lecture2

Measurement and Structure of the National Economy

Course Overview

  • Course Title: Measurement and Structure of the National Economy

  • Institution: Washington University in St. Louis

  • Instructor: Miguel Faria-e-Castro, Federal Reserve Bank of St. Louis

  • Date: January 2025

Introduction

  • Key Concepts in Measurement:

    1. National income accounting

    2. Gross Domestic Product (GDP)

    3. Saving and wealth

    4. Real GDP, price indexes, and inflation

    5. Real and nominal interest rates

National Income Accounting

Overview

  • Definition: An accounting framework to measure current economic activity.

  • Importance: Provides comparable GDP measures across different countries.

    • Example: Allows comparison between Canada and Senegal.

  • U.S. System: Known as NIPA (National Income and Product Accounts).

  • Administration: Maintained by the Bureau of Economic Analysis (BEA).

  • Historical Context: Developed around World War II to systematically measure industrial production capacity.

Approaches to National Income Accounting

  1. Product Approach: Measures total final output produced in a period.

  2. Income Approach: Measures total income received by production factors.

  3. Expenditure Approach: Measures overall expenditure by agents purchasing goods and services.

    • Fundamental Equation: Production = Income = Expenditure.

Example of National Income Accounting

  • Economy with Two Companies:

    • OrangeInc: Produces oranges.

    • JuiceCorp: Produces orange juice using oranges from OrangeInc.

  • Financial Overview:

    • OrangeInc:

      • Wages: $15,000

      • Taxes: $5,000

      • Revenue: $35,000

    • JuiceCorp:

      • Wages: $10,000

      • Taxes: $2,000

      • Revenue: $40,000

      • Cost of oranges: $25,000

Product Approach Calculation

  • Value Added: Total value produced is revenue minus the cost of inputs.

    • Calculation:

      • Total Value = Revenue (OrangeInc + JuiceCorp) - Cost of Inputs (JuiceCorp)

      • Total Value = $35,000 + $40,000 - $25,000 = $50,000

  • Avoids double counting intermediate goods.

Income Approach Calculation

  • Involves summing incomes generated:

    • Example Calculation:

      • Wages OrangeInc: $15,000, Profits: $20,000

      • Wages JuiceCorp: $10,000, Profits: $5,000

      • Total Income = $50,000

Expenditure Approach Calculation

  • Measures final expenditure by users:

    • Total Expenditure = Sales to public by OrangeInc + Sales to public by JuiceCorp

    • Total = $10,000 + $40,000 = $50,000

    • Avoids double counting by focusing on final sales.

Fundamental Identity of National Accounting

  • Key Concept: All production is purchased, hence Production = Expenditure = Income = $50,000.

    • Establishes equivalence between production, income generated, and expenditure incurred.

Gross Domestic Product

Definitions

  • Definition: Market value of final goods and services newly produced within a nation during a specified period.

  • Characteristics:

    • Market Value: Reflects selling price in the market.

    • New Production: Counts only goods and services produced in the current period.

    • Final Goods: Excludes intermediate goods to avoid duplication.

GDP vs. GNP

  • GDP (Gross Domestic Product): Measures production within a country's borders.

  • GNP (Gross National Product): Measures production by domestic factors, regardless of location.

  • Key Distinction: GDP = GNP - Net Factor Payments (NFP) from abroad.

    • Example of NFP: Earnings of foreign workers in the domestic economy and vice versa.

Expenditure Approach to GDP Calculation

  • Formula: Y = C + I + G + NX

    • Y = GDP

    • C = Private Consumption

    • I = Investment

    • G = Government Purchases

    • NX = Net Exports (Exports - Imports)

Expenditure Categories Example (2014)

  • Personal Consumption Expenditures (C): $11,930 Billion (68.5% of GDP)

  • Gross Private Domestic Investment (I): $2,852 Billion (16.4% of GDP)

  • Government Purchases (G): $3,175 Billion (18.2% of GDP)

Additional Details on Consumption

  • Categories include durable and nondurable goods and services.

  • Durable goods (e.g., cars, furniture) represent major investments.

  • Nondurable goods (e.g., food, clothing) are essential for daily use.

Investment Spending

  • Types:

    • Changes in inventories, new capital goods.

    • Includes business fixed investments and residential investments.

Government Purchases

  • Definition: Spending on newly produced goods and services, not including transfer payments.

  • Typically a smaller fraction of overall spending but crucial for public services.

Income Approach to GDP Calculation

  • Components:

    • Employee Compensation

    • Proprietor’s Income

    • Rental Income

    • Corporate Profits

    • Net Interest

    • Taxes on Production and Imports

    • Business Current Transfer Payments

  • Total Income should equal total GDP.

Statistical Discrepancies

  • Addressing discrepancies in national accounting and capital depreciation.

  • Adjust GNP based on factors like net foreign payments.

Saving and Wealth

Definitions

  • National Wealth: Value of a nation’s assets minus liabilities.

  • National Saving: Sum of private saving and government saving.

  • Formula: S = Spvt + Sgovt

Saving Components

  • Private Saving: Savings available to private households after consumption.

  • Government Saving: Difference between government income and spending.

Uses of Private Saving

  • Fund investments, cover government deficits, and facilitate foreign loans.

  • Establishes relationships between private saving and overall investment through the current account balance.

Real GDP, Price Indexes, and Inflation

Real vs. Nominal Variables

  • Nominal Variables: Measured in current dollars, can mislead due to price changes.

  • Real Variables: Measure quantities while fixing prices, enables accurate economic assessments.

Price Indexes

  • Purpose: Measure changes in price levels over time, essential for assessing inflation and real GDP.

  • Types of Price Indexes: GDP Deflator, Consumer Price Index (CPI), and Personal Consumption Expenditure price index (PCE).

Inflation Rate

  • Definition: Growth rate of a price index, crucial for understanding economic health and purchasing power.

  • Methods to calculate the inflation: annualized vs year-over-year.

Interest Rates

Interest Rate Definitions

  • General Definition: Compensation to lenders from borrowers expressed as a percentage.

  • Interest rates vary based on loan maturity and market conditions.

  • Nominal vs. Real Interest Rates:

    • Nominal: Traditional measure; real takes inflation into account.

    • Expected real interest: Important in decision-making regarding loans and investments.

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