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GROSS DOMESTIC PRODUCT

DEFINITION OF GDP
Gross domestic product is the market value of the final goods and services produced within a country
in a given time period.
1. Market value --> converted to market values so that they can be added up
2. Final G/S --> bought by the final user
o Intermediate G/S: item that is produced by one firm but bought by another (not consumed
by the end user; used as a component)
o We can only take the final G/S into count because we do not want to double count
o Stocks and bonds are not final or intermediate G/S
3. Produced within a country --> whatever is produced within the country, doesnt matter if the
company is foreign
4. In a given time period --> usually quarterly or annually
o GDP also measures total income and total expenditure
Equality between those 2 values are important because it shows the link between
productivity and living standards
When we have more income we can buy more G/S, but there must be an
increase in production of G/S for us to buy
GDP AND THE CIRCULAR FLOW OF EXPENDITURE AND INCOME
Households and firms (C)
o Households sell labour, capital and land while firms buy them
o In return, firms pay us wages, interest, rent, profit
o Firms sell and households buy G/S (called consumption expenditure)
o Investment (I): purchase of new plant, equipment and buildings, additions to inventories

Governments (G)
o Government expenditure: G/S that the gov't buys
o They also use their taxes to buy things and transfer funds to households such as security and
unemployment benefits
Rest of the world
o Exports (X) and imports (M)
o Net exports = exports - imports (X-M)
GDP = expenditures = income

o
o

Total expenditure = aggregate expenditure = consumption expenditure + investment + gov't


expenditure + net exports
Total income = aggregate income = cost of FOP (wages, interest, rent, profit)

Y=C+I+G+X-M

WHY IS DOMESTIC PRODUCT GROSS?


Depreciation: decrease in the value of a firm's capital from wear, tear and obsolescence
Gross investment: amount spent buying new capital and replacing deprecated capital (included in
measuring GDP)
Net investment: the increase in the value of a firm's capital

Net investment = gross investment - depreciation


MEASURING CANADA'S GDP
1. Expenditure approach
o

Y = C + I + G + (X - M)

2. Income approach
o Sum of the incomes that firms pay households (for the FOP they hire)
o Income is divided into 5 categories (when you add them together, they make the net
domestic income at factor cost)
1. Wages, salaries, and supplementary labour income
2. Corporate profits
3. Interest and miscellaneous investment income
4. Farmers income
5. Income from non-farm unincorporated businesses
o Indirect taxes - subsidies (to get market price)
o Depreciation (capital consumption) + new domestic product = gross domestic product

NOMINAL AND REAL GDP


Real GDP: value of final G/S produced in a year
o Valued at the prices of a reference base year
o Currently, the reference base year is 2000
Nominal GDP: the value of G/S produced in a year
o Valued at the prices of the current year
o A more precise name for GDP

THE USES AND LIMITATIONS OF GDP

Economists use estimates of real GDP to:


1. Compare the standard of living over time
2. Compare the standard of living across countries

THE STANDARD OF LIVING OVER TIME

To measure this, we calculate the real GDP per person =


o
o

It tells use the value of G/S that the average person can enjoy
By using real GDP, we remove any influence that rising prices and rising cost of living on the
comparison

Long term trend


o Look at long term, e.g. real GDP doubled from 1971 to 2007 (people were twice as better off
in 2007 that 1971)

2 FEATURES OF OUR EXPANDING LIVING STANDARD


1. The growth of potential GDP per person

o Potential GDP: the max level of real GDP that can be produced when FOP are all used
2. Fluctuations of real GDP around potential GDP
o Real GDP in Canada doubled in 36 years

PRODUCTIVITY GROWTH SLOWDOWN


The growth rate of real GDP slowed down after 1970
Lucas wedge: dollar value of the accumulated gap between real GDP per person would have been
if the 1960s growth rate had continued, and what real GDP per person turned out as

REAL GDP FLUCTUATIONS

Business cycle: periodic but irregular up & down movement of total production and economic
activity
Two phases:
o Expansion (period when real GDP increases)
o Recession (period when real GDP decreases; growth rate is negative for at least 2 successful
quarters)
Two turning points:
o Peak (high point; right after an expansion stops)
o Trough (low point, when recession ends)

THE STANDARD OF LIVING ACROSS COUNTRIES


Two problems to comparing:

1. The real GDP of one country must be converted into the same currency units as the real GDP
of the other country
2. The value of G/S in both countries must be the same
The same products in different countries can have very different prices
FACTORS THAT INFLUENCE THE STANDARD OF LIVING BUT ARE NOT A PART OF GDP
1. Household production (producing at home is not accounted for; part of the increase in GDP is the
decrease in home production)
2. Underground economic activity (unreported production hidden from the government to avoid
taxes and regulations; not included in GDP)
3. Health and life expectancy
4. Leisure time
5. Environmental quality
6. Political freedom and social justice