3 National Income Accounts: Provide the formal structure for our macro-theory modelsAggregate Demand….aggregate income..consumed or investedAggregate Supply….Total output..paid as wages, interest anddividendsIn equilibrium….Aggregate Demand=Aggregate Supply (growth)Inputs=OutputsReal outputprice levelBroad magnitudes to characterize the economy
4 Basic Measures:Gross Domestic Product (GDP) is the value of final goodsand services produced in the country within a given periodNotable termsfinal goodsIntermediate goodsValue AddedPast output vs. current outputsMeasure of welfareUse of resources to avoid bads such as crimeImprovement in the qualityin the country
5 Factors of production….labor, capital, land GDP= sum of payments to labor, capital, land and profits˸Gross National Product (GNP)GDP+receipts from abroad made as factor payments to domesticallyowned factors of production.
6 Net Domestic ProductGPP minus depreciationDepreciation is usually 11%NDP=89% of GDPNational IncomeNDP-Indirect taxes that Business payIndirect taxes that Business pay nearly 10%NI is nearly 90% of NDP
7 PI is the total income received – whether it is earned or unearned – by the households of the economy before the payment of personal taxes.It is found by adding transfer payments to and subtracting social security contributions ,corporate income taxes and undistributed corporate profits from the NI.DI is the total income available to households after the payment of personal taxes. It is equal to PI less personal taxes and also equal to personal consumption expenditures plus personal saving.
8 GDP in 2003$millionUnited StatesJapanGermanyUnited KingdomFranceItlayChinaSpainCanadaMexico10,881,6094,326,4442,400,6551,794,8581,747,9731,465,8951,409,852836,100834,390626,080
9 GDP:An important and versatile conceptWe will see that GDP measures§ total income§ total expenditure§ total output§ the sum of value-added at all stagesin the production of final goods
10 How to measure GDP?There are three approaches to the measurement of GDP:spending,income,and production.
11 Spending Approach The spending approach divides GDP into four areas: households (consumption) (C)businesses (investment) (I)government (G) andforeigners (net exports) (X-IM).
12 Investment (I)def1: spending on [the factor of production] capital.def2: spending on goods bought for future use. Includes:§ business fixed investment spending on plant and equipment thatfirms will use to produce other goods & services§ residential fixed investment spending on housing units by consumersand landlords§ inventory investment the change in the value of all firms’ inventories
13 Investment vs. Capital§ Capital is one of the factors of production.At any given moment, the economy has a certain overall stock of capital.§ Investment is spending on new capital.Example (assumes no depreciation):§ 1/1/2002: economy has $500b worth of capital§ during 2002: investment = $37b§ 1/1/2003: economy will have $537b worth of capital
14 Stocks vs. FlowsFlow StockMore examples:stock flowa person’s wealth a person’s saving# of people with # of new collegecollege degrees graduatesthe govt. debt the govt. budget deficit
15 A question for you:Suppose a firm§ produces $10 million worth of final goods§ but only sells $9 million worth.Does this violate the expenditure = output identity?
16 Why output = expenditure § Unsold output goes into inventory,and is counted as “inventory investment”… .….whether the inventory buildup was intentional or not.§ In effect, we are assuming that firms purchase their unsold output.
17 The income approachThe income approach divides GDP according to who receives the income from the spending flow.In addition to aggregate income, national income and personal income are also used as measures of income.
19 The income approach The Income Components Include: Wages and salaries Corporate profitsProprietors income (the profits of partnerships and soley owned businesses, like a family restaurant)Farm incomeRentInterestSales taxesDepreciation (the amount of capital that has worn out during the year)
20 Interest (only the interest payments made by business firms are included and the interest payments made by government are excluded).Corporate profits which are subdivided intoCorporate income taxesDividendsUndistributed corporate profits
21 Three additions are made to the income side to balance it with expenditures. 1.Indirect business taxes are added because they are initially income that later gets paid to government.2.Depreciation or the consumption of fixed capital is added because it is initially income to businesses that later gets deducted in calculating profits.3.Net foreign factor income is added because it reflects income from all domestic output regardless of the foreign or domestic ownership of domestic resources.
22 The production approach The production approach looks at GDP from the standpoint of value added by each input in the production process.The three approaches--spending, income, and production– (should) result in equivalent values for GDP.
