NationalIncomeAccounting

.IntroductionWhydowestudythenationalincomeaccounts?NationalincomeaccountingprovidesformalstructureformacrotheorymodelsIntroducesstatisticsthatcharacterizetheeconomyOutputdefinedintwowaysProductionside:output=paymentstoworkers(wages),capital(interestanddividends)Demandside:output=purchasesbydifferentsectorsoftheeconomyOutputtypicallymeasuredasGDP=valueofallfinalgoodsandservicesproducedwithinacountryoveraparticularperiodoftime2-2ProductionSideoftheEconomyTheproductionsideoftheeconomytransformsinputs(labor,capital)intooutput(GDP)Inputs=factorsofproductionPaymentstothesefactors=factorpaymentsTherelationshipbetweeninputsandoutputsdefinedbytheproductionfunction

whereY=output,N=labor,K=capital“Outputisafunctionoflaborandcapital,”wherethefunctionalformcanbedefinedinvariouswaysForexample:corn=f(land,labor,seed,machines)2-3FromGDPtoFactorPaymentsWeusethetermsoutputandincomeinterchangeablyinmacroeconomics

aretheyreallyequivalent?Thereareafewcrucialdistinctionsbetweenthem:CapitalwearsdownovertimewhileitisbeingusedintheproductionprocessNetdomesticproduct=GDP–depreciationNDPisthetotalvalueofproductionminusthevalueoftheamountofcapitalusedupinproducingthatoutputNDPisusually87-89%ofGDP2-4FromGDPtoFactorPaymentsWeusethetermsoutputandincomeinterchangeablyinmacroeconomics

aretheyreallyequivalent?Thereareafewcrucialdistinctionsbetweenthem:2.Businessespayindirecttaxes(i.e.taxesonsales,property,andproduction)thatmustbesubtractedfromNDPbeforemakingfactorpaymentsFactorpayments=NDP–indirectbusinesstaxesIndirectbusinesstaxesaccountformorethan10%ofNDPFactorpaymentsareroughly80%ofU.S.GDP?offactorpaymentsgotolabor2-5ComponentsofDemandTotaldemandfordomesticoutputismadeupoffourcomponents:Consumptionspendingbyhouseholds(C)Investmentspendingbyfirms(I)Governmentspending(G)Foreigndemandforournetexports(NX)Thefundamentalnationalincomeaccountingidentityis

(3)2-6ConsumptionConsumptionreferstothepurchasesofgoodsandservicesbythehouseholdsectorIncludesspendingondurable(ex.Cars),non-durable(ex.Food),andservices(ex.Medicalservices)ConsumptionistheprimarycomponentofdemandConsumptionasashareofGDPvariesbycountryFigure2-2comparesconsumptionasashareofGDPfortheU.S.toJapan2-7Government

Governmentalsomakestransferpayments=paymentsmadetopeoplewithouttheirprovidingacurrentserviceinexchangeEx.Socialsecurity,unemploymentbenefitsTransferpaymentsareNOTincludedinGDPsincenotapartofcurrentproductionGovernmentexpenditure=transfers+purchases2-8GovernmentpurchasesofgoodsandservicesincludenationaldefenseexpendituresandsalariesofgovernmentemployeesInvestmentInvestment=additionstothephysicalstockofcapital(i.e.buildingmachinery,constructionoffactories,additionstofirmsinventories)Inthenationalincomeaccounts,investmentassociatedwithbusinesssector’saddingtothephysicalstockofcapital,includinginventoriesHousehold’sbuildingupofinventoriesisconsideredconsumption,althoughnewhomeconstructionsconsideredpartofI,notCGrossinvestmentincludedinGDPmeasure,whichisnetinvestmentplusdepreciation2-9NetExportsAccountsfordomesticpurchasesofforeigngoods(imports)andforeignpurchasesofdomesticgoods(exports)NX=Exports–ImportsSubtractimportsfromGDPsinceaccountingfortotaldemandfordomesticproductionNXcanbe>,<,or=0U.S.NXhasbeennegativesincethe1980’stradedeficit2-10SomeIdentities:ASimpleEconomyAssumenationalincomeequalsGDP

usetermsincomeandoutputinterchangeably(convenience)Beginwithasimpleeconomy:closedeconomywithnopublicsectoroutputexpressedas(4)Onlytwothingscandowithincome:consumeandsavenationalincomeexpressedas(5),whereSisprivatesavingsCombine(4)and(5):(6)Rearrange(6)s.t.(7),orinvestment=savingsinthesimpleeconomy2-11SomeIdentities:ASimpleEconomyAssumenationalincomeequalsGDP

usetermsincomeandoutputinterchangeably(convenience)Beginwithasimpleeconomy:closedeconomywithnopublicsectoroutputexpressedas

(4)Onlytwothingscandowithincome:consumeandsavenationalincomeexpressedas(5),whereSisprivatesavingsCombine(4)and(5):(6)Rearrange(6)s.t.(7),orinvestment=savingsinthesimpleeconomy2-12SomeIdentities:ASimpleEconomyAssumenationalincomeequalsGDP

usetermsincomeandoutputinterchangeably(convenience)Beginwithasimpleeconomy:closedeconomywithnopublicsectoroutputexpressedas

(4)Onlytwothingscandowithincome:consumeandsavenationalincomeexpressedas(5),whereSisprivatesavingsCombine(4)and(5):(6)Rearrange(6)s.t.(7),orinvestment=savingsinthesimpleeconomy2-13SomeIdentities:ASimpleEconomyAssumenationalincomeequalsGDP

usetermsincomeandoutputinterchangeably(convenience)Beginwithasimpleeconomy:closedeconomywithnopublicsectoroutputexpressedas

(4)Onlytwothingscandowithincome:consumeandsavenationalincomeexpressedas(5),whereSisprivatesavingsCombine(4)and(5):(6)Rearrange(6)s.t.(7),orinvestment=savingsinthesimpleeconomy2-14SomeIdentities:ASimpleEconomyAssumenationalincomeequalsGDP

usetermsincomeandoutputinterchangeably(convenience)Beginwithasimpleeconomy:closedeconomywithnopublicsectoroutputexpressedas

(4)Onlytwothingscandowithincome:consumeandsavenationalincomeexpressedas(5),whereSisprivatesavingsCombine(4)and(5):(6)Rearrange(6)s.t.(7),orinvestment=savingsinthesimpleeconomy2-15SomeIdentities:AddingGandNXWhenaddingthegovernmentandtheforeignsector,thefundamentalidentitybecomes (8)Disposableincome,YD,iswhatconsumerssplitbetweenCandSwhenhaveapublicsector,or(9),whereTR=transferpaymentsandTA=taxes

(10)Ifrearrange(9)andsubstitute(8)forY,then(11)Substituting(10)into(11):(12)Rearranging:(13)2-16SomeIdentities:AddingGandNXWhenaddingthegovernmentandtheforeignsector,thefundamentalidentitybecomes (8)Disposableincome,YD,iswhatconsumerssplitbetweenCandSwhenhaveapublicsector,or

(9),whereTR=transferpaymentsandTA=taxes

(10)Ifrearrange(9)andsubstitute(8)forY,then(11)Substituting(10)into(11):(12)Rearranging:(13)2-17Whenaddingthegovernmentandtheforeignsector,thefundamentalidentitybecomes (8)Disposableincome,YD,iswhatconsumerssplitbetweenCandSwhenhaveapublicsector,or

(9),whereTR=transferpaymentsandTA=taxes

(10)Ifrearrange(9)andsubstitute(8)forY,then

(11)

SomeIdentities:AddingGandNX2-18SomeIdentities:AddingGandNXWhenaddingthegovernmentandtheforeignsector,thefundamentalidentitybecomes (8)Disposableincome,YD,iswhatconsumerssplitbetweenCandSwhenhaveapublicsector,or

(9),whereTR=transferpaymentsandTA=taxes

(10)Ifrearrange(9)andsubstitute(8)forY,then

(11)Substituting(10)into(11):(12)2-19SomeIdentities:AddingGandNXWhenaddingthegovernmentandtheforeignsector,thefundamentalidentitybecomes (8)Disposableincome,YD,iswhatconsumerssplitbetweenCandSwhenhaveapublicsector,or

(9),whereTR=transferpaymentsandTA=taxes

(10)Ifrearrange(9)andsubstitute(8)forY,then

(11)Substituting(10)into(11):(12)Rearranging:(13)2-20S,I,GovernmentBudget,andTrade

