4 MONITORING THE VALUE

OF PRODUCTION: GDP
(Part 1)
After studying this chapter, you will be able to:
 Define GDP and explain why GDP equals
aggregate expenditure and aggregate income
 Explain how the Statistics Canada measures GDP
and real GDP
 Describe how real GDP is used and explain its
limitations as a measure of economic well-being
 Gross Domestic Product

GDP Defined
GDP or gross domestic product is the market value of
all final goods and services produced in a country in a
given time period.
This definition has four parts:
 Market value
 Final goods and services
 Produced within a country
 In a given time period

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 Gross Domestic Product

Market Value
GDP is a market value—goods and services are valued at
their market prices.
To add apples and oranges, computers and popcorn, we
add the market values so we have a total value of output
in dollars.

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 Gross Domestic Product

Final Goods and Services

GDP is the value of the final goods and services produced.
A final good (or service) is an item bought by its final user
during a specified time period.
A final good contrasts with an intermediate good, which
is an item that is produced by one firm, bought by another
firm, and used as a component of a final good or service.
Excluding the value of intermediate goods and services
avoids counting the same value more than once.

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 Gross Domestic Product

Produced Within a Country

GDP measures production within a country—domestic
production.
In a Given Time Period
GDP measures production during a specific time period,
normally a year or a quarter of a year.

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 Example 1

Does my purchase of a Ford car that was

manufactured in Windsor, Ontario in 2000 add to
the current Canadian GDP? Why? How about my
purchase of a domestically produced, newly
produced Ford? Why?

The purchase of the used Ford does not add to the

current Canadian GDP though it did add to GDP in
2000 when the car was newly produced. GDP
measures production within a given time period and
the used Ford was not produced within the current
year.
A new Ford car is counted in current Canadian GDP
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 Example 2

To estimate GDP you add the value of all the goods

and services produced, both final and intermediate
goods. Is this procedure correct? Why?

Adding all the goods and services produced is

incorrect because it will lead to significant double
counting. Intermediate goods and services will be
double counted.
For instance, if a CPU produced by Intel and then
used in a Dell computer is counted both as a CPU
from Intel and as part of the computer from Dell,
the CPU has been double counted.
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 Example 3

Does my purchase of 100 shares of stock in Google

add to the nation's GDP? Why?

Purchasing shares of stock does not add to the

nation’s GDP. GDP measures production. Shares of
stock are not the production of a good or service
and therefore are not included in GDP.

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 Example 4

If a homeowner cuts his or her lawn, is the value of

this work included in real GDP? Suppose that the
homeowner hires a neighbourhood student to cut
the lawn. Is this activity included in real GDP?

The homeowner’s work around his or her home is

not included in GDP because home production is
excluded. Hiring a neighbourhood student to cut the
lawn is, in theory, included in GDP because it is a
service that has been sold in a market.

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 Gross Domestic Product

GDP and the Circular Flow of Expenditure and Income

GDP measures the value of production, which also equals
total expenditure on final goods and total income.
The equality of income and value of production shows the
link between productivity and living standards.
The circular flow diagram in Figure 4.1 illustrates the
equality of income and expenditure.

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 Gross Domestic Product

The circular flow diagram shows the transactions among

households, firms, governments, and the rest of the world.

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 Gross Domestic Product

Households and Firms

Households sell and firms buy the services of labour,
capital, and land in factor markets.
For these factor services, firms pay income to households:
wages for labour services, interest for the use of capital,
and rent for the use of land. A fourth factor of production,
entrepreneurship, receives profit.
In the figure, the blue flow, Y, shows total income paid by
firms to households.

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Gross Domestic Product

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 Gross Domestic Product

Firms sell and households buy consumer goods and

services in the goods market.
Consumption expenditure is the total payment for
consumer goods and services, shown by the red flow
labelled C .
Firms buy and sell new capital equipment in the goods
market and put unsold output into inventory.
The purchase of new plant, equipment, and buildings and
the additions to inventories are investment, shown by the
red flow labelled I.

