ECON 140W - Week 2

Class 3 - Jan. 13, 2026

Circular Flow

Expenditure -> Production -> Income -> Back to Expenditure

• Doesn't ask questions on exams about this

Defining Gross Domestic Product

• GDP is "market value of all final goods and services produced within a country in a year"
• Breaking down that definition:
  • Market value
    • It's what is spent on a product, doesn't matter if you list it a $100, if it's $25 that's all that matters
  • Final goods and services
    • Don't want to recount things all the time
  • Produced within a country
    • We don't care who made it, all we care is that it's made in Canada
  • usually in a year
    • Can also be in a given time period

Three Ways to Measure Production

1. Spending
   • Consumption
     • How much did residents buy?
     • Broken up into categories
       • Goods
         • durable goods
           • Washing machine
         • semi-durable goods
           • Clothes, sportswear
         • non-durable goods
           • Food
       • Services
         • Restaurant meals count as services (kind of both though)
       • A bunch more
   • Investment
     • Business assets
     • Inventory
     • Residential construction
   • Government purchases
     • When government buys something - including services
     • Not transfers
       • For example, a share of a company because a company didn't make it
   • Net Exports
     • Exports
       • Was made in Canada so we count that
     • Minus imports
       • We don't count this as it wasn't made in Canada
2. Output
   • Final goods and services
     • Ex. Most things bought from Apple are final goods and services. However, an iPad bought by Ken is paid back from the University and then the final good is tuition paid by students.
     • Ignore intermediate production (in this case it would be the iPad)
   • Or measure value added
     • Revenue minus cost of inputs for all businesses
     • Simple profit statement:
       • Profit = Revenue - Cost of Inputs for all goods - Wages
3. Income - all of this is BEFORE tax
   • Add up all sources of income from production
     • Total wages
     • Total profits
     • Does not include capital gains (that isn't income from production)

is GDP a Useful Measure?

• Strong correlation between income per capita and other positive measures
  • Life satisfaction, education, infant mortality, life expectancy
  • Correlations aren't perfect - there is variation in each value across countries
• GDP per capita is a good indicator, not a good target
  • Whether this goes up or down may not be the best metri
  • For example, killing people who don't produce output (old people) increases GDP per capita but this is obviously terrible policy
• Limitations of using GDP as a measure of well-being
  • It is a indicator not a measure
  • Market value (not use value) of purchased goods
    • This comes up in social media a lot - probably don't pay for it at all so hard to come up with a market value
  • Cost (not use value) of publicly provided goods
    • Government provides elementary school education so we measure cost of providing the school (teachers, janitors, etc.) and there is no market value for this so we just measure the cost
    • Military spending - no market value so we add up all the costs
      • Not a measure of well-being
    • Primary school education might be worth a lot more than the cost it provides but we can't measure that
  • Non-market activities not included - home production
    • If you buy a restaurant meal, that counts. If you buy food, that counts. However, if you buy food that then provides more value than what you paid to buy it, that doesn't count.
    • In countries where subsistence farming is important
      • Backyard gardens don't count
  • Shadow economy not included - illegal and unreported economy
    • If you build a deck yourself, labour part doesn't count
    • If you pay a company to do it but nobody reports it, you miss it entirely
  • Environmental degradation - are all actions good?
  • Leisure - is more work always good?
  • Distribution of incomes or spending
    • This is ignored completely

Real vs. Nominal GDP

• How should we think about changes in output?
  • Quantities of output change from year-to-year
  • But, so do markets
  • Since we are measuring production, we want to measure that change
• Use average prices over two years to calculate real GDP
  • Chain-weighting
    • Look at average price over year 1 and year 2 and use that price when calculating GDP.

Strategies for Scaling Large Numbers

• Per capita measures (or per household)
  • Measuring income or spending per person
• Numbers as a fraction of the economy
  • Government spending as a fraction of the economy
• Compare numbers to their own past values
  • Unemployment compared to experience in past recessions or booms
• Rule of 70 -> time to double = 70/growth rate
  • If Real GDP growth rate is 2% per year. That means, in 35 years, GDP will double.