24 Below is a list of domestic output and national income figures for a given year. All figures are in billions.Determine the major national income measures by both the expenditures and income methods.Personal consumption expenditures$245Net foreign factor income earned in the U.S.0004Transfer payments0012Rents0014Consumption of fixed capital (depreciation)0027Social security contributions0020Interest0013Proprietors’ income0033Net exports0011Dividends0016Compensation of employees0223Indirect business taxes0018Undistributed corporate profits0021Personal taxes0026Corporate income taxes0019Corporate profits0056Government purchases0072Net private domestic investmentPersonal saving
26 Introducing govt. in the above identity G= govt. purchases of goods and servicesTA=all taxesTR=transfers to private sector (including interest)NX=net exports (exports-imports)YD=disposable incomeY=C+I+G+NX……….(3)YD=Y+TR-TA………..(4)YD= C+S………………(5)C+S=Y+TR-TA
27 T - G: the Government's Budgetary Balance; LEAKAGES (Withdrawals (W) : (T + S + IM) out of the system must equal INJECTIONS (J): (G + I + X) for the circular flow to balance (be in EQUILIBRIUM).Withdrawals [ T + S + IM] = Injections [G + I + X] can be broken down to three important balances in the economy:T - G: the Government's Budgetary Balance;S - I: the Private Sector's Saving/Investment Balance;IM - X: the Country's Trade Balance (current account of Balance of Payments)
28 C=YD-S=Y+TR-TA-S……………………..(6) Consumption is disposable income less savingOr consumption is equal to income plus transfers less taxes and savingUsing RHS of (6) in (3):Y=C+I+G+NX……….(3)Y= (Y+TR-TA-S)+ I+G+NXS-I=(TR-TA+G)+NX…………………………(7)Govt. budget deficit,I.e., total govt. expenditure consisting of govt.Purchases of goods and services(G) plus govt. transfer payments (TR)Minus amount of taxes (TA) received by govt. equals excess of private saving over investment and net exports
29 The budget deficit, trade, saving and investment(in Rs. Billion) Saving (S)……………Investment(I)…………Budget Deficit(BD)…Net Exports (NX)……
30 ExercisesQ.1 What would happen to GDP if the govt. hired unemployedWorkers, who had been receiving amount $TR in unemploymentBenefits, as govt. employees and now paid them $TR to do nothing?Explain.Q.2In the national income accounts, what is the difference between:a)A firm’s buying an auto for an executive and the firm’s paying theExecutive additional income to buy the automobile herself?b)Your hiring your spouse (who takes care of the house) ratherthan having him or her do the work without pay?c)Your deciding to buy an Indian car rather than a German car?
31 3. The following is information from the national income accounts for a hypothetical country: GDP $6, 000Gross investmentNet investmentConsumption , 000Government purchases of goods and services 1, 100Government budget surplusWhat is:a. NDP? d. Disposable personal income?b. Next exports? e. Personal saving?c. Government taxes minus transfers?
32 GDP and GDP deflator§ We would like to convert different goodsquantities and prices into one single quantity of composite good andone general price level. How?§ We use the concepts of nominal GDP, real GDP andGDP deflator to achieve such aggregation.
33 Real vs. Nominal GDP§ GDP is the value of all final goods and servicesproduced domestically.§ Nominal GDP measures these values using current prices.§ Real GDP measure these values using the prices of a base year.
34 Real and Nominal GDP 2001 Nominal GDP 2006 Nominal GDP 2006 Real GDP Bread (ton)1 at Rs.1 thousand… Rs. 1thousand2 at Rs.2 thousand.. Rs. 4 thousand2 at Rs. 1 thousand…………Rs.2 thousandMilk (thousand Litres)1 at Rs 0.5 thousand………....Rs. 0.5 thousand3 at Rs.0.75 thousand…………..Rs thousand3 at Rs.0.50 thousand…………..Rs.1.50 thousandTotal GDPRs. 1.5thousandRs thousandRs thousand
35 Real GDP and living standard Changes in nominal GDP can be due to:§ changes in prices§ changes in quantities of outputproducedChanges in real GDP can only be due tochanges in quantities, because real GDP isconstructed using constant base-yearprices. Therefore, changes in real GDPmeasure changes in living standard.
36 GDP DeflatorWhile real GDP captures living standard,cost of living is measured by general price level.One measure of the general price level is the GDP Deflator, defined asGDP deflator = 100 * Nominal GDP /Real GDP
37 Measuring the Cost of Living § Inflation refers to a situation in which the economy’soverall price level is rising.§ The inflation rate is the percentage change in the price levelfrom the previous period.
38 Exercise: The following table shows nominal GDP and an appropriate price index for a group of selected years. Compute real GDP. Indicate in each calculation whether you are inflating or deflating the nominal GDP dataNominal GDP billionsPrice index (1992=100)Real GDP billions1959$ 507.223.0$______1964663.024.61967833.626.619731382.635.419885049.686.119957265.4107.8
39 CPI vs. GDP deflatorprices of capital goods• included in GDP deflator (if produced domestically)• excluded from CPIprices of imported consumer goods• included in CPI• excluded from GDP deflatorthe basket of goods• CPI: fixed• GDP deflator: changes every year
40 International Comparisons of GDP In any attempt to compare GDP between countries, some account must be taken of differences in prices.Adjustment for GDP based on exchange rates makes some improvement in the comparison of GDP figures.However, if we wish to determine the value of GDP in another country, some information on the price differences of goods is needed.
41 Purchasing power parity exchange rates attempt to adjust exchange rates fordifferences in the prices of goods acrossborders through the use of a ratio of price indexes.The exchange rate is adjusted to reflect this ratio
42 Once this adjustment is made, international rankings of countries based on GDP or per capita GDP tend to fluctuateas exchange rates vary, while the corresponding prices do not.Despite their variability due to exchange rate fluctuations,purchasing power parity exchange rates provide a better basisfor international comparisons than an adjustment basedsolely on exchange rates.