Ragan: Macroeconomics

Seventeenth Canadian Edition

Chapter 5
The Measurement of
National Income

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Chapter Outline/Learning Objectives
Section Learning Objectives
Blank After studying this chapter, you will be able to
5.1 National Output and Value 1. see how the concept of value added
Added solves the problem of “double counting”
when measuring national income.
5.2 National Income Accounting: 2. explain how GDP is measured from the
The Basics expenditure side and from the income
side.
5.3 National Income Accounting: 3. explain the difference between real and
Some Further Issues nominal GDP.
4. discuss the many important omissions
from official measures of GDP.
5. understand why real per capita GDP is a
good measure of average material living
standards but an incomplete measure of
overall well-being.

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5.1 National Output and Value Added
(1 of 2)

• Production occurs in stages.

• Some firms produce outputs that are used as inputs
by other firms, and these firms, in turn, produce
outputs that are used as inputs by yet other firms.
• The error that would arise in estimating the nation’s
output by adding all sales of all firms is called double
counting.
• Compare intermediate goods to final goods

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5.1 National Output and Value Added
(2 of 2)

• To avoid double counting, use the concept of value

added.
Value added = Sales rev. − Cost of intermediate
goods
and
Value added = Payments owed to the firm’s
factors of production
• The sum of all values added in an economy is a
measure of the economy’s total output.

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APPLYING ECONOMIC CONCEPTS
5-1 Value Added Through Stages of Production

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5.2 National Income Accounting: The
Basics
• Three different ways of measuring national income.
1. The concept of value added.
2. Sum the total flow of expenditure on final domestic
output.
3. Sum the total flow of income generated by the flow of
domestic production.
• All three measures yield the same total, gross
domestic product (GDP), which is the total value of
goods and services produced in the economy during a
given period.

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Figure 5-1 The Circular Flow of Income and
Expenditure

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GDP from the Expenditure Side (1 of 4)
• GDP for a given year is calculated from the
expenditure side by adding up the expenditures
needed to purchase the final output produced in that
year.
1. Consumption Expenditure
 Household expenditure on all goods and services.
2. Investment Expenditure
 Expenditure on the production of goods not for present
consumption.

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GDP from the Expenditure Side (2 of 4)
• Investment expenditure also includes inventories.
• Investment expenditure also includes capital goods
and residential housing.
• The economy’s total quantity of capital goods is called
the capital stock.
• Creating new capital goods is called fixed
investment.

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GDP from the Expenditure Side (3 of 4)
• Net investment = Gross investment – Depreciation
• 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.
3. Government Purchases
 Government purchases
– Expenditure on currently produced goods and services,
exclusive of government transfer payments.

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GDP from the Expenditure Side (4 of 4)
4. Net Exports
 Net exports = Exports – Imports

Measured from the expenditure side, GDP is equal to the

total expenditure on domestically produced output.

GDP = Ca + Ia + Ga + NXa

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Table 5-1 GDP from the Expenditure
Side, 2020 (1 of 2)
Category Billions of Dollars Percent of GDP
Consumption (C) Blank Blank
Durable goods 164.5 Blank
Semi-durable goods 84.1 Blank
Non-durable goods 317.8 Blank
Services 699.2 Blank
Blank 1265.6 57.4
Investment (I) Blank Blank
Plant and equipment 185.8 Blank
Residential structures 185.2 Blank
Inventories 19.8 Blank
Other 41.4 Blank
Blank 392.6 17.8

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Table 5-1 GDP from the Expenditure
Side, 2020 (2 of 2)
Category Billions of Dollars Percent of GDP
Government Purchases (G) Blank Blank
Current expenditure 498.7 Blank
Investment 94.2 Blank
Blank 592.9 26.9
Net Exports (X − IM) Blank Blank
Exports of goods and services 638.4 Blank
Imports of goods and services 683.7 Blank
Blank 45.3 2.1
Statistical Discrepancy 0.9 0.0
Total GDP 2204.9 100.0
• GDP measured from the expenditure side of the national accounts
gives the size of the major components of aggregate expenditure.
• (Source: Based on Statistics Canada, “Gross Domestic Product,
Expenditure based, Table 36-10-0104-01.)
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GDP from the Income Side (1 of 3)
• Involves adding up factor incomes and other claims
on the value of output until all of that value is
accounted for.
1. Factor Incomes
 Three main components of factor incomes: wages and
salaries, interest, and business profits.
2. Non-factor Payments
 Indirect taxes are taxes on the production and sale of
goods and services.
 Subsidies act like negative taxes. They are payments
from the government to firms.

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GDP from the Income Side (2 of 3)
• Some portion of current output replaces worn out
physical capital—depreciation.
• So from the income side, GDP is the sum of factor
incomes plus indirect taxes (net of subsidies) plus
depreciation.

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GDP from the Income Side (3 of 3)
• When we calculate GDP from the income side, we
include a “fudge factor”, called statistical
discrepancy.
• Statistical discrepancy makes sure that the
independent measures of income and expenditure
come to the same total.
• Although national income and national expenditure
are conceptually identical, in practice both are
measured with slight error.

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Table 5-2 GDP from the Income Side,
2020
Billions of Percent of
Category Dollars GDP
Factor Incomes Blank Blank
Wages, salaries, and supplementary income 1157.2 52.5

Interest and other investment income 210.3 9.5

Business profits (including rent) 279.5 12.7
Net Domestic Income at Factor Cost 1647.0 74.7
Non-factor Payments Blank
Depreciation 388.9 17.6
Indirect taxes less subsidies 168.1 7.6
Statistical Discrepancy 0.9 0.0
Total 2204.9 100.0

• GDP measured from the income side of the national accounts gives
the sizes of the major components of the income generated by
producing the nation’s output.
• (Source: Based on Statistics Canada, “Gross Domestic Product,
Income based, Table 36-10-0430-01.)
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5.3 National Income Accounting: Some
Further Issues
• Real and Nominal GDP
– Total GDP valued at current prices is called nominal
GDP.
– GDP valued at base-period prices is called real GDP.
• The GDP Deflator
– If nominal and real GDP change by different amounts
over a given time period, then prices must have
changed over that period.

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GDP from the Income Side
• We compare what has happened to nominal GDP and
real GDP by calculating the GDP deflator.
• The GDP deflator is an index number derived by
dividing nominal GDP by real GDP.
• Its change measures the average change in price of
all the items in GDP.

Nominal GDP
GDP Deflator  100
Real GDP
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Figure 5-2 Nominal and Real GDP in Canada,
1985–2020 (billions of dollars)

Nominal GDP tells us about the money value of output; real GDP tells us about the quantity of physical output.
Nominal GDP gives the total value of output in any year, valued at the prices of that year. Real GDP gives the total
value of output in any year, valued at prices from some base year, in this case 2012. The comparison of real and nominal
GDP implicitly defines a price index, changes in which reveal changes in the (average) prices of goods produced
domestically. Note that in 2012, nominal GDP equals real GDP (measured in 2012 prices), and thus the GDP deflator
equals 100.
(Source: Based on Statistics Canada, Table 36-10-0104-01.)

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GDP Deflator versus the CPI
• The GDP deflator does not necessarily change in line
with changes in the CPI.
• The two price indices are measuring different things.
• Movements in the CPI measure the change in the
average price of consumer goods.
• Movements in the GDP deflator reflect the change in
the average price of goods produced in Canada.

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Omissions from GDP
• GDP is an excellent measure of the flow of economic
activity in organized markets in a given year.
• But much economic activity takes place outside the
markets that the national income accountants survey.
• These activities include:
– Illegal Activities (Cannabis now formally included)
– The Underground Economy
– Home Production, Volunteering, and Leisure
– Free Products in the Digital World
– Economic “Bads”

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Do the Omissions Matter?
• The current approach to measuring GDP is useful
because:
1. It would be difficult to correct the major omissions.
2. The level of GDP may be inaccurate but the change
in GDP is a good indication of the changes in
economic activity.
3. To design policies to control inflation it is necessary to
know the flow of money payments made to produce
and purchase Canadian output. Modified measures
that included non-market activities would distort these
figures and likely lead to policy errors.

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GDP and Living Standards
• To what extent does GDP provide a useful measure of
our living standards?
• Changes in real per capita income are a good
measure of average material living standards.
• But material living standards are only part of what
most people consider their overall well-being.

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