Introduction to Macroeconomics - GDP and Its Components - PDF Lecture Notes

Measurement: GDP and its components Introduction to Macroeconomics - Winter 2025 1 Jean-Paul Lam January 13, 2025 1 These lecture notes are the prope...

Measurement: GDP and its components Introduction to Macroeconomics - Winter 2025 1 Jean-Paul Lam January 13, 2025 1 These lecture notes are the property of the author. They are intended for the Econ 102 class and can only be used and shared with students registered in the class. You cannot reproduce these notes with the intent of distributing them to anyone not registered in this course or online for and not for profit without my written consent. 1 / 110  Economic Data - the trinity This and the following lectures focus on some vital economic statistics, in particular on 1 The Gross Domestic Product (GDP) National Accounts 2 Consumer Price Index (CPI) Consumer price index 3 The Unemployment Rate Labour force survey Policymakers and economists use these statistics to understand how the economy is performing, formulate policy, and forecasting These statistics are often regarded as the most important measures of how a country is performing at any given period in time 2 / 110  GDP, CPI and Unemployment rate GDP provides a measure of how much goods and services Canada is producing at a given point in time The CPI measures the rate at which aggregate prices are increasing over time in Canada The unemployment rate is a measure of how many people who are actively looking for work did not at a given point in time In Canada, these three statistics are computed and published by Statistics Canada 3 / 110  Economic Data Statistics Canada publishes GDP and its components every three months or every quarter. GDP is part of the Canadian System of Macroeconomic Accounts (CSMA), more precisely, the System of National Economic Accounts (SNEA). CSMA The CSMA also includes productivity measures, international accounts and international trade data, data on government finances and provincial measures of output The CSMA adheres to an international set of standards on how to measure economic activity, making it easy to compare Canadian GDP across time and countries 4 / 110  Statistics Canada computes GDP Statistics Canada has collected and computed GDP for an extended period, and we have a time series of them A time series is a collection of observations of the same variable over time For example, on the website of Statistics Canada, you can easily find data on Canadian GDP from 1961 Quarter 1 (1961Q1), the unemployment rate from January 1976 and the CPI from January 1914. Historical GDP data, that is before 1961, exists, but it is not as easily accessible 5 / 110  What is GDP? We start with GDP and its components Statistics Canada video on GDP GDP is a measure of the total market value of the amount of goods and services produced in Canada in a given year It is a measure of aggregate economic activity, that is, how much goods and services Canada is producing at a given point in time. GDP as a measure of economic activity was introduced in 1937 when economies were mostly manufacturing-based 6 / 110  When is GDP published? In Canada, GDP is computed every three months or every quarter I 1st quarter ending March 31 (data published on May 31) I 2nd quarter ending June 30 (data published on August 31) I 3rd quarter ending September 30 (data published on November 30) I 4th quarter ending December 31 (data published on February 28) Statistics Canada publishes the statistical estimates of GDP about 2 months after the end of the reference quarter This can be a problem since policymakers make decisions in real time and have to decide on some policies even before seeing the data 7 / 110  Monthly Gross Domestic Product But Statistics Canada also publishes monthly industry-level GDP that offers a more immediate snapshot of how the economy is doing The monthly GDP data focuses on industries and uses the output method Other methods of GDP (income and expenditure) which contain vital information about the economy are only published quarterly Statistics Canada also computes GDP for each province in Canada, but the data is only available every year (usually published 6-9 months after the year ends). 8 / 110  GDP is a measure of how well we are doing Economists, politicians and the media often use GDP to measure how well a country is doing and for many other policy decisions GDP tells us how much we are producing, and since it is published every 3 months (quarterly), we know whether or not we are producing more or fewer goods and services over time As it is a standardized measure across time and regions, it is also the measure we use to compare how well we are doing relative to other countries 9 / 110  A first look at Real v/s Nominal GDP GDP is a measure of the market value of all final goods and services produced in a given country at a given time. For example, the market value of apples produced in 2024 = the price of apples at a given period in time × the quantity of apples produced in 2024 The market value of all goods and services can be measured using current prices (2024 prices) or constant prices (for example, 2017 prices) Real GDP is computed using constant prices, and nominal GDP is calculated using current prices Economists focus on real GDP since we want to know whether or not the quantity of goods and services produced has changed over time if prices stayed constant 10 / 110 GDP focuses on the market value of goods and services Since GDP focuses on the market value of goods and services; this implies that some goods and services are not counted in GDP I Baking cookies at home and eating them is not counted in GDP I Baking cookies at home and selling them in a store is counted in GDP I Producing and selling marijuana legally is counted in GDP I Producing and selling marijuana illegally is not counted in GDP 11 / 110 GDP only includes goods and services produced at home Other important details about the computation of GDP: I GDP counts only the goods and services produced within a country F Only goods produced in Canada are counted in Canada’s GDP, even if the firm or worker producing the good is not Canadian F A good produced by a Canadian living in the U.K is not counted in Canada’s GDP but is included in UK’s GDP F GM producing cars in Ontario is counted in Canada’s GDP, although GM is a U.S. company. F The output of Bombardier, based in West Virginia, is not counted in Canada’s GDP even though it is a Canadian company. 12 / 110  GDP as a time series Since Statistics Canada publishes GDP every quarter, we have a time series on GDP Time series are helpful since we can study how a variable evolves over time We compare the current level of GDP with its past level to know whether or not and by how much GDP has grown or shrunk over time Hence, one of the transformations that we do with GDP is to calculate its growth rate, that is, the rate at which it is changing from one year to another or from one quarter to another 13 / 110  YoY Growth Rate Calculation Table: Canadian GDP (millions of 2017 $) Year GDP (2017 dollars) YoY growth rate 2019 Q3 2,248,933 2020 Q3 2,146,901 −4.54 % 2021 Q3 2,266,642 5.58 % 2022 Q3 2,362,933 4.25 % 2023 Q3 2,383,979 0.89 % 2024 Q3 2,419,572 1.49 % The year over year growth rate of GDP (in percent) from 2023Q3 to 2024Q3 is thus   2419572 − 2383979 GDP YoY growth = × 100 = 1.49% 2383979 This implies that GDP in 2024Q3 (using 2017 prices) was 1.49 percent higher than the same period one year ago 14 / 110  Annualized v/s YoY Growth Rate Statistics Canada and the Bureau of Economic Analysis in the U.S. calculate the annualized growth rate of GDP instead of the year over year growth rate The year-over-year (YoY) growth rate measures how GDP has changed compared to the same period the previous year The annualized growth rate uses short-term growth (e.g., monthly or quarterly growth) to predict what the growth would be if it continued at the same rate for a full year. With the annualized growth rate, we estimate how much GDP would change over one year if the growth observed over a quarter continued at the same rate throughout the year. The Daily, Nov 29, 2024 15 / 110  Annualized Growth Rate Table: Canadian GDP (millions of 2017 $) Year GDP (2017 dollars) YoY growth rate Annualized growth rate 2019 Q3 2,248,933 2020 Q3 2,146,901 -4.54 % 41.59 % 2021 Q3 2,266,642 5.58 % 8.30 % 2022 Q3 2,362,933 4.25 % 2.44 % 2023 Q3 2,383,979 0.89 % -0.55 % 2024 Q3 2,419,572 1.49 % 1.03 % 16 / 110  Annualized versus YoY growth rate For example,  the annualized  growth rate of GDP for 2024Q3 is calculated as 4 GDP2024Q3 follows GDP2024Q2 − 1 × 100 Given that the value of GDP in 2024Q3 was 2,419,572 and the value of GDP in 2024Q2 was 2,413,400 , the annualized growth rate of GDP (in percent) in 2024Q3, is thus " 4 # 24195724 GDP Annualized growth = − 1 × 100 = 1.03% 2413400 It means that if GDP continues to grow at the same rate it did from the period 2024Q2 to 2024Q3, GDP would change at 1.03% over a period of one year or 4 quarters. 17 / 110 Annualized versus YoY growth rate, which one to use? Canada, the U.S and many other countries compute the annual growth rate of GDP using the Annualized growth rate On the other hand, many other countries, such as China, India, and some EU countries use YoY growth rate Annualized growth rate focuses on the short-term changes of the economy to reflect annual growth, whereas YoY focuses more on longer-term trends YoY calculation evens out seasonal and short-term variations better than annualized growth rate measures 18 / 110  Recessions and Booms If the growth rate is positive (negative), it implies that GDP has increased (decreased) from one period to another If real GDP falls for two consecutive quarters, economists argue that the economy might be in a recession; that is, the economy has suffered a general slowdown in economic activity. A recession is defined as a period of an economic slowdown that lasts for several months, and that is spread across the economy Economists typically look at other variables (industrial production, employment, and real income) and not only real GDP growth to determine whether the economy is in a recession or not NBER Business Cycle Dating Committee 19 / 110 Canada’s GDP (chained 2017 dollars), 1961Q1-2024Q3 2.5 2.5 2 2 trillions of dollars 1.5 1.5 1 1 0.5 0.5 0 0 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 20 / 110 Annualized Growth Rate of Canada’s GDP (chained 2017 dollars), 1961Q1-2024Q3 50 50 40 40 30 30 20 Average growth rate of GDP = 3.14% 20 10 10 Percent 0 0 -10 -10 -20 -20 -30 -30 -40 -40 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 and author’s calculation 21 / 110  Changes in Canadian GDP (2017 prices) A few observations about Canada’s GDP (2017 prices) and GDP growth 1 GDP has been trending up since 1961Q1 at an average rate of 3.14% per year 2 However, since 1961, GDP has contracted several times, such as in the early 1980s, early 1990s, 2007-2008 and 2020Q2 3 The annualized growth rate of real GDP has varied considerably from decade to decade 4 The fall in GDP growth in 2020Q2 was huge, but GDP growth bounced back immediately Table: Average annualized growth rate of Canadian real GDP by decade Year Average growth rate (percent) 1961 - 1970 5.88 1971 - 1980 4.10 1981 - 1990 2.80 1991 - 2000 2.59 2001 - 2010 1.99 2011 - 2020 2.25 2021 - 2024Q3 2.51 5 Slower growth rate compared to 1960-1990 6 Many economists expect GDP to grow at a rate of around 2% in the following decades - is this the new normal? 22 / 110  Trend growth rate Policymakers and economists are not only very interested in the actual level of GDP but also in the trend of real GDP or the trend growth rate of real GDP Economists often associate the long-run or trend growth rate of GDP with the potential growth rate of GDP The potential growth rate or potential output growth indicates the maximum GDP growth that an economy can sustain over the long run without triggering inflation; Knowing the potential growth rate of the economy is important as it gives policymakers a way of gauging whether or not the economy is currently close to its potential growth rate 23 / 110  Trend growth rate We directly observe the level and the growth rate of real GDP, but we do not observe its trend growth rate One can assume that the trend growth rate is constant or is equal to the long-term average growth rate of real GDP Since 1961, the average growth rate of real GDP has been 3.14% However, this assumption is not very appealing as we saw that the average growth rate of GDP varies considerably from decade to decade 24 / 110  Trend growth rate Moreover, assuming that the trend growth rate is constant implies that future growth rates are known in advance, that is, the trend growth rate is deterministic, not random However, economists believe that the trend growth rate of GDP is random or stochastic and not deterministic After all, if technological progress is one of the most important drivers of GDP growth in the long run, assuming that the trend growth rate of GDP is stochastic is compelling Economists employ different statistics methodologies to estimate the trend growth rate of GDP All of these methodologies are rather complex and beyond the scope of this course 25 / 110  The Output-gap Policymakers and economists often compare the actual level of GDP with the economy’s potential GDP (or trend growth) Denote the economy’s actual GDP by Yt and the economy’s potential GDP by Ȳt where in both cases, the subscript t is an index of time The difference between actual and potential GDP that is Yt − Ȳt is known as the output-gap Periods of positive output-gaps (Yt > Ȳt ) are known as booms or expansions - too much demand compared to the economy’s full potential Periods of negative output-gaps (Yt < Ȳt ) implies that the economy is operating below its potential - not enough demand in the economy compared to its full potential The output gap is an important concept, and the Bank of Canada, for example, uses the output gap to determine the appropriate level of monetary stimulus 26 / 110 Actual, potential output and the output-gap using a linear trend, 1961Q1-2024Q3 Actual and trend output (trillions of $) 2.5 2.5 Real GDP (2017 dollars) 2 Linear trend GDP 2 1.5 1.5 1 1 0.5 0.5 0 0 1970 1980 1990 2000 2010 2020 0.1 0.1 Output-gap (millions of $) 0 0 -0.1 -0.1 -0.2 -0.2 -0.3 -0.3 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 and author’s calculation 27 / 110  How is GDP measured? Economists and policymakers rely heavily on measures of GDP in their research or to formulate policy Since GDP measures the total value of goods and services produced by a given country in a given year, it is very complex to do so Statistics Canada relies on various sources of data, mostly surveys and administrative data, to estimate GDP and its components 28 / 110  Measuring GDP using a variety of sources “GDP, relies heavily on a wealth of information from various areas of Statistics Canada. A large amount of information from various survey divisions within the bureau, along with other data, is compiled, integrated and analyzed as part of the complex process of arriving at GDP and its component categories and underlying sector accounts.” Because the measurement of GDP relies on surveys, preliminary estimates and administrative data, initial estimates of GDP are often subsequently revised as additional sources of data become available 29 / 110  Many challenges to measure GDP Measuring what is produced in a country poses many challenges. Some challenges are: 1 Quality and source of data F Reliance on surveys, censuses, and administrative records, which may be inaccurate, outdated, or incomplete 2 Informal and underground economy F It is difficult to capture unreported activities (gig economy, quasi or illegal activities, cash economy) - can lead to underreporting 3 Digitization of the economy F It is challenging methodologically to measure the digital economy/service and intangible assets (IP, R&D, e-commerce, ICT, digital media) 30 / 110  The digital economy and intangibles The digitization of the economy is fundamentally changing how people and businesses interact and produce goods and services The intangible, global, and rapidly evolving nature of the digital economy clashes with GDP methodologies that were designed to measure tangible goods and services in localized markets. Many digital goods and services, such as software, streaming, and cloud storage, are intangibles, making it difficult to assign value to them compared to traditional goods Investments in R&D, algorithms, and other IPs used to be treated as intermediate expenses but are now included in investment - difficult to measure Statistics Canada estimated that the share of the digital economy was about 5.9% of total economic activity in 2020, about the same size as mining, oil and gas extraction Digital economy and society 31 / 110  The three methods to measure GDP GDP can be measured in three different ways: 1 By adding up all the money spent each year (Expenditure approach) 2 By adding up all the money earned each year (Income approach) 3 By adding up all the value-added each year (Output approach) The three measures of GDP should, in theory, be identical to each other, but in practice, they are not the same because of measurement and other errors. We describe each method of calculating GDP in some detail. 32 / 110  The expenditure approach The expenditure approach defines GDP as the sum of final uses or expenditures on goods and services by resident institutional units (consumption, investment and government expenditures), plus net exports of goods and services (exports minus imports) Thus, according to the expenditure approach, GDP is the sum of consumption (C ), investment (I ), government expenditures (G ), exports of goods and services (X ) minus imports of goods and services (M) The difference between exports (X ) and imports (M) is known as net exports (NX = X − M) GDP = C + I + G + NX 33 / 110  The income approach According to the income approach, GDP is defined as the total income earned domestically by owners of factors of production. It includes income earned domestically by foreigners but not income earned by Canadians abroad. For example, wages earned by a U.S. citizen working for Shopify in Canada would be counted but not income earned by a Canadian citizen working for Google in the U.S. 34 / 110  The output approach The output approach defines GDP as the sum of gross value added of the industries plus taxes and less subsidies on products. The output approach focuses on the final value of the goods or services sold/purchased. To avoid double-counting, the output approach computes the value added to each good at each stage of production The value added at each stage of production is calculated as the sale value minus the cost of purchasing goods/services to manufacture the good 35 / 110  Circular Flow Before analyzing in more detail how GDP is calculated using these three different approaches by Statistics Canada, we provide some simple examples that will illustrate the essence of these methods. To explain the expenditure and income approach and to derive a measure of GDP, we use the concept of the circular flow of expenditure and income. Consider a very primitive economy that uses one input, labour, to produce one good, bread. There are two types of agents in this economy: workers and firms. Firms employ workers to produce bread. Workers purchase bread from the firm and consume it 36 / 110 The equivalency between income and expenditure approach Workers in this economy: 1 Supply labour to firms, and they are paid a wage for their hours of work 2 Purchase and consume bread from firms. Firms in this economy : 1 Purchase labour from workers and pay them for the labour supplied. 2 Sell bread to the workers. This simple economy has two types of markets: 1 Goods markets (bread). 2 Factor markets (labour) 37 / 110  The flow of income and expenditure The circular flow of income and expenditure in this economy is shown in the next slide As the name suggests, the circular flow illustrates how income and expenditure flow in the economy. The arrow pointing to firms indicates that workers sell their labour to firms for a wage The arrow going from firms to households indicates that firms sell their output (bread) to workers 38 / 110  Circular flow of income Expenditure ($) Bread Workers Firms Labour Income ($) Source: Author’s example The outer loop (blue arrows) represents the corresponding flows of expenditure and income. Workers pay the firms to purchase bread. This expenditure is represented by the arrow from households to firms (the outer loop). On the other hand, firms pay workers wages for their labour services. This income is represented by the arrow going from firms to workers. The outer loop (blue arrows) represents the corresponding flows of expenditure and income. 39 / 110  Circular Flow of expenditure GDP, using the expenditure method, is straightforward to calculate - total expenditure on bread (total value of bread sold). GDP is also very easily calculated using the income method - total income received by workers from bread production. Both methods yield the same result since income and expenditures depend on each other in this simple example (and also in the real world). The income generated from producing goods and services equals the total expenditure on those goods and services, as every dollar spent by buyers becomes income for sellers. 40 / 110 Accounting Identity - expenditure and income approach To see this, consider the following example. Suppose bread production is increased by one more loaf of bread. From the expenditure side, GDP is increased by the value of the extra loaf of bread produced. Since the firm has to employ an additional unit of labour to produce that extra unit of bread, hence wages must also increase. In this case, expenditure and income will increase by precisely the same amount. Hence, any changes on the expenditure (income) side will affect the income (expenditure) side of the circular flow of income. 