Macroeconomics

Ninth Canadian Edition

Chapter 2
The Measurement and
Structure of the Canadian
Economy

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Main Questions
• How do we measure our current economic
activity?
• What is national income account?
• What are the relationships among key
macroeconomic variables
• How are the different sectors of the economy
related to each other?

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National Income Accounting (1 of 3)
• The national income accounts is an accounting
framework used in measuring current economic
activity.
• There are three approaches to calculate national
income.

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National Income Accounting (2 of 3)
• The product approach measures the amount of
output produced, excluding output used up in
intermediate stages of production.
– Value added = the value of output − the value of inputs
purchased from others.

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National Income Accounting (3 of 3)
• The income approach measures the incomes
received by the producers of output.
• The expenditure approach measures the amount
of spending by the ultimate purchasers of output.

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National Income Accounting Numerical
Example (1 of 3)
AppleInc Transactions
Wages paid to AppleInc employees 15,000
Taxes paid to government 5,000
Revenues received from the sale of 35,000
Apples sold to public 10,000
Apples sold to JuiceInc 25,000
JuiceInc Transactions
Wages paid to JuiceInc employees 10,000
Taxes paid to government 2,000
Apples purchased from AppleInc 25,000
Revenues received from the sales 40,000
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National Income Accounting Numerical
Example (2 of 3)
Product Approach
AppleInc value added 35,000
JuiceInc value added 15,000
Total Production 50,000
Income Approach
Wages income 25,000
Taxes paid to government 7,000
Profits 18,000
Total Income 50,000

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National Income Accounting Numerical
Example (3 of 3)
Expenditure Approach
Expenditures on apples 10,000
Expenditures on apple juice 40,000
Total Expenditures 50,000

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Why the Three Approaches Are
Equivalent (1 of 2)
• The market value of a good (product) and the
spending on a good (expenditure) are always the
same.
• The seller’s receipts (expenditure) are equal to the
total income generated by the economic activity
(income).

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Why the Three Approaches Are
Equivalent (2 of 2)
• Fundamental identity of national income
accounting:

total production = total income = total expenditure

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The Product Approach to Measuring
GDP (1 of 4)
• A nation’s gross domestic product (GDP) is the
market value of final goods and services newly
produced within a nation during a fixed period of
time.
• Using market values allows adding the production
of different goods and services.

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The Product Approach to Measuring
GDP (2 of 4)
• Problems with the market values:
– Some goods are not sold in markets.
– The underground economy – illegal activities and legal
activities hidden from the government.
– Lack of market values to use when calculating the
government’s contribution to the GDP.

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The Product Approach to Measuring
GDP (3 of 4)
• GDP includes only goods and services newly
produced within the current period. It is a sum of
value added – value of an output minus value of
its inputs.
• Intermediate goods are those used up in the
production of other goods in the same time period.

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The Product Approach to Measuring
GDP (4 of 4)
• GDP includes only final goods – not intermediate
goods, the end products.
• Capital goods and inventory investment are final
goods.

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GDP versus GNP (1 of 4)
• Gross national product (GNP) is the market
value of final goods newly produced by domestic
factors of production (capital, labour) during the
current period.

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GDP versus GNP (2 of 4)
• Canadian-owned capital and labour used abroad
produce output and income.
• This is included in Canadian GNP, not GDP.
• Foreign-owned capital and labour used in Canada
produce output and income.
• This is included in Canadian GDP, not GNP.

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GDP versus GNP (3 of 4)
• Net factor payments from abroad (NFP) is
– Income paid to domestic factors of production by the
rest of the world
– Minus income paid to foreign factors of production by
the domestic economy

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GDP versus GNP (4 of 4)

GDP + NFP = GNP

• In 2015 Canadian GDP was $1,983 billion and

Canadian GNP was $1,956 billion, a difference of
just over 1%.

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The Expenditure Approach to
Measuring GDP

Y = C + I + G + NX
Y = GDP
C = consumption
I = investment
G = government purchases of goods and services
NX = net exports of goods and services (exports
minus imports)

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The Expenditure Approach (1 of 3)
• GDP
– Total production or total income or total expenditure.
• Consumption (57.5% of GDP)
– Consumer durable goods
– Semi-durable goods
– Nondurable goods
– Services

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The Expenditure Approach (2 of 3)
• Investment (23.6% of GDP)
– Fixed investment
 Residential construction
 Nonresidential investment
 Machinery and equipment
– Inventory investment
– Government investment

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The Expenditure Approach (3 of 3)
• Government purchases of goods and services
(21.2% of GDP)
– Government purchases, other than capital goods;
– Transfers
• Net exports of goods and services
(−2.3% of GDP)
– Exports minus imports, which in 2015 was negative

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The Income Approach to Measuring
GDP (1 of 3)
• Compensation of employees: (51.6% of GDP)
– Total remuneration, in cash or in kind, payable by an
enterprise to an employee in return for work done
• Gross operating surplus: (25.7% of GDP)
– Income earned from the production of goods and
services that is paid to the owners of incorporated
companies
– Dividends and other sorts of investment income

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The Income Approach to Measuring
GDP (2 of 3)
• Gross mixed income: (11.7% of GDP)
– Income paid to unincorporated enterprises.
• Taxes less subsidies on production:
(4.3% of GDP)
– Taxes (less subsidies received) that companies pay on
the use of labour, machinery, buildings, or other assets
used in the production of goods and services.

