadian national wealth
what are the 2 ways national wealth can change over time
- Value of existing assets or liabilities that make up national wealth
- National saving
how can the national wealth change from the value of existing assets or liabilities that make up national wealth
- The increase of the value of domestic and foreign assets increases national wealth
- The decrease in assets (like depreciation) decreases national wealth
how can national saving change national wealth
- Over any period, when the value of existing assets and liabilities are held constant, each additional dollar of national savings = an additional dollar to national wealth
- With national savings (S) = I + CA, it means that national savings has 2 uses:
1. Increase the stock of domestic physical capital through investment (I)
2. Increase the nation’s stock of net foreign assets by lending to foreigners or acquiring foreign assets in an amount equal to the current account balance (CA) - So if either I or CA increases by a dollar, national wealth will increase by a dollar
- Since national savings increases national wealth dollar to dollar, the faster national savings increase, the faster national wealth will increase
If the government budget deficit (that only part of it can be offset with increased private saving) increases, what will happen
national savings will decrease, and national wealth will also decrease
what are nominal variables
Variables that are measured in terms of current market values
what is a good thing and a bad thing about nominal variables
- good thing: it allows you to sum up different types of goods and services
- bad thing: not good to use when comparing an economic variable at two different points in time
- Ex. If the current market value of the goods/services included in GDP changes over time, you can’t tell if its because of the changes in quantities produced, the changes in prices, or both
what is a real variable
- An economic variable that is measured by the prices of a base year
- Measures the physical quantity of economic activity
what is real gdp (constant-dollar gdp)
Measures the physical volume of an economy’s final production using the prices of a base year
what is nominal GDP (current-dollar GDP)
The dollar value of an economy’s final output, measured at current market prices
how do you calculate the value of a real variable (like GDP)
- To determine how much of the total % increase is caused from an increase in physical output is to measure the value of production in each year, using the prices from a base year
- in the base year, the real GDP will always = nominal GDP
what is a price index
A measure of the average level of prices for some specified set of goods and services relative to the prices in a specified base year
what is GDP deflator
- a price index that measures the overall level of prices of goods/services included in GDP
- its calculated quarterly
what is the consumer price index (CPI)
- Measures the prices of consumer goods
- its calculated monthly
how is CPI calculated
- Statistics Canada calculates the CPI by finding the current prices of a fixed list/basket of consumer goods and services (like specific foods, clothing, housing, and fuel) each month and divides it by the same basket of goods/services in the base year
- the base year basket of goods and services should be updated occasionally so it better resembles the basket of goods/services that consumers choose in the current year
what is the rate of inflation measured with
price indexes
what is the rate of inflation
- the % rate of increase in the price index per period
- Ex. CPI rises from 100 in year 1, to 105 in year 2
- The rate of inflation = (105 - 100)/100 = 5% per year
what is an interest rate
- A rate of return promised by a borrower to a lender
- ex. the interest rate on a one year loan of $100 is 8%
- Borrow needs to pay back $100 + ($100 x 8%) = $100 (principal)+ $8 (interest) in one year
how does interest rates differ
different based on factors like who is the one borrowing, how long they are borrowing for, etc
which assets don’t have a specific interest rate
like shares of a corporate stock that don’t pay a specific interest rate, but pay a return in the form of dividends and share price appreciation
what do interest rates and other rates of return indicate
- how quickly the nominal/dollar value of an interest-bearing asset increases over time, but it doesn’t show how quickly the value of the asset changes in real/purchasing power terms
- Ex. a savings account has $300 and 4% interest per year
- After a year, the account has $312
- But that is only if inflation is 0%, which allows the account to gain 4% in interest
- But if inflation was 4%, then what costed $300 before now costs $312 and in real terms your gain from interest is none (since inflation rate is the same as the interest rate)
what is the nominal interest rate (nominal rate of return
- The rate at which the nominal value of an asset increases over time (i)
- conventionally measured interest rates, those that are reported
what is real interest rate (real rate of return)
- The rate at which the real value or purchasing power of the asset increases over time
- ex. If the saving account pays 4% interest (nominal interest rate), and the inflation rate is 0, the real interest rate on that savings account = 4% - 0% = 4%
- A 4% real interest rate on the account means the owner of the account can buy 4% more goods & services by the next year compared to the current
- If inflation is 4%, the real interest rate on that savings account = 4% - 4% = 0%
- This means the purchasing power of the account isn’t any different from the current year to the next
can you calculate the real interest rate
- Usually when you borrow, lend, or make a bank deposit, you know the nominal interest rate beforehand
- if you also have the inflation rate, you can calculate the real interest rate
- but the inflation rate isn’t determined until the end of the period
- Ex. the period of the loan or deposit is a year, you won’t know what the inflation rate is during the year until the year is over
- So when you make a loan or deposit, you won’t be able to know what the real interest rate is
- but you can calculate what you expect it to be to help you determine how much to borrow, lend or deposit