41 / 110  Aggregate income and agrregate expenditure If this is the case, then we know that aggregate income (denoted by Y ) must be equal to aggregate expenditure (represented by E ) or Y = E. The left-hand side of this equation represents the factor payments paid by firms to workers, and the right-hand side is the expenditure of households on bread produced by firms. Since GDP equals total expenditure on final goods and services, hence we have GDP = Y in this primitive economy. Moreover, since Y =E , we also have GDP =Y = E 42 / 110  Output approach The output or value-added approach defines GDP as the sum of gross value added of the industries plus taxes and less subsidies on products. It is equal to the value of the final good sold or purchased. We illustrate this method with a straightforward example. Suppose that each iPad sells for $600, and to make the iPad, Apple has to buy their motherboard from Foxconn for $200 each. In turn, Foxconn has to buy their semiconductors from ARM for $75. What is the value of GDP if only one iPad is produced? 43 / 110  An example of the output approach GDP, according to the output or value-added approach, is simply the value of the final good, which is the value of the iPad, hence $600. GDP can also be calculated by adding the value-added at each stage of the production process, as shown in the table below Table: Value-added approach to calculate GDP Value added ARM $75 Foxconn 200-75 = $125 Apple 600-200 = $400 Total of value-added 75+125+400 = $600 Value-added = price of output- price of input or intermediate good bought from other firms 44 / 110  An example of the output approach When using the output or value-added approach, one has to be careful not to double-count. For example, using the example above, one could make a mistake by calculating GDP as the sum of the value of the output at each stage of production, which is 75+200+600 = $875. This would be wrong as we would be double-counting at some stages of production. When using this method, we should be cautious about how we treat intermediate goods or goods used in the production of other products. GDP includes only the value of final goods or the sum of the value-added at each production level. Value-added is the value of a firm’s output minus the cost of intermediate goods bought from other firms. 45 / 110  System of national accounts We examine in more detail how GDP at market prices is calculated by Statistics Canada using the income and expenditure approach. We start with the income approach. The System of National Economic Accounts divides income into many categories. The income approach measures GDP as the income earned by owners of factors of production in Canada. It includes the following main items 1 all incomes paid by firms to households (that is, wages, salaries and all supplementary income labour), 2 net income of non-farm unincorporated businesses, including rent, 3 corporate and government business enterprise profits before taxes, 4 interest and miscellaneous investment income, 5 capital consumption allowance 46 / 110  Statistics Canada - Income method 2024Q3 Table: Canadian GDP 2024Q3, in millions of dollars - income approach Estimates 2024Q3 Compensation of employees 1,579,892 Wages and salaries 1,372,348 Employers’ social contributions 207,544 Gross operating surplus 799,4956 Net operating surplus: corporations 386,900 Consumption of fixed capital: corporations 311,140 Consumption of fixed capital: general governments 101,916 Gross mixed income 386,356 Net mixed income 287,148 Consumption of fixed capital: unincorporated businesses 99,208 Taxes less subsidies on production 109,144 Taxes less subsidies on products and imports 204,876 Statistical discrepancy -1,824 Gross domestic product at market prices 3,078,400 Source: Statistics Canada, Table 36-10-0103-01 Gross domestic product at market prices = compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production, products and imports + statistical discrepancy 47 / 110  Components of the income method From the table in the previous slide, we can see that the component “Compensation of employees (labour income)” represents around 51.3% of total income or GDP in 2024Q3 Since labour income represents a significant portion of total income, total consumption by individuals will also represent a substantial proportion of total expenditure. Gross operating surplus is the return on capital (a concept related to profits) of incorporated entities (businesses), and this accounts for roughly 26.0% of total income in 2024Q3 Gross mixed income is the return on capital of unincorporated entities, accounting for approximately 12.6% of total income in 2024Q3 Taxes less subsidies on production, products, and imports account for about 10.2% of total income in 2024Q3 48 / 110  The expenditure method We conduct a similar exercise as above, this time using the expenditure approach. In our simple economy that we described earlier using the circular flow of income, we assumed that consumption was the only component of aggregate expenditure. However, in reality, this is not the case. The System of National Economic Accounts divide GDP into four main categories of expenditure: Consumption (C ), Investment (I ), Government expenditure (G ), Net exports (NX ) or (Exports (X ) - Imports (M)). 49 / 110  Statistics Canada - Expenditure method 2024Q3 Table: Canadian GDP 2024Q3, in millions of dollars - Expenditure approach Estimates 2024Q3 Final consumption expenditure 2,375,900 Household final consumption expenditure 1,656,880 Non-profit institutions serving households’ final consumption expenditure 46,168 General government final consumption expenditure 672,852 Gross fixed capital formation 691,620 Business gross fixed capital formation 567,528 Non-profit institutions serving households’ gross fixed capital formation 4,048 General governments gross fixed capital formation 119,844 Investment in inventories 21,596 of which: business investment in inventories 20,900 Exports of goods and services 986,260 Export of goods 767,300 Exports of service 218,960 Less: imports of goods and service 998,796 Imports of goods 781,788 Imports of services 217,008 Statistical discrepancy 1,820 Gross domestic product at market prices 3,078,400 Source: Statistics Canada, Table: 36-10-0104-01, 50 / 110  Comparison of the expenditure and income method Compensation of employees Final consumption expenditure + + gross operating surplus gross fixed capital formation + + gross mixed income investment in inventories + + taxes less subsidies on production, exports products and imports + - statistical discrepancy imports - statistical discrepancy = = Gross domestic product at market prices Gross domestic product at market prices 51 / 110  Consumption as the main component of expenditure Consumption 2024Q3 Share of Consumption (percent) Durable goods 213,336 12.9 Semi-durable goods 107,520 6.5 Non-durable goods 394,996 23.8 Total goods 715,852 43.2 Services 941,028 56.8 Source: Statistics Canada and author’s calculation 1 Durables: Goods that take time to wear out, e.g. appliances, furniture. I Houses are not counted as consumer durables but as residential investment 2 Semi-durables: Goods that are expected to last for some time but have a shorter lifespan than durable goods, e.g. shoes, clothing 3 Non-durables: Goods that do not last very long. They are also known as consumables, mostly consumer goods such as food and utilities. 4 Services: Includes services that individuals consume, such as legal and financial services, movies, theatre 52 / 110  Consumption of goods and services Services account for around 56.8% of total consumption, non-durable goods about 23.8%, durable goods about 12.9% and semi non-durable goods approximately 6.5%. Total consumption of goods and services by households accounts for roughly 54% of GDP in Canada. This ratio is relatively stable over time and is very similar across Western nations. Consumer durables are the most volatile component of consumption and behave like investment expenditures Services are the least volatile component of consumption 53 / 110 Annualized growth rates of goods and services, 1961Q1-2024Q3 Durable goods Non-durables 250 250 250 250 200 200 200 200 150 150 150 150 Percent Percent 100 100 100 100 50 50 50 50 0 0 0 0 -50 -50 -50 -50 1970 1980 1990 2000 2010 2020 1970 1980 1990 2000 2010 2020 Year Year Semi-durables Services 250 250 250 250 200 200 200 200 150 150 150 150 percent percent 100 100 100 100 50 50 50 50 0 0 0 0 -50 -50 -50 -50 1970 1980 1990 2000 2010 2020 1970 1980 1990 2000 2010 2020 Year Year 54 / 110  Consumption of some goods are excluded in GDP Consumption of goods and services obtained through illegal activities (black market, drugs) are excluded from GDP Allowances, charity giving and gifts are not counted as they are considered transfers from one party to another Activities such as cooking meals, cleaning, or childcare within your own home are not included in GDP because they do not involve market transactions 55 / 110  Investment as a component of GDP Investment (I ) accounts for roughly 22% of total GDP, with investment in machinery and equipment accounting for approximately 17% and residential investment accounting for 41.6% of total business investment Investment in structures is divided into three main categories: 1 investment in residential structures - purchase of new houses by families for their own use or rental purposes. 2 investment in non-residential structures - new capital that is used in production such as buildings, work equipment 3 investment in machinery and equipment used in production 56 / 110  What counts as investment? Investment in non-residential structures, machinery and equipment also includes intangible products such as intellectual property, research and development, software Intangible products such as intellectual property and research and development used to be treated as salaries (an intermediate expense) in the computation of GDP, but it is now part of business investment These intangible assets have a significant impact on labour productivity and GDP growth Statistics Canada and many other international agencies do not measure the contribution of these intangibles very well, as the traditional sources of data do not accurately capture the real impact of R&D, IPs, and patents on GDP 57 / 110  Importance of inventory investment Investment in inventories is a tiny proportion of GDP, yet it is a closely watched component of expenditure Economists use fluctuations in inventories as an early indicator to estimate whether firms are anticipating sales to increase or decrease in the future. Inventories are known as a leading indicator of the economy since it moves before GDP does If firms anticipate that sales will increase in the future, they will add to inventory investment immediately, that is, produce and stock more goods to take advantage of future growth in sales. This increase in inventory helps boost inventory investment and hence actual GDP. 58 / 110  Government as a component of GDP Government purchases (G ) are goods and services bought by the Canadian federal, provincial and municipal government (e.g. military equipment, building infrastructure) Many transfers paid by the Canadian government, such as old age security benefits, employment insurance and other social assistance payments, are not included in the calculation of GDP These transfer payments are counted in the government budget as part of expenditure but are not included in the calculation of GDP. The government sector accounts for roughly 20% of GDP, and its share has also been relatively stable over time. 59 / 110  Net exports as a component of GDP Net exports (NX ) is the difference between the value of goods and services that Canada exports (X ) to other countries and the value of goods and services Canada imports (M) from other countries. Net exports are a small component of the economy, but exports and imports account for roughly 33% of GDP in Canada. About 75% of our exports of goods and services go to the U.S, 8% to the EU, 4% to China We import about 63% of our goods from the U.S., 10% from the EU and 8% from China 60 / 110  Interpreting changes in aggregate expenditure If we denote gross domestic income by Y , and gross domestic expenditure by E , hence Y ≡ E = C + I + G + NX. This equation is usually known as the national income or accounts identity. This equation is only an identity (it is true by construction) and not a theory of how things work. We should be cautious about how we interpret this identity. If there is an increase in G , for example (on the right-hand side of the equation), this does not necessarily mean that Y will increase (that is, the left-hand side will increase). An increase in G may leave Y unchanged if the increase in G is followed by a similar decrease in C (because of crowding out). 61 / 110 Gross National Product and Gross Domestic Product Gross domestic product (GDP) focuses on the economic output produced within Canada (does not matter if residents or non-residents produce it) or all income earned in Canada regardless of nationalities It includes income earned domestically by foreigners but not income earned by Canadians abroad. GDP will include the income earned by a Swede working in Canada but not that of a Canadian working in Sweden. 62 / 110  Difference between GNP and GDP Gross National Product (GNP) focuses on the economic output of residents of all Canadians at home or abroad (whether or not it is produced within the geographical area of Canada) or the total income earned by Canadians wherever they live and work It includes the income earned by all Canadians, whether they are living in Canada or abroad. GNP excludes income earned by foreign workers living in Canada. GNP will include the income earned by the Canadian working in Sweden but exclude the income earned by the Swede working in Canada. 63 / 110  GNP and GDP Hence GNP = GDP + income earned by Canadian residents from the rest of the world - income earned by non-Canadian residents within Canada. GNP = GDP + net factor payments from abroad Canada’s GDP and GNP are usually not significantly different in size. Currently, Canada’s GDP is about 1.2% larger than GNP, indicating that more foreigners are contributing to the Canadian economy than Canadians working abroad Because of the small difference, we use GDP in Canada to measure how much we are producing at any given time 64 / 110 Ratio of GNP and GDP, Canada 1961Q1— 2024Q3 0.995 0.995 0.99 0.99 0.985 0.985 0.98 0.98 Ratio 0.975 0.975 0.97 0.97 0.965 0.965 0.96 0.96 0.955 0.955 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0122-01 65 / 110 Big differences in GNP and GDP for some countries While Canada’s GDP and GNP are very similar this is not the case for many countries. For example, GDP and GNP will be different if the country is a recipient of considerable foreign investment. In that case, GDP will be much higher than GNP since the former will include foreign direct investment but not the latter. GNP is much higher than GDP if many residents of a country work abroad, as is the case for many developing economies, or if the country receives a significant amount of foreign aid 66 / 110 Ratio of GNP to GDP, Ireland and the Philippines 1.2 1.2 Ireland Phillipines 1.1 1.1 1 1 Ratio 0.9 0.9 0.8 0.8 0.7 0.7 0.6 0.6 1985 1990 1995 2000 2005 2010 2015 2020 Year Source: World Bank and author’s