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National Income Accounts Chapter 1,2 Macroeconomics Dornbusch, Fischer, Startz (9/e) National Income Accounting - National income accounting turns economic data into information. - Two reasons for study: 1. National income accounts provide the formal structure for our macrotheory models. It divides national output in two ways. 1. Production /supply side output is paid out to labour in the form of wages and to capital in the form of interest and dividends 2. Demand side output is consumed or invested for future 2. Studying national income accounts helps learning vital statistics of an economy.

2 Production of Output - Production side of the economy transform inputs (labor, capital) into output, called *G*ross *D*omestic *P*roduct (GDP). - Inputs are called factors of production. - Payments made to factors (wage, interest) are called factor payments. - The production function: GDP (Y) = f (N,K) - Y = factor payments = labor payment + capital payment + profit - Y = (w X N) + (r X K) + Profit

3 Some Complexity - GNP (Gross National Product) - Payments include receipts from abroad made as factor payments to

domestically owned factors of production - NDP (Net Domestic Product) - NDP = GDP Depreciation - Depreciation is on average 11 percent - NI (National Income) - Business pay indirect taxes. Taxes must be subtracted from NDP to make factor payments. - What available for factor payment is called *national income*. Taxes around 10 percent

4 Outlays and Components of Demand - Y = C + I + G + NX - Y = GDP - C = Consumption spending by households - I = Investment by firms and households - G = Government purchases - NX = Net export (Export Import)

5 Consumption (C) - All type household expenditures including expenditure on durables - A major part of GDP

6 Investment (I) - Investment means addition to physical stock of capital - Any activity that increases the economys ability to produce output in the future - Investment not only in physical capital, but also in human capital. Human capital means knowledge and ability to produce that is embodied in the labour force.

- Inventory is also investment - Normally gross investment. Net Investment = Gross Investment Depreciation

7 Government (G) - All types of government purchases of goods and services. - Government spending also includes transfer payments. - Payments made to people without any service/good in exchange - It is not counted as part of GDP because transfers are not part of current production - Government Expenditure = transfer + purchases

8 Net Export (NX) - Difference between export and import - More export than import , NX is positive - More import than export, NX is negative

9 Some Identity - Simple Economy - No foreign sector, no government -YC+I - Income allocated -YC+S - Hence -C+IYC+S -IYC -SYC -IYCS

-IS - Investment is identically equal to savings

10 Government and Foreign Trade - Y C + I + G + NX - Government (G) Taxes - TA - TR Transfer - Disposable Income: - YD Y + TR TA - Allocation of YD, - YD C + S

11 Important Identity - YD Y + TR TA - YD TR + TA Y - YD TR + TA C + I + G + NX - C + S TR + TA C + I + G + NX - S I (G + TR TA) + NX - Government Budget Deficit (BD) G + TR TA Government expenditure - G + TR Government - TA Earnings - Government Budget Surplus (BS) TA (G + TR)

12 Measuring Gross Domestic Product - GDP is the value of final goods and services produced. - Exclude intermediate goods - Work with value added - Current Output - GDP consists of the value of output currently produced.

- It excludes transactions in existing goods. - But transaction fees in existing goods may be included.

13 Problems of GDP Measurement - GDP measure of output and same time should be measure of welfare of the residents of a country. - Is it measure of welfare? - Major Problems: 1. Non-traded products are poorly measured in GDP 2. Some activities added to GDP in fact are use of resources to avoid certain bads. 3. It is difficult to account for improvements in the quality of goods. 4. Illegal/immoral activities are not measured in GDP - Adjusted GNP!!!

14 Inflation and Price Indexes - *Real GDP *measures in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same prices, or in constant money. - *Nominal GDP *measures the value of output in a given period in the prices of that period, or, as it is sometimes put, in current money.

15 Inflation and Prices - Inflation is the rate of change in the prices - The price level is the cumulation of past inflation - Deflation - If *P**t-1** *represents the price level previous year and *P**t*represents current year price level, ** is inflation; then:

16 Price Indexes - GDP Deflator - The GDP deflator is the ratio of nominal GDP in a given year to real GDP of that year. - If GDP deflator is p, then purchasing power of money is 1/p. - Consumer Price Index (CPI) - The consumer price index measures the cost of buying a fixed basket of goods and services representative of the purchases of urban consumers. - Producer Price Index (PPI) - It is a measure of the cost of a given basket of goods.

17 Unemployment - The unemployment rate measures the fraction of the workforce that is out of work and looking for a job or expecting a recall from a layoff.

18 Interest and Exchange Rates - Interest Rate: - The rate of payment on a loan or other investment - Nominal - Real (nominal inflation rate) - Exchange Rate - The price of foreign currency - Fixed and float

19 Problem 3

- The following is information from the national income accounts for a hypothetical country: - What is 1. NDP? 2. Net Export? 3. Government taxes minus transfers? 4. Disposable personal income? 5. Personal Saving?

Account Value GDP $6,000 Gross Investment 800 Net Investment 200 Consumption 4,000 Government purchases of goods and services 1,100 Government budget surplus 30

20 Problem 4 - Assume that GDP is $6,000, personal disposable income is $5,100, and the government budget deficit is $ 200. Consumption is $3,800, and trade deficit is $100. - How large is savings (S)? - How large is investment (I)? - How large is government spending (G)? Problem 5 - If a countrys labor is paid a total of $6 billion, its capital is paid a total of $2 billion, and profits are zero, what is the level of output? Problem 7 - Suppose a countrys CPI increased from 2.1 to 2.3 in the course of 1 year. Use this fact to compute the rate of inflation for that year. Why may the CPI overstate the rate of inflation?

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