ECO3200 Chap 2 Notes

Introduction

• Why do we study national income accounts?

  • National income accounting provides formal structure for macro theory models

  • Introduces statistics that characterize the economy

• Output defined in 2 ways

  • Production side: output= payments to workers (wages), capital (interest and dividends)

  • Demand side: output=purchases by different sectors of the economy

• Output typically measured as GDP= value of all final goods and services produced within a country over a particular period of time

Production function

• The production side of the economy transforms inputs (labor, capital) into output (GDP)

  • Inputs= factors of production

  • Payments to these factors= factor payments

• Relationship between inputs and outputs defined by production function where Y=output, N=labor, K=capital

  • Output is a function of labor and capital where functional form defined in various ways

  • Corn=f (land, labor, seed, machines)

GDP to factor Payments

• Demand for output components: C+I+G

  • Consumption sending by households

  • Investment spending by firms

  • Government spending

  • Foreign demand for our net exports

  • Y=C+I+G+NX

• Payments to factors of production; employee comp, taxes and other, depreciation, corporate profits, net interest, rental income of persons, proprietors income

Consumption

• Purchases of goods and services by household sector

• Include spending on durable (cars), nondurable (food), and services

• Consumption is primary component of demand (accounts for 70% total demand in U.S)

• Consumption as share of GDP varies by country

Government

• Government purchases of goods and services include national defense expenditures and salaries of gov employees

• Gov make transfer payment: payments to ppl without providing current service in exchange (Social Security Payments)

• Transfer payments aren't included in GDP since not art of current production

Investment

• Additions to the physical stock of capital (building machinery, construction of factories, additions to firms inventories)

• In national income accounts, investment associated w business sectors adding to physical stock of capital, including inventories

  • Household building up inventories (indiv/household accumulate goods for future personal use) is considered consumption

  • New home construction part of I not C

• Gross investment included in GDP measure, when is net investment + depreciation

Net Exports

• Accounts for domestic purchases of foreign goods (imports) and foreign purchases of domestic goods (exports) --> NX= Exports-Imports

• Subtract imports from GDP since accounting for total demand for domestic production

• NX can be >, <, or =0

• U.S net exports has been negative since 80's= trade deficit

Simple economy

• Assume national income equals GDP, use income and output interchangeably

• Simple econ: closed econ w no public sector so output expressed as y=c+I

• 2 things to do w income: consume and same --> national income is y=c+s where s is private savings

• C+I=Y=C+S

• I=Y-C=S// investment= savings

S, I, Gov budget, and Trade

• G+TR is tot give expenditures and TA is gov income

  • Difference between expenditures and income is the government budget deficit

• Any sector that spends more than receives in income has to borrow to pay for the excess spending

• Private sector can dispose of saving in 3 ways

  • Make loans to the gov

  • Private sector lend to foreigners

  • Private sector lend to firms who use funds for investment

Measuring GDP

• GDP: val of final g and s currently produces within a country over period of time

• Final goods and services--> no double counting

• G and s currently (in time period being considered) produced and excludes transactions involving used goods

• G and s produced within a country, regardless of ownership/nationality of producing firm

• Problems (3 main criticisms of GDP measure)

  • Omits non market g and s

  • No accounting for bads such as crime and pollution

  • No correction for quality improvements

  • GDP still considered one of the best econ indicators for estimating growth in an economy

Nominal vs Real GDP

• NGDP is the value of output in a given period measured in current dollars

• NGDP in 2007 is sum of the value of all outputs measured in 2007 dollars

• Changes in NGDP could be purely due to changes in prices --> if GDP is to be used as measure of output, need to control for prices

• RGDP is the value of output in constant dollars --> scaled by a based year price, so that any change in GDP is due to change in production, not prices

Inflation, II, is the rate of change of prices:

• P_t=P_t-1+(P_t-1*II): todays price equals last years price, adjusted for inflation

• If II>0, prices are increasing over time=inflation

• If II<0, prices are decreasing over time=deflation

• How we measure prices

  • For the macroeconomy, need measure of overall prices (price index)

  • Most common indexes are CPI, PPI, and GDP deflator

Price index: GDP Deflator

• GDP deflator: ratio of NGDP in given year to RGDP of that year

• GDP deflator is based on a calc involving all goods produced in the econ and widely based price index that is frequency used to measure inflation

• Measures the change in prices between the base year ad current year

• Ex) if NGDP in 2012 is $6.25 and RGDP in 2012 is $3.5, then GDP deflator for 2012 ($6.25/$3.5)*100=179--> prices have increased by 79% since the base year

PPI

• PPI measures the cost of buying a fixed basket of goods and services representative of a firm

• Captures the cost of production for a typical firm

• Market basket includes raw materials and intermediate goods

• PPI is constructed from prices at an earlier stage of the distribution process than the CPI

• PPI signals changes to come in the CPI and is closely watched by policymakers

• Over long period of time CPI and PPI yield similar values and trends for inflation

CPI

• CPI: measures cost of buying fixed basket of goods and services representative of purchases of urban consumers

• Measure of cost of living for average household

• Differs from GDP deflator:

  • CPI measures prices of more limited basket of goods and services (only household g and s)

  • Bundle of goods in consumer basket is fixed, while deflation's can vary

  • CPI includes price of imports, while GDP deflator only considers those goods produced within U.S

Unemployment

• Unemployment rate: measures fraction of workforce that's out of work and looking for a job/expecting recall from layoff

• Important indicator of well being of an econ/households

• Optimal unemployment rates differ from country to country

• Optimal unemployment rate linked to potential level of output for given economy

Interest Rates

• Interest rate: rate of payment on loan/other investment over and above principle repayment in terms of annual percentage

• Cost borrowing money/benefit of lending money

• Nominal int rate: return on investment in current dollars

• Real int rate: return on investment adjusted for inflation

• If R= nominal rate, and r is real rate, then nominal rate is R=r+II