calculation 67 / 110  Other statistics from the National Accounts From GDP, we can calculate many other variables GNP = GDP + net factor payments from abroad (NFP) Net National Product (NNP) = Gross National Product - Depreciation National income = NNP - indirect business taxes Private disposable income = GDP + net factor payments from abroad + transfer payments + net interest payment - taxes Private savings = Private disposable income - consumption Government savings = Taxes - transfer payments - interest payment - government spending National savings = private savings + government savings = GDP + net factor payments from abroad - consumption - government spending National savings = (C+I+G+NX) + NFP - C - G = I + (NX+ NFP) = I + current account balance 68 / 110  Real and Nominal GDP When using GDP as a measure of economic welfare or well-being, economists use real rather than nominal GDP. Nominal GDP measures the market value of final goods and services produced using current or today’s prices. Real GDP measures the market value of final goods and services produced using constant prices. Nominal GDP in 2024 is equal to the amount of goods and services produced in 2024 multiplied by their market price in 2024. Real GDP in 2024 measured using 2017 prices is equal to the amount of goods and services produced in 2024 multiplied by their market price in 2017. 69 / 110  Real and Nominal GDP, an example For example, assume a fictitious economy that produces only three goods: cheese (c), wine (w ) and grapes (g ). Denote the price of cheese as Pc , price of wine as Pw , and price of grapes as Pg Denote the quantity of cheese produced as Qc , wine produced as Qw , and grapes produced as Qg Thus, Nominal GDP in 2023 is calculated as: Nominal GDP in 2023 = Pc2023 × Qc2023 + Pw2023 × Qw2023 + Pg2023 ∗ ×Qg2023


70 / 110  How to calculate real and nominal GDP We can use this formula to calculate nominal GDP for any year. Suppose the following prices and quantities prevailed in 2023: Goods Price (2023 $) Quantity Cheese 1 10 Wine 5 10 Grapes 2 10 Therefore nominal GDP for this economy in 2023 is: Nominal GDP in 2023 = (1 × 10) + (5 × 10) + (2 × 10) = $80 71 / 110  How to calculate real and nominal GDP Now, assume that in 2024, we have the following prices and quantities. Goods Price (2024 $) Quantity Cheese 2 8 Wine 10 8 Grapes 3 8 Therefore nominal GDP for this economy in 2024 is Nominal GDP in 2024 = (2 × 8) + (10 × 8) + (3 × 8) = $120 72 / 110  Comparing real and nominal GDP If we use nominal GDP as a measure of well-being, one will be tempted to conclude that individuals are better off in 2024 since the level of (nominal) GDP is higher in 2024 compared to 2023 ($120 in 2024 compared to $80 in 2023). The year-over-year growth rate of nominal GDP in 2024 is 120−80
80 × 100 = 50% Based on nominal GDP, you would conclude that individuals are better off in 2024 compared to 2023 since the economy has grown by 50% and the economy is producing 50% more in 2024 compared to 2023 But are individuals really better off in 2024 compared to 2023? 73 / 110  Using nominal GDP can be misleading Despite an increase in nominal GDP, people in this economy were not better off in 2024 The amount of goods produced decreased, and the increase in nominal GDP only comes from higher prices Hence nominal GDP is a misleading measure of how well we are doing and how much GDP is growing over time. This example shows that if we want to know whether we are better off over time, we have to use a measure of GDP that compares how much production has changed over time while assuming prices are constant. 74 / 110  Use real GDP as a measure of welfare To get a better measure of whether changes in GDP have improved economic well-being, economists use Real instead of Nominal GDP. Real GDP measures the market value of the output of final goods and services produced in a given period using constant prices or a base-year price This is why real GDP is also known as constant dollar GDP since it assumes prices are constant over time Real GDP shows what would have happened to expenditure on output if quantities had changed but not price 75 / 110  Use real GDP as a measure of welfare Let us take our simple three-goods economy and calculate real GDP, assuming 2023 as the base price Using this common base price, if real GDP is higher in 2024, then clearly, individuals must be better off since the higher GDP purely comes from more goods being produced Put differently, if at the same set of prices as 2023, there are now more goods to be consumed in 2024, then clearly, individuals are better off in 2024 compared to 2023 76 / 110  Real and Nominal GDP - an example Real GDP in 2024 (using 2024 as base prices) is given by: Real GDP = (Pc2023 × Qc2024 ) + (Pw2023 × Qw2024 ) + (Pg2023 × Qg2024 ) = (1 × 8) + (5 × 8) + (2 × 8) = $64 Recall that (real) GDP in 2023 using 2023 prices was $80 Based on the real GDP measure, individuals are not better off in 2024 compared to 2023 since the amount of goods available has decreased. In this case, the growth rate of real GDP in 2024 is 64−80
80 × 100 = −20%. When we compare if individuals are better off over time, we always use Real GDP and not nominal GDP. 77 / 110 Nominal and Real GDP (2017 prices), Canada 1961-2024Q3 3.5 3.5 Real GDP (2012 dollars) Nominal GDP 3 3 2.5 2.5 trillions of dollars 2 2 1.5 1.5 1 1 0.5 0.5 0 0 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 78 / 110  GDP deflator Using nominal and real GDP, we can compute the GDP deflator. The GDP deflator, also called the implicit price deflator for GDP, is the ratio of nominal to real GDP, thus:   NominalGDP GDP Deflator = × 100 RealGDP The GDP deflator measures how the overall level of prices of all goods and services produced domestically is changing over time The value of the GDP deflator depends on the base year that one chooses, and this in itself can be a problem Later on, we will learn another statistic that measures how prices are changing over time - Consumer Price Index (CPI) 79 / 110  Chain weighted GDP The method that we have described to calculate GDP involves using a fixed weight (also known as the Laspeyres index), and it was used by Statistics Canada until May 2001 to calculate real GDP After May 2001, Statistics Canada changed its methodology to compute real GDP. Instead of using fixed weights, it used an implicit chain price index (also known as the Fisher index). What this entails is calculating a series (or chain) of GDP deflators. 80 / 110  Fixed weighted GDP Statistics Canada and many other agencies around the world changed their methodology since the old method of calculating GDP using a fixed weight index had many problems One major problem with the fixed-weight GDP is that as time elapses, some goods get too much weight in the calculation of GDP For example, the price of computers has fallen rapidly over time, and as a result, the demand and production of computers have significantly increased over the same period These substitutions due to changes in relative prices are not taken into account when a fixed-weighted measure of real GDP is used 81 / 110  Fixed weighted GDP Using the fixed-weighted real GDP method, computers in 2024 would still be weighted by their old base price of, say, 1980 The contribution of computers to GDP would be overstated using the old method as we would count the number of computers produced in 2024 using 1980 prices The problem becomes more acute if changes in technology lead to significant changes in relative prices and demand for goods As a result, the measure of real GDP becomes less and less accurate as one moves further away from the base year. 82 / 110  Chain weighted GDP The chain-weighted measure of real GDP solves the problem of fixed weighted measure of real GDP by updating the weights in every period The chain-weighted measure of real GDP measures output using current and previous year price When Statistics Canada switched to measuring real GDP in May 2001 using the chain-weighted measure, it had to recalculate and revise the entire history of real GDP, including historical growth rates. 