whereG+TRistotalgovernmentexpendituresandTAisgovernmentincomedifferencebetweenexpendituresandincomeisthegovernmentbudgetdeficit2-21S,I,GovernmentBudget,andTradeExcessofsavingsoverinvestment(S>I)intheprivatesectorisequaltothegovernmentbudgetdeficitplusthetradesurplusAnysectorthatspendsmorethanitreceivesinincomehastoborrowtopayfortheexcessspendingPrivatesectorcandisposeofsavingsinthreeways:MakeloanstothegovernmentPrivatesectorcanlendtoforeignersPrivatesectorcanlendtofirmswhousethefundsforI2-22MeasuringGrossDomesticProductGDP=valueoffinalgoodsandservicescurrentlyproducedwithinacountryoveraperiodoftimeFinalgoodsandservicesNODOUBLECOUNTINGEx.WouldnotincludethefullpriceofacarANDthetiresboughtbythemanufacturerforthecartires=intermediategoods2-23MeasuringGrossDomesticProductGDP=valueoffinalgoodsandservicescurrentlyproducedwithinacountryoveraperiodoftimeGoodsandservicescurrently(inthetimeperiodbeingconsidered)produced&excludestransactionsinvolvingusedgoodsEx.IncludetheconstructionofnewhomesincurrentGDP,butnotthesaleofexistinghomes2-24MeasuringGrossDomesticProductGDP=valueoffinalgoodsandservicescurrentlyproducedwithinacountryoveraperiodoftimeGoodsandservicesproducedwithinacountry,regardlessoftheownership/nationalityoftheproducingfirmEx.IncludethesaleofacarproducedbyaJapanesecarmanufacturerlocatedintheU.S.inU.S.GDP2-25ProblemsofGDPMeasurementTherearethreemajorcriticismsoftheGDPmeasure:Omitsnon-marketgoodsandservicesEx.Workofstay-at-homemothersandfathersnotincludedinGDPNoaccountingfor“bads”suchascrimeandpollutionEx.Crimeisadetrimenttosociety,butthereisnosubtractionfromGDPtoaccountforitNocorrectionforqualityimprovementsEx.Technologicalimprovementsarebeneficialtotheeconomy,butnothingisaddedtoGDPtoaccountforthemDespitethesedrawbacks,GDPisstillconsideredoneofthebesteconomicindicatorsforestimatinggrowthinaneconomy2-26Nominalvs.RealGDPNGDPisthevalueofoutputinagivenperiodmeasuredincurrentdollarsNGDPin2007isthesumofthevalueofalloutputsmeasuredin2007dollars:

ChangesinNGDPcouldbepurelyduetochangesinprices

ifGDPistobeusedasameasureofoutput,needtocontrolforprices2-27Nominalvs.RealGDPRGDPisthevalueofoutputinconstantdollarsscaledbyabasedyearprice,sothatanychangeinGDPisduetochangeinproduction,notpricesIfPBisthepriceinthebaseyearforgoodi,RGDPin2007is:vs.2-28Nominalvs.RealGDP

2-29InflationandPricesInflation,,istherateofchangeofprices:

wherePtistoday’spriceandPt-1islastperiod’spriceAdditionally,,ortoday’spriceequalslastyear’sprice,adjustedforinflationIf>0,pricesareincreasingovertimeinflationIf<0,pricesaredecreasingovertimedeflationHowdowemeasureprices?Forthemacroeconomy,needameasureofoverallprices(priceindex)MostcommonindexesareCPI,PPI,andtheGDPdeflator2-30PriceIndexes:GDPDeflatorGDPdeflatoristheratioofNGDPinagivenyeartoRGDPofthatyearSinceGDPdeflatorisbasedonacalculationinvolvingallgoodsproducedintheeconomy,itisawidelybasedpriceindexthatisfrequentlyusedtomeasureinflationMeasuresthechangeinpricesbetweenthebaseyearandthecurrentyearEx.IfNGDPin2012is$6.25andRGDPin2012is$3.50,thentheGDPdeflatorfor2012is$6.25/$3.50=1.79priceshaveincreasedby79%sincethebaseyear2-31PriceIndexes:CPICPImeasuresthecostofbuyingafixedbasketofgoodsandservicesrepresentativeofthepurchasesofurbanconsumersMeasureofthecostoflivingfortheaveragehouseholdDiffersfromGDPdeflatorinthreeways:CPImeasurespricesofamorelimitedbasketofgoodsandservices(onlyhouseholdgoodsandservices)Thebundleofgoodsintheconsumerbasketisfixed,whilethatofthedeflationisallowedtovaryCPIincludespricesofimports,whileGDPdeflatoronlyconsidersthosegoodsproducedwithintheU.S.2-32PriceIndexes:PPIPPImeasuresthecostofbuyingafixedbasketofgoodsandservicesrepresentativeofafirmCapturesthecostofproductionforatypicalfirmMarketbasketincludesrawmaterialsandsemi-finishedgoodsPPIisconstructedfrompricesatanearlier