Economists keep track of the flows of money between sectors with the national income and product accounts, or national accounts. Households earn income via the factor markets from wages, interest on bonds, profit accruing to owners of stocks, and rent on land. In addition, they receive government transfers from the government. Disposable income, total household income minus taxes plus government transfers, is allocated to consumer spending (C) and private savings. Via the financial markets, private savings and foreign lending are channelled to investment spending (I), government borrowing, and foreign borrowing. Government purchases of goods and services (G) are paid for by tax revenues and any government borrowing. Exports (X) generate an inflow of funds into the country from the rest of the world, but imports (IM) lead to an outflow of funds to the rest of the world. Foreigners can also buy stocks and bonds in Canadian financial markets.
Factor incomes are incomes earned by factors of production, which include wages, interest, rent dividends, and profits. Non-factor payments are the difference between the prices paid for final goods and services and the amount received by factors of production, which include net indirect taxes and capital depreciation.
Gross domestic product, or GDP, measures the value of all final goods and services produced in the economy. It does not include the value of intermediate goods and services, but it does include inventories and net exports (X − IM). It can be calculated in three ways: add up the value added by all producers; add up all spending on domestically produced final goods and services, leading to the equation GDP = C + I + G + X − IM, also known as aggregate expenditure; or add up all the income earned from the production of goods and services. These three methods are equivalent because in the economy as a whole, one person’s spending will always be another person’s income. Thus, total spending on final goods and services must be equal to total income earned from production.
Real GDP is the value of the final goods and services produced calculated using the prices of a selected base year. Except in the base year, real GDP is not the same as nominal GDP, the value of aggregate output calculated using current prices. Analysis of the growth rate of aggregate output must use real GDP because doing so eliminates any change in the value of aggregate output due solely to price changes. Real GDP per capita is a measure of average aggregate output per person but is not in itself an appropriate policy goal. Canadian statistics on real GDP are always expressed in chained dollars.
To measure the aggregate price level, economists calculate the cost of purchasing a market basket. A price index is the ratio of the current cost of that market basket to the cost in a selected base year, multiplied by 100.
The inflation rate is the yearly percent change in a price index, typically based on the consumer price index, or CPI, the most common measure of the aggregate price level. A similar index for goods and services purchased by firms is the industrial producer price index, or IPPI. Finally, economists also use the GDP deflator, which measures the price level by calculating the ratio of nominal to real GDP times 100.