83 / 110  Chain weighted GDP The idea of the chain-weighted measure of real GDP is to continuously update the base year by incorporating new information on prices and the effects that price changes have on production. Thus, under chain weights, the price of a computer in 2024 is the average or the chain of what it costs to buy it in 2023 and 2024. One of the advantages of the chain-weighting system is that it takes into account substitutions due to changes in relative prices Another advantage of the chain-weighting system is that it measures the value of the final goods and services produced, taking into account the economy’s structure at the time. 84 / 110 Example: Chain-weighted and fixed weight real GDP Year Price Quantity Price Quantity Price Quantity of cheese of cheese of wine of wine of grapes of grapes 2021 10 10 20 40 5 5 2022 11 9 15 45 6 4 2023 9 11 10 50 8 3 Using 2021 as the base year Fixed weight real GDP in 2021 = (10 × 10) + (20 × 40) + (5 × 5) = $925 Fixed weight real GDP in 2022 = (10 × 9) + (20 × 45) + (5 × 4) = $1, 010 Fixed weight real GDP in 2023 = (10 × 11) + (20 × 50) + (5 × 3) = $1, 125 85 / 110 Example: Chain-weighted and fixed weight real GDP Year Price Quantity Price Quantity Price Quantity of cheese of cheese of wine of wine of grapes of grapes 2021 10 10 20 40 5 5 2022 11 9 15 45 6 4 2023 9 11 10 50 8 3 Using 2021 as the base year, we know that real GDP in 2021 = $925 To obtain chain-weighted Real GDP for 2022, we need these four things: (a) 2021 quantities at 2021 prices = $925 (b) 2022 quantities at 2021 prices = (10 × 9) + (20 × 45) + (5 × 4) = $1, 010 (c) 2021 quantities at 2022 prices = (11 × 10) + (15 × 40) + (6 × 5) = $740 (d) 2022 quantities at 2022 prices = (11 × 9) + (15 × 45) + (6 × 4) = $798 1010−925
Growth rate of GDP with 2021 price = 925 × 100 = 9.19% 798−740
Growth rate of GDP with 2022 price = 740 × 100 = 7.84% 86 / 110  Example: Chain-weighted and fixed weight real GDP (a) 2021 quantities at 2021 prices = $925 (b) 2022 quantities at 2021 prices = (10 × 9) + (20 × 45) + (5 × 4) = $1, 010 (c) 2021 quantities at 2022 prices = (11 × 10) + (15 × 40) + (6 × 5) = $740 (d) 2022 quantities at 2022 prices = (11 × 9) + (15 × 45) + (6 × 4) = $798 The chain-weighted growth rate for 2022 = average growth rate for 2021 and 2022 = 9.19+7.84 2 = 8.51% Real GDP in 2022 = Real GDP in 2021× chain-weighted growth rate for 2022 = 925 + (925 × 0.0851) = $1, 003.72 You can do the same and find 2023 real GDP using the chain-weighted index method Once the calculation of real GDP for all periods is put together; we get a chain of real GDP 87 / 110  GDP per capita Real GDP may be growing over time, but it does not necessarily mean that each person is enjoying more goods and services every year For example, the production of goods in real terms may be increasing by 10% per year, but if the population is growing at a faster rate, then each person on average will have fewer and fewer goods Hence, to know whether or not each person on average is enjoying more goods and services in a given year, economists use Real GDP per capita or Real GDP per person, which is equal to real GDP divided by the size of the population. Real GDP Real GDP per capita = Population 88 / 110  GDP Per Capita, Canada 1961Q1-2024Q3 4 10 4 10 6.5 6.5 6 6 5.5 5.5 5 5 2012 dollars 4.5 4.5 4 4 3.5 3.5 3 3 2.5 2.5 2 2 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 and author’s calculation 89 / 110 Growth rate GDP Per Capita, Canada 1961Q1-2024Q3 50 50 40 40 30 30 20 Average growth rate of GDP per 20 capita = 1.82% 10 10 percent 0 0 -10 -10 -20 -20 -30 -30 -40 -40 1970 1980 1990 2000 2010 2020 Year Source: Statistics Canada, Table: 36-10-0104-01 and author’s calculation 90 / 110 Correlation of GDP per capita with other measures Economists use real GDP per capita as a measure of the standard of living and usually compare real GDP per capita across time and countries. Although GDP per capita is widely used by governments and international organizations to compare living standards across time and countries; it is often a poor measure of human welfare However, even if GDP per capita is a flawed measure of welfare, it is nevertheless highly correlated with various measures that affect human welfare, such as life expectancy, infant mortality, education attainment, and inequality 91 / 110 GDP Per Capita, Life Expectancy and Infant Mortality, 2020 Infant mortality (per 1,000 live births) 90 85 Central African Republic 80 80 Life expectancy (years) 70 Canada 75 60 50 70 40 65 30 60 20 Canada 55 10 Central African Republic 0 50 0 20,000 40,000 60,000 80,000 0 20,000 40,000 60,000 80,000 GDP per capita (2012 US$) GDP per capita (2012 US$) Source: World Bank and author's calculation 92 / 110  GDP per capita as a measure of welfare GDP per capita as a measure of human welfare is flawed for many reasons. 1 GDP per capita excludes production from the underground or “informal” economy and also home production 2 GDP per capita does not account for externalities (good and bad) 3 GDP per capita ignored how wealth and income are distributed 4 GDP per capita ignores some forms of investment, in particular, investment in human capital 93 / 110 Informal economy and GDP per capita as a measure of welfare GDP measures only output that is traded in markets and does not include the amount of goods and services that are produced at home or destined for the underground or black market economy In developing countries, home production accounts for a large proportion of GDP, and the official measure of GDP per capita typically under-reports the “true” value of all the goods and services produced. Similarly, in many developing countries, the underground economy accounts for a large proportion of GDP, about 40% in developing economies The underground economy does not only consists of illegal activities such as drugs, but it is also made up of legal activities where individuals use barter to trade 94 / 110 Pollution and GDP per capita as a measure of welfare When GDP is calculated, the effects of pollution, the by-product of production, are entirely ignored. For example, the effects of acid rain, water pollution, or smog that directly lower our welfare and our future well-being are not accounted for in the calculation of GDP. Pollution can be regarded as “negative production” in the sense that it destroys part of our environment Two countries may have the same GDP per capita while having vastly different pollution level In which country would you rather live? 95 / 110 Externalities and GDP per capita as a measure of welfare The calculation of GDP also excluded good externalities. Leisure and sleep are two examples of good externalities. For example, if a person works, this contributes to GDP, but if the person chooses leisure or sleep instead, then it is not counted in GDP even though the increased leisure or rest may improve their welfare. More vacation time for everyone would decrease the number of hours worked and GDP, but is that a bad thing? 