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The Income Approach to Measuring
GDP (3 of 3)
• Taxes less subsidies on products and imports:
(6.6% of GDP)
– Taxes payable after a product is produced and sold in
Canada or imported from abroad.

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Private Sector and Government Sector
Income (1 of 3)
• Private disposable income (PDI) is the amount of
income the private sector has available to spend
after paying taxes and receiving government
transfers.

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Private Sector and Government Sector
Income (2 of 3)

Private Disposable Income  Y  NFP  T  TR  INT

Y = gross domestic product (GDP)

NFP = net factor payments from abroad
TR = transfers received from the government
INT = interest payments on the government’s debt
T = taxes

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Private Sector and Government Sector
Income (3 of 3)

Net Government Income  T  TR  INT

TR = transfers received from the government

INT = interest payments on the government’s debt
T = taxes

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Saving and Wealth
• Wealth is the difference between assets and
liabilities.
• National wealth is the wealth of an entire nation.
• Saving is current income minus spending on
current needs.

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The Government Budget Surplus and
Budget Deficit
• The government budget surplus is a positive
difference between government revenue (T) and
government expenditure (G + TR + INT).
• The government budget deficit is a negative
difference between T and (G + TR + INT).

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The Uses of Private Saving

S  Y  NFP  C  G
 (C  I  G  NX )  NFP  C  G
 I  ( NX  NFP )
 I  CA

CA is current account balance – payments received

from abroad for exports minus payments made to
foreigners for imports, NFP included.

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The Uses of Saving Identity

S  S govt  I  CA  S govt
S pvt  I  ( S govt )  CA

• Private saving is used in 3 ways

– Investment (I)
– Government budget deficit (−Sgovt)
– Current account balance (CA)

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Relating Saving and Wealth (1 of 2)
• Saving is a flow variable—a variable that is
measured per unit of time.
• Wealth is a stock variable—a variable that is
measured at a point in time.

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Relating Saving and Wealth (2 of 2)
• National wealth
– Country’s domestic physical assets
– Country’s net foreign assets =
country’s foreign assets – its foreign liabilities.
• National wealth can change through changes in
value of national saving (I + CA).

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Real GDP
• Nominal GDP (or current-dollar GDP) is the dollar
value of an economy’s final output at current
market prices.
• Real GDP (or constant-dollar GDP) is the physical
volume of an economy’s final output using the
prices of a base year.

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GDP Deflator (1 of 2)
• A price index is a measure of the average level of
prices for some specified set of goods and
services.
• The GDP deflator is a price index that measures
the overall level of prices of goods and services
included in GDP.

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GDP Deflator (2 of 2)

Nominal GDP
GDP Deflator 
Real GDP

• The measurement of real GDP and the GDP

deflator depends on a choice of a base year.

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The Consumer Price Index
• The consumer price index (CPI) measures the
price of consumer goods.
• The CPI is calculated for a fixed consumer
“basket.”
• The basket should be occasionally updated or
chain-weighted indexes should be used.

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CPI and Inflation
• The rate of inflation is the percentage rate of
increase in a price index (the CPI, for example)
per a period of time.

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The Rate of Inflation

( Pt 1  Pt ) Pt 1
 t 1  
Pt Pt

πt+1 is the rate of inflation between t and t+1

Pt is the price level in period t
Pt+1 is the price level in period t+1
ΔPt+1 is change in the price level between t and t+1
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Real versus Nominal Interest Rates (1 of 2)
• An interest rate is a rate of return promised by a
borrower to a lender.
• We talk about “the” interest rate. Although they are
numerous, they move up and down together.

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Real versus Nominal Interest Rates (2 of 2)
• The real interest rate is the rate at which the real
value of an asset increases over time.
• The nominal interest rate (i) is the rate at which
the nominal value of an asset increases over time.

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Real Interest Rate

real interest rate  i  

i = nominal interest rate

π = inflation rate

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Expected Real Interest Rate
• The expected real interest rate (r) is the rate at
which the real value of an asset is expected to
increase over time.

r =iπ e

πe = an expected inflation rate

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