Gross Domestic Product Essay Sample

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Gross Domestic Product (GDP) – is the total market value of all FINAL gods and services produced within a country in a year. It is used for measuring the economic growth of a country – how much a country’s economy has grown from one year to the next

GDP can be calculated in two ways:
1. Expenditure Approach: add p the total spent on final goods and services in one year 2. Income Approach: add up all the income earned in producing final goods in one year (GDP should be same in each case, since an expenditure for one person is an income for another)

Expenditure Approach Formula for GPD: C + G + I + (X – M)
C = consumption; what households spend on goods and services (such as durable goods, semi-durable goods, non-durable goods, services)

G = government spending; all government purchases by all levels of government (such as employee wages, office supplies, hospitals, schools)

I = Investments; purchase of new capital goods for the use in the. (Production process, construction of new buildings, changes in business inventories)

X = Exports, M = Imports
(X – M) = net exports

Two types of GDP
Nominal GDP; Is the production of goods and services valued at current prices (not adjusted for inflation) Real GDP; Unlike nominal GDP, real GDP can account for changes in the price level, and prove a more accurate figure

A rising GDP indicates a strong and expanding economy.
A falling GDP is associated with higher unemployment and overall economic weakness.

Things the GDP does not included
1. Intermediate goods and services, which are inputs in the production of goods (i.e. Steel) 2. Second hand goods (not included, since they were already previously counted) 3. Buying & selling of stocks

4. Transfer payments (social security benefits, unemployment compensation, scholarships) 5. Profits from Canadian owned companies overseas & income earned by Canadian citizens ….working aboard 6. Non-market goods and services (baby-sitting)

7. Illegal goods and services (drugs)

Drawbacks to GDP
1. Population size –
2. Non-market production –
3. Underground economy –
4. Types of goods produced –
5. Leisure –
6. Environmental degradation –
7. Distribution of income –
8. Improved quality –

Nominal GDP (Money GDP): Is the production of goods and services valued at current prices (not adjusted for inflation) (I.E. – if real output was the same in 2007 and 2008, but the prices were higher in 2008, the GDP would appear to have grown although real output did not increase at all)

Real GDP (constant dollar’s GDP): GDP that accounts for changes in the price level, and provides a more accurate figure than Nominal GDP

GDP deflator: Is a price index for all goods and services produced, it illustrates how much of the change in the GDP from a base year is reliant on changes on the price level

Real GDP (Rearrange to find GDP deflator, Nominal GDP):

GDP deflator:

Nominal GDP:

Real GDP growth rate:

Aggregate Demand (AD)
The TOTAL demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels.

Factors that will shift the AD curve:
1. Changes in consumption
Consumer income can be divided into 4 possible uses
i) Consumption (60%)
ii) Pay government taxes
iii) Saved for future use
iv) Spent on imports
Increased consumption shifts AD curve right. Decreased consumption shifts AD curve left.

2. Changes in investment
Increased investments (expected higher profits) shifts AD curve right Decreased investments (expected lower profits of a company) shifts AD curve left Increased interest rates tend to reduce investment spending shifts AD curve left Decreased interest rates tend to increase investment spending shifts AD curve right

3. Changes in Government Spending
Increased government spending shifts AD curve right
Decreased government spending shifts AD curve left

4. Changes in Export Demand (foreign trade)
Increased exports shifts AD curve right
Decreased exports shifts AD curve left

Conclusion of the AD curve
– An economy with too little AD will have a recessionary gap that will reflect unemployment, low inflation and low levels of GDP – An economy with too much AD will have a inflationary gap that reflects high employment, high inflation, and high levels of GDP – Movements of the AD curve can explain alternating periods of growth and contraction

Draw examples:

Aggregate Supply (AS)
The TOTAL OUTPUT produced in the economy at different price levels

Factors that affect the AS curve:
1. Changes in price of inputs
If land, labour, capital decreases – firms will produce less at each price level If land, labour, capital increases – firms will produce more at each price level

2. Changes in amount of inputs available
New resources are discovered, more capital goods, workforce grows will mean more inputs available for use.

3. Changes in efficiency
Improvements in technology make the workforce more productive, meaning they can produce more with the same resources


Leading Indicators
The Canadian Composite Leading Indicator is comprised of 10 components which lead cyclical activity in the economy and represent all the major categories
of the GDP. Leading Indicators anticipate the short-term course of the economy because they are sensitive indicators of what consumers and business actually have begun to buy and produce.

Ten components to ensure adequate coverage and back-up:
1. Furniture and appliance sales
2. Other durable goods sales
3. House spending Index
4. New orders for durable goods
5. Shipments to inventory ratio of finished goods
6. Average work week (hours)
7. Business and personal service employment
8. United States composite leading Index
9. TSE 300 stock price index
10. Money supply

Phases of the Business Cycle
Expansion – The phase that follows through, and output begins to expand and income increases, consumption expenditures and employment also sees increases. Business people are optimistic; people are confident and feel good about the economy.

