# The Measurement of National Income

The Measurement of National Income
The Measurement of National Income
Question 2
a) GDP; GNP
b) prices; quantities (real output); base-period; real
c) average income per person
d) productivity
Question 4
a) Using the expenditure approach, GDP = C I G NX, where C is consumption
(3900), I is gross private investment (1100 = 950 150), G is government purchases
(1000), and NX is net exports (–40 = 350 –390). Therefore, GDP = 3900 1100 1000 –
40 = 5960 (millions of dollars).
b) Using the income approach, GDP = wage and salaries (5000) plus interest (200) plus
business profits (465) plus indirect taxes less subsidies (145 = 175 – 30) plus depreciation
(150). The total is 5960 (millions of dollars).
c) Net domestic income at factor cost is just the total of factor payments, which is the sum
of wages and salaries plus interest plus business profits. Therefore, net domestic income at
factor cost is 5000 200 465 = 5665 (millions of dollars).
Question 6
Generally the two measures of inflation will be similar but not identical. Inflation as
measured by the rate of change of the GDP deflator indicates the change in prices of goods
and services produced in the Canadian economy. Inflation as measured by the rate of
change of the Consumer Price Index indicates the change in prices of the goods and
services consumed by the average Canadian household. The two “baskets of goods” are
different. For example, forestry products (and the goods derived therefrom) will have a
larger weight in the Canadian GDP deflator than in the CPI because Canada is a large net
exporter of forestry products. Conversely, coffee, sugar, and tropical fruits and vegetables
will have a larger weight in the CPI than in the GDP deflator because Canada consumes but
does not produce these goods. So, in general, changes in the prices of traded goods will
tend to influence the two price indexes differently. But even large changes in the prices of
individual traded goods will have a small effect on either overall price index for the simple
reason that the indexes are made up of many goods, each good having a very small weight.
The two indexes tend to move together because the overall inflationary (or deflationary)
pressures in the economy tend to apply to all goods and services.
Question 8
The Measurement of National Income
a) Nominal GDP is simply the sum of price × quantity for the two goods. The values are:
Year 1: Nominal GDP = (100 × \$2) (40 × \$6) = \$200 \$240 = \$440
Year 2: Nominal GDP = (120 × \$3) (25 × \$6) = \$360 \$150 = \$510
b) Real GDP is computed by using the prices from the base year. Since Year 1 is the base
year, nominal and real GDP are the same in that year. The values are:
Year 1: Real GDP = (100 × \$2) (40 × \$6) = \$200 \$240 = \$440
Year 2: Real GDP = (120 × \$2) (25 × \$6) = \$240 \$150 = \$390
Real GDP falls from Year 1 to Year 2 by a percentage equal to (390 – 440)/440 = –0.113 or
–11.3 percent.
c) The GDP deflator is equal to (Nominal GDP/Real GDP) × 100. Using Year 1 as the base
year, nominal and real GDP are the same in Year 1. The values for the deflator are:
Year 1: Deflator = (440/440) × 100 = 100
Year 2: Deflator = (510/390) × 100 = 130.8d) This was done in (c). In Year 1 the deflator is 100. In Year 2 the deflator is 130.8.
e) To do this we must first compute real GDP in both years, using Year 2 as the base year.
Since Year 2 is the base year, nominal and real GDP are the same in that year. The values
of real GDP are:
Year 1: Real GDP = (100 × \$3) (40 × \$6) = \$300 \$240 = \$540
Year 2: Real GDP = (120 × \$3) (25 × \$6) = \$360 \$150 = \$510
Now, compute the GDP deflator (base year 2) as:
Year 1: Deflator = (440/540) × 100 = 81.5
Year 2: Deflator = (510/510) × 100 = 100.0
f) Let’s compile the information we have gathered in the following table.
Base Year Change of Real GDP Change in GDP Deflator
Year 1 –11.3% 30.8%
Year 2 (510 – 540)/540 = –5.6% (100–81.5)/81.5=22.7%
These numbers may look puzzling. Does real GDP fall by 11.3% or only 5.6%? Do prices
rise by 30.8% or only by 22.7%? Which are the “correct” figures?
This is a good way to understand why the choice of base year affects calculations of
real GDP and the GDP deflator. The key point here is that if there are changes in relative
prices from one year to the next, then the choice of base year will matter. To understand
why, suppose we choose Year 1 as the base year. In this case, the relative price of honey to
milk is 6/2 or 3. The very large drop in the quantity of honey produced (from 40 to 25 kg)
is weighted heavily, and thus real GDP drops significantly. But if we use Year 2 as the base
year, the relative price of honey to milk is 6/3 or only 2. In this case, the same large drop in
the quantity of honey gets a smaller weight than in the case where Year 1 is the base year.
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