Chapter 6: Measuring Total Output and Income

Start Up:

It is early morning when a half-dozen senior officials enter a room at the Finance Department in Ottawa. Once inside, they get to work to calculate one of the most important indicators of economic activity we have: the official estimate of the value of the economy’s total output, known as its gross domestic product (GDP).

When the team has finished its computations, the results will be placed in an envelope and shared with other finance executives and the Prime Minister. The senior officials who meet to compute GDP are economists. The adviser who delivers the estimate to the PM is on his Council of Economic Advisers.

Once this information is shared it will appear in major stories on the Internet and in the next editions of the nation’s newspapers; the estimate of the previous quarter’s GDP will be one of the lead items on television and radio news broadcasts that day. It is a very important statistic. The estimate of GDP provides the best available reading of macroeconomic performance. It will affect government policy, and it will influence millions of decisions in the private sector. Prior knowledge of the GDP estimate could be used to anticipate the response in the stock and bond markets, so great care is taken that only a handful of trusted officials have access to the information until it is officially released.

The GDP estimate took on huge significance in the fall of 2008 as the Canada, the United States, and much of the rest of the world went through the wrenching experience of the worst financial crisis since the Great Depression of the 1930s. The expectation that the financial crisis would lead to an economic collapse was widespread, and the quarterly announcements of GDP figures were more anxiously awaited than ever.

The primary measure of the ups and downs of economic activity—the business cycle—is real GDP. When an economy’s output is rising, the economy creates more jobs, more income, and more opportunities for people. In the long run, an economy’s output and income, relative to its population, determine the material standard of living of its people.

Clearly GDP is an important indicator of macroeconomic performance. It is the topic we will consider in this chapter. We will learn that GDP can be measured either in terms of the total value of output produced or as the total value of income generated in producing that output. We will begin with an examination of measures of GDP in terms of output. Our initial focus will be on nominal GDP: the value of total output measured in current prices. We will turn to real GDP—a measure of output that has been adjusted for price level changes—later in the chapter. We will refer to nominal GDP simply as GDP. When we discuss the real value of the measure, we will call it real GDP.

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