Notes on National Accounts and Macroeconomic Variables

Page 1: National Accounts Overview

• Topic: National Accounts and Income Distribution

• Speaker: Valerio Pieroni

• Presentation Start: 1/41

Page 2: Today's Discussion Points

• Measuring macro variables:

  • National accounts

  • Gross Domestic Product (GDP)

  • Inflation measures

  • Unemployment statistics

  • Neoclassical model of income distribution

Page 3: Measurement of Economic Variables

• Key Questions:

  • How are aggregate economic variables measured?

  • How do we compare the economic performance of different countries?

  • How to evaluate the performance of a single country over time?

Page 4: National Accounting Framework

• Definition: National accounts serve as a framework to measure aggregate economic variables.

• Origin: Developed by Prof. Richard Stone in the 1940s during WWII; awarded the Nobel Prize in 1984 for this work.

• Implementation: Post WWII, countries began producing national statistics.

• Standards: Updated by UN Statistical Office, latest in 2008 (UN-SNA 2008).

• UK Statistics: Produced by the Office for National Statistics (ONS).

Page 5: Economic Performance Measurement

• Question: How should economic activity be gauged?

Page 6: GDP as an Economic Indicator

• Concept: Economic activity and production are positively correlated.

• Definition: Gross Domestic Product (GDP) is defined as the value of all final goods and services produced in a given timeframe within a country's borders.

Page 7: UK GDP Growth

• Statistic: Estimated growth of UK GDP by 0.2% in July 2022.

• Visualization: Monthly index from January 2007 to July 2022, indexed to 2019 = 100.

Page 8: Precision in GDP Calculation

• Details on GDP Measurement:

  • Focus only on final goods—no intermediate goods.

  • Only goods and services currently produced within specified time (usually quarterly/yearly).

  • Excludes illegal market activities and home production (changes in practice occurring).

Page 9: Changes in GDP Measurement

• Inclusion: Changes to account for illegal activities (like drugs and prostitution), which increased annual GDP estimates by £65 billion effective September.

Page 10: Methods for Measuring GDP

• Three Methods:

  1. Product approach (Value added).

  2. Income approach.

  3. Expenditure approach.

• Key Point: These methods should yield equivalent results.

Page 11: Circular Flow of the Economy

• Conceptual Framework: Highlight how income, expenditure, and revenue are interconnected—one's income is another's expenditure, forming a circular flow.

Page 12: Product Approach to GDP

• Formula:

  • $GDP<em>t = ext{Value of final goods produced}</em>t - ext{Value of intermediate goods used in production}_t$

Page 13: Income Approach to GDP

• Formula:

  • $GDP_t = ext{Sum of all income received by economic agents contributing to production at time } t = ext{profits} + ext{wages} + ext{capital payments} + ext{taxes}$

Page 14: Expenditure Approach to GDP

• Formula:

  • $GDP_t = ext{Total spending on all final goods produced in the economy in a given time period}$

  • Breakdown:

  • $C_t$ - Total household consumption

  • $I_t$ - Total investment expenditure

  • $G_t$ - Total government expenditure

  • $NX<em>t$ - Net exports (Exports ($Xt$) - Imports ($M_t$))

Page 15: Gross National Income (GNI)

• Definition: GNI focuses on production by nation rather than location.

• Formula:

  • $GNI<em>t = GDP</em>t + ext{Net factor payments from abroad}$

Page 16: National Accounting Identity

• Identity: Income equals expenditure.

• Expression:

  • $Y<em>t = C</em>t + I<em>t + G</em>t + NX_t$

• Implication: Reflects overall economic activities and balances.

Page 17: Interpretation of National Accounting Identity

• Insight: Analyzes allocations in economies and can provide insights on consumer demand and supply dynamics.

Page 18: Trade Balance

• Definition: Difference between exports and imports.

• Relation to Identity: $NX = Y - (C + I + G)$

  • If Y > C + I + G, then NX > 0 (Trade Surplus).

  • If Y < C + I + G, then NX < 0 (Trade Deficit).

Page 19: Closed Economy Assumptions

• Concept: No international trade implies $NX = 0$.

Page 20: Governments and Macroeconomic Variables

• Focus: Relationship between savings (S) and investment (I) in macroeconomic context.

• Total Savings Equation:

  • $S = S<em>{ ext{public}} + S</em>{ ext{private}}$

• Public Savings:

  • $S_{ ext{public}} = T - G$

• Private Savings:

  • $S_{ ext{private}} = Y - T - C$

Page 21: Current Account Overview

• Definition: Balance of payments regarding trade in goods and services along with net income flows.

• Derivation:

  • $S = I + NX + NFP$

Page 22: Current Account Calculations

• Implications:

  • S > I
    ightarrow CA > 0
    ightarrow ext{net lender abroad}

  • S < I
    ightarrow CA < 0
    ightarrow ext{net borrower abroad}

Page 23: Current Account in Closed Economies

• Note: In a closed economy, $CA = 0$ and thus $S = I$.

Page 24: Price Considerations

• Concept: Importance of measuring real variables against price variables.

Page 25: Analysis of GDP Growth

• Consideration: Increase in GDP may result from higher production or inflation.

• Task: Isolate economic activity using price indices.

Page 26: Nominal vs Real GDP

• Definitions:

  • Nominal GDP (NGDP): Market value at current prices, reflecting both quantity and price changes.

  • Real GDP (RGDP): Market value based on constant base year prices, changes only with quantity changes.

• Conclusion: RGDP is preferable for assessing economic performance.

Page 27: Understanding NGDP and RGDP

• Impact of Price Changes: NGDP will vary with both production and price changes, while RGDP focuses purely on production volume.

Page 28: Example of NGDP and RGDP Changes

• Definitions:

  • $P_t$ - Price at time t.

  • $Q_t$ - Quantity produced at time t.

• Example:

  • $P<em>t = 10, P</em>{t+1} = 15, Q<em>t = 20, Q</em>{t+1} = 16$

Page 29: NGDP Calculation

• Calculations:

  • For $t$:

  • $NGDP_t = 10 imes 20 = 200$

  • For $t+1$:

  • $NGDP_{t+1} = 15 imes 16 = 240$

  • Conclusion: NGDP increasing.

Page 30: RGDP Calculation

• RGDP Evaluation:

  • For $t$:

  • $RGDP_t = 10 imes 20 = 200$

  • For $t+1$:

  • $RGDP_{t+1} = 10 imes 16 = 160$

  • Conclusion: RGDP decreasing.

Page 31: Understanding Inflation

• Definition: Inflation rate measures price level increases, formulated as:

  • $ext{Inflation} ext{ (π)} = rac{P<em>t - P</em>{t−1}}{P_{t−1}} imes 100$

• Note: Deflation occurs with negative price growth.

Page 32: GDP Deflator

• Definition: Ratio of NGDP to RGDP, used to measure inflation related to overall production.

• Formula:

  • $GDP<em>{deflator</em>t} = rac{NGDP<em>t}{RGDP</em>t} imes 100$

Page 33: Utilizing GDP Deflator

• Applications: To derive RGDP calculations from NGDP data for economic analysis.

Page 34: Consumer Price Index (CPI)

• Definition: Measures changes in the cost of a fixed basket of goods and services.