King’s University College National Income Accounting and the Current Account Surplus and Deficits J.D. Han, King’s University College

Review of Intermediate Macroeconomics National income accounts measures of National Income (Y): Income measures of value of Aggregate Output (S Pi Qi) : Supply measures of value of Aggregate Expenditure(AE): Demand: AE = C + I + G + EX - IM Disposal of National Income : Y = T + C + S Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Ex-post, Supply = Demand P = E = Y Records the value of national income that results from production and expenditure. Producers earn income from buyers who spend money on goods and services. The amount of expenditure by buyers (E)= the amount of income for sellers (Y)= the value of production(P). National income is often defined to be the income earned by a nation’s factors of production. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Y= S Pi Qi = Supply Side NI: GNP Y: What are factors of production? workers (labor), physical capital (like factories and equipment), natural resources and other factors that are used to produce goods and services. S Pi Qi: The value of final goods and services produced by labor, capital and natural resources, which belong to the Canadian nationals, are counted as Canadian GNP. National Income and the total value of aggregate products are always equal to each other at ll times. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

AE = Demand Side NI: GNE GNE is calculated by adding the value of expenditure on final goods and services produced. There are 4 types of expenditure: Consumption: expenditure by domestic residents Investment: expenditure by firms on plants & equipment Government purchases: expenditure by governments on goods and services Exports = expenditures by foreigners on domestic goods and services AE = Cd + Id + Gd + EX Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Y = P at all times: Supply Side E: Demand Side At equilibrium, Supply = Demand Y (= P )= E at equilibrium Y = Cd + Id + Gd + EX Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

C = Cd + Cf; I = Id + If; G = Gd + Gf However, for statistical convenience, consumption, investment, and government expenditures are all inclusive of expenditures on domestic and foreign goods. - Noone is always checking and classifying where the product he spends on is made! C = Cd + Cf; I = Id + If; G = Gd + Gf Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Y = Cd + Id + Gd + EX = (C-Cf) + (I-If) + (G-Gf) + EX = C + I + G + EX – (Cf + If +Gf) = C + I + G + EX – IM = C + I + G + CA surplus Expenditure By domestic residents Net expenditure by foreigners Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Now Incorporating Y = C + I + G + X-M and Y = C + S + T There are 2 ways of doing so: Method 1 C+ I + G + EX – IM = C + S + T EX – IM = S – I + T - G Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Method 2: From Y = C + I + G + EX - IM (current account surplus) = Y – (C + I + G ) Trick is to put +T and –T so that Y = C+S+T is incorporated. = (Y – C – T) + (T – G) – I = S- I + T – G, or = SPrivate + SGovernment- I = SN – I * Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. d

*Savings (1) SPrivate : the saving of the private sector or the households. Y = C + SPrivate + T SPrivate =Y – C - T (2) SGovernment: It is equal to government budget surplus. * SGovernment = T – G (3) National Savings SN = SP+ SG Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

If National Savings> Investment, then CA + Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

I = SNational + SForeign * CA deficits are in fact Savings or Investment (supplemented) by Foreigners for this country I = SN – CA surplus = SN + CA deficits I = SNational + SForeign Countries can finance investment either by national savings or by acquiring foreign funds equal to the current account deficit, which is in fact savings by foreigners (non-residents) for this economy. When national S < I, then CA < 0, financial capital inflows for the domestic economy. A current account deficit implies a financial capital inflow or negative net foreign investment(= positive net investment by foreigners = net negative foreign investment by Canadians. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

*In the short-run, Sp does not change very much, but Sg does: Government Deficits are the major determinant of Current Account CA = Sp + Sg – I = Sp – government deficit – I Government deficit is negative government saving equal to G – T A high government deficit causes a negative current account balance, all other things equal. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

Relationship Between Government Deficits and Current Account Illustrated Source: Congressional Budget Office, US Department of Commerce Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.

**We can derive the same equation in an alternative way: Equilibrium National Income Condition was Sprivate + T + IM = I + G + EX IM – EX = Current Account Deficits = = I – Sprivate + ( G – T) = I – SPrivate + SGovernment = I – SNational Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley.