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.