96 / 110 Human capital and GDP per capita as a measure of welfare GDP accounts for physical capital but ignores human capital Human capital and socio-economic indicators are not counted in GDP These factors include: 1 educational achievement 2 gender equality 3 mortality rate 4 access to clean water and food 5 percentage of females in secondary, tertiary education and the labour force 6 freedom of speech, press and religion 7 levels of corruption 8 level of xenophobia, etc... These factors, although not counted in GDP, affect how happy a population is. 97 / 110 Income distribution and GDP per capita as a measure of welfare GDP per capita is an average, and it says nothing about the distribution of goods and services, wealth or income Averages can be misleading as it hides how equal or unequal a country can be Higher GDP per capita can be misleading as only a tiny fraction of the population may be benefiting from the increase Would you rather live in a country with a GDP per capita of $100 where the income of each of the 5 inhabitants is $100 or in a country with the same level of GDP per capita but where one person (not you) earns $496 and the other 4 persons $1 each? 98 / 110  Externalities and GDP as a measure of welfare There is another critical flaw with GDP per capita as a measure of welfare that economists have highlighted recently; its inability to capture the benefits of technology in our lives, in particular, free technologies Many technologies have positive externalities that raise the standard of living of individuals (e.g. free content on the internet, free apps on our phones, safer cars, etc.) GDP as a measure of output assigns zero value to these technologies and apps that are free, yet they have a significant impact on our well-being and happiness 99 / 110  Alternative measures of GDP Because of the flaws of GDP per capita as a measure of welfare, many economists have proposed alternative indicators of welfare Alternatives to the GDP Many economists argue that we should stop associating the growth rate of GDP per capita with happiness and human welfare When computing standards of living, we should also consider factors such as the impact of growth on the environment, leisure, freedom of speech and religion, access to education, health indicators, gender equity, governance, etc.... 100 / 110 Can we use these alternative methods to measure welfare? All of the alternative measures try to account for the limitations of GDP per capita 1 Various United Nations Indices such as UN Human Development Index (takes health, education, gender equity and other factors affecting human capital into account), the Multidimensional Poverty Index, World Happiness Report (ranks countries based on subjective well-being, using data on life satisfaction and happiness) 2 China’s green GDP 2.0 - takes environmental factors into account 3 OECD’s GDP alternatives - account for the amount of work and leisure 4 Bhutan’s Gross National Happiness takes indicators of health, the environment, governance, diversity and leisure into account to compute living standards 5 Happy planet index takes into account the ecological footprint, inequality, and life expectancy of a country, 101 / 110  Are these alternative measures better? Are these alternative measures better? None of the alternative measures proposed will replace GDP per capita any time soon as they also have flaws Many of these measures are difficult to compute and often use subjective data and inputs Bhutan’s Gross National Happiness index, for example, asks 148 questions to its residents, and many questions are very subjective 102 / 110  International comparison of GDP per capita GDP measures the market value of goods and services each country is producing at a given period in time Economists often compare the performance of different countries by looking at the size of their GDP per capita However, it is not easy to make this comparison as each country computes GDP in its currency. 103 / 110 How do we compare GDP per capita measured in different currencies For international comparisons, we often convert the GDP of all countries into a single currency, U.S. dollars. Direct conversion using market exchange rates is sometimes used but has limitations, as these rates fluctuate and do not reflect the true cost of living or local price levels. To address this, GDP is converted using Purchasing Power Parities (PPP) for better accuracy 104 / 110 Using PPP to convert GDP per capita in U.S. dollars PPP equalizes the purchasing power of different currencies by eliminating differences in price levels between countries. It is based on the law of one price, which states that the same good should sell at the same price in all countries (excluding transportation costs and other country-specific taxes). PPP adjusts for local cost differences, providing a better measure of the real standard of living across countries compared to the market exchange rate 105 / 110 Using market exchange rate to convert and compare GDP can be misleading For example, assume that Brazil decides to devalue its currency, the Real, by 50% vis à vis the U.S dollar. Based on this market exchange rate, the value of Brazil’s GDP in U.S dollar will fall by 50% also. Can we conclude that Brazil’s GDP expressed in U.S. dollar is now 50% lower than U.S. GDP? No. It would be misleading since the value of production, or the total amount of goods, did not fall by 50%; only the exchange rate based on market value did. 106 / 110  Big Mac Index One of the most famous examples of the PPP index is the Big Mac index published by the magazine The Economist. Burgernomics Since a Big Mac is relatively homogenous across countries, the price of a Big Mac, according to the PPP theory and the law of one price, should be the same in all countries If we make this assumption, we can then use the Big Mac index to calculate the exchange rate between countries. 107 / 110  Example - Big Mac Index Canada’s GDP per capita was 60,000 CAD, and US GDP per capita was 68,000 USD in 2023. Which country has a higher GDP per capita? We need to convert Canada’s GDP into USD. According to The Economist, in 2023, a Big Mac cost 7.55 CAD in Canada and 5.70 USD in the U.S. Based on the Big Mac index and the PPP, the exchange rate between one USD and the CAD equals 7.55 5.70 = 1.32 That is, one USD buys 1.32 CAD or 1 CAD buys 0.75 USD Using the Big Mac index and the PPP, therefore Canada’s GDP per capita in USD would be 60000 × 0.75 = 45, 000. Big Mac index 108 / 110 Distribution of world GDP Country % of world GDP in 2022 United States 24.2 Japan 5.0 Germany 4.0 France 2.8 UK 3.1 Italy 2.2 Canada 2.0 G7 43.3 Brazil 1.8 Russia 1.7 India 3.4 China 18.6 BRIC 25.5 Mexico 1.4 South Korea 1.7 Source: World Bank and author’s calculation 109 / 110  Conclusion and what we learned In this lecture, we learned how GDP is measured using the three approaches. The GDP (and its growth rate) of a country tells us how well or poorly a country is doing. We should compare real GDP and not nominal GDP over time since the former measures how much more goods and services a country is producing, keeping prices constant. Although real GDP per capita is often used as a measure of welfare and to make comparisons between countries and across time, it is not a perfect measure of human welfare, happiness, and well-being GDP per capita as a measure of standard of living ignores many factors that affect our welfare. 110 / 110