Peak – When the economy’s resource has reached capacity, is the peak. During the peak, real GDP has reached its highest level, and since the economy’s resources are fully employed, increases in demand lead not to increases in real output but to increases in prices.

Recession – Consumption and investment spending decline, business are becoming unprofitable. Real output decreases and unemployment increases, and it is not a good time to call an election

Trough – Actual output might be significantly less than potential output. Unemployment tends to be high; business people’s expectations for the future are pessimistic, resulting in lower investment. Banks will experience an increase n the amount of money available for loans because of inability to find good and willing borrowers. Fall of real output and the increase in unemployment = trough (depression)

Monetary Policy
A monetary authority of a country (Bank of Canada) controls the interest rate and money supply to obtain a set of objectives oriented towards the growth and stability of the economy.

Tight Monetary Policy (To control Inflation)
1. Decrease AD, and reduce upward pressure on prices
2. Increase interest rates (shift AD curve to left)
(to discourage borrowing & spending and to decrease disposable income of consumers)

Easy Monetary Policy (To combat Recession)
1. Decrease interest rates (shift AD curve to right)
(to stimulate economic growth and lower unemployment rates and increase disposable income of consumers)

Fiscal Policy
Changes in government spending and tax revenues to influence the level of AD

Changes in Spending
1. Increase/decrease government expenditures (building/repairing roads, bridges, parks) 2. Government spending on transfer payments also tend to increase during a recession to provide more support to help AD

Changes in Taxation
1. Increase / decrease of taxes
2. Reducing taxes during a recession can boost aggregate demand by leaving households and business with more money to spend (reduction in personal taxes lead to more $$$ for consumers)


Types of Unemployment
Cyclical Unemployment – Caused by periodic cyclical weaknesses in aggregate demand associated with recessions

Frictional Unemployment – Caused by people being temporarily out of work because they are in the process of changing jobs

Seasonal Unemployment – Caused by seasonal downturns in employment in some industries

Structural Unemployment – Caused by a mismatch between the skills required by employers and those of unemployed people (robots, usually technology replacing humans)

Unemployed – people are not working, but they are ACTIVELY seeking work Labour Force – people have jobs & unemployed people

Labour force DOES NOT include:
1. Discouraged workers; ppl not seeking work actively b/c they believe they can’t find a job)
2. People under 15 years old
3. Institutional people (prison, school)
4. People who could work, but chose not too (retired people, homemakers)

Unemployment Rate; % of the labour force that is actively seeking work but is unable to find work at a given time

It is a key indicator of the health of the economy and society. When economic growth is strong, the unemployment rate tends to be low, and vice versa.

The # of people unemployed is not the same as the # of people receiving employment insurance (EI) since not everyone is eligible for the benefits.

Limitations of Employment Data

Hidden Unemployed
Underemployed and discouraged workers are referred to as “hidden unemployed”, if they were included the official unemployment rate would significantly increased.

1. Underemployment; part time workers are recorded as fully employed Workers may have jobs that do not fully utilize their skills and education 2. Discouraged Workers
People would like to work, but have stopped looking because they believe there are no job opportunities

Costs of Unemployment
1. Less consumer spending
2. Lower tax revenues for the government
3. Lower incomes
4. Higher EI payments by the government
5. Human/society problems (loss of skills, self-esteem lost, family/social problems, crime, political upheaval)

# of unemployed people = Labour Force – Employed
Employment Rate = (Employed people / Labour Force) x 100
Unemployment Rate = (Unemployed people / Labour Force) x 100 Participation Rate = (Labour Force / Population) x 100

The GDP gap – The forfeited output of a country’s economy resulting from the failure to create sufficient jobs for all those willing to work.

Natural rate of unemployment; an economy like Canada has an unemployment rate in the range of 6-7%

Unemployment means we are not using all of our labour resources, financial cost of EI programs, lost tax revenues, and potentially creating a budget deficit.

Okun’s Law
For every percentage point that the actual unemployment rate exceeds the natural rate, a GDP gap of 2% occurs

Formula for GDP gap:

Price Stability

Types of Inflation (Read Sheet called, ‘Inflation: a general rise in prices in the economy’) Demand-Pull Inflation: excessive increases in aggregate demand relative to available aggregate production Cost-Push Inflation: passing down increased operating cost from producer to consumer

Consumer Price Index (CPI): A price index that measures changes, through time, in the prices of a fixed basket of consumer goods

Basket of goods: StatsCan surveys Canadians about their usual spending on consumer goods and services, and this survey will determine the contents in the ‘basket of goods’

Steps in calculating CPI
1. Calculate the basket of goods, the value of the basket of goods is a ( $ dollar amount)
2. Calculate CPI (number)
3. Calculate the inflation rate (percentage)

The CPI for the base year is always 100.

CPI for a particular year:


Negative effects of Inflation (See notes)
1. Exports
2. Economically Weak
3. Saving – Investment Process

Limitations of CPI (See notes)
1. Fixed Weights
2. Quality of Products
3. CPI only looks at consumer goods

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