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Gross Domestic Product

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 Gross Domestic Product

Governments
Governments buy goods and services from firms and their
expenditure on goods and services is called government
expenditure.
Government expenditure is shown as the red flow G.
Governments finance their expenditure with taxes and pay
financial transfers to households, such as unemployment
benefits, and pay subsidies to firms.
These financial transfers are not part of the circular flow of
expenditure and income.

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Gross Domestic Product

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 Gross Domestic Product

Rest of the World

Firms in Canada sell goods and services to the rest of the
world—exports—and buy goods and services from the
rest of the world—imports.
The value of exports (X ) minus the value of imports (M) is
called net exports, the red flow X – M.
If net exports are positive, the net flow of goods and
services is from Canadian firms to the rest of the world.
If net exports are negative, the net flow of goods and
services is from the rest of the world to Canadian firms.

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Gross Domestic Product

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 Gross Domestic Product

The blue and red flows are the circular flow of expenditure
and income.

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 Gross Domestic Product

The sum of the red flows equals the blue flow.

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 Gross Domestic Product

That is: Y = C + I + G + X – M

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 Gross Domestic Product

The circular flow shows two ways of measuring GDP.

GDP Equals Expenditure Equals Income
Total expenditure on final goods and services equals GDP.
GDP = C + I + G + X – M.
Aggregate income equals the total amount paid for the use
of factors of production: wages, interest, rent, and profit.
Firms pay out all their receipts from the sale of final goods,
so income equals expenditure,
Y = C + I + G + (X – M).

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 Gross Domestic Product

Why Is Domestic Product “Gross”?

“Gross” means before deducting the depreciation of
capital.
The opposite of gross is net.
“Net” means after deducting the depreciation of capital.

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 Gross Domestic Product

Depreciation is the decrease in the value of a firm’s

capital that results from wear and tear and obsolescence.
Gross investment is the total amount spent on purchases
of new capital and on replacing depreciated capital.
Net investment is the increase in the value of the firm’s
capital.
Net investment = Gross investment  Depreciation.

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 Gross Domestic Product

Gross investment is one of the expenditures included in

the expenditure approach to measuring GDP.
So total product is a gross measure.
Gross profit, which is a firm’s profit before subtracting
depreciation, is one of the incomes included in the income
approach to measuring GDP.
So total product is a gross measure.

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 Measuring Canadian GDP

The Bureau of Economic Analysis uses two approaches to

measure GDP:
 The expenditure approach
 The income approach

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 Measuring Canadian GDP

The Expenditure Approach

The expenditure approach
measures GDP as the sum of
the red flow: consumption
expenditure, investment,
government expenditure on
goods and services, and net
exports.
GDP = C + I + G + (X  M)
Table 4.1 on the next
slideshows the expenditure
approach with 2020 data.
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 Measuring Canadian GDP

The Income Approach

The income approach
measures GDP by summing
the incomes that firms pay
households for the factors
of production they hire.
Two broad categories are
1. Wages, salaries, and
other labour income
2. Other factor incomes

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 Measuring Canadian GDP

The payment for labour

services is the sum of all
wages plus benefits such as
pension contributions and is
shown by the blue flow W.
Other factor incomes are a
mixture of interest, rent, and
profit and includes some
labour income from self-
employment. They are
included in the blue flow
OFI.

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 Measuring Canadian GDP

The other factor incomes

are net incomes after
deducting depreciation.
To get them to a gross
measure, we must add
depreciation.
Other factor incomes plus
depreciation are included in
the blue flow OFI.

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 Measuring Canadian GDP

The flows W and OFI sum to gross domestic income at

factor cost.
GDP measured by the expenditure approach is valued at
market prices.
So we must add indirect taxes and subtract subsidies to
get from factor cost to market prices.
The gap between the expenditure approach and the
income approach is the statistical discrepancy and it
equals GDP expenditure total minus GDP income total.
Table 4.2 on the next slide shows the income approach
with data for 2020.
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 Measuring Canadian GDP

Nominal GDP and Real GDP

Real GDP is the value of final goods and services
produced in a given year when valued at valued at the
prices of a reference base year.
Currently, the reference base year is 2012 and we
describe real GDP as measured in 2012 dollars.
Nominal GDP is the value of goods and services
produced during a given year valued at the prices that
prevailed in that same year.
Nominal GDP is just a more precise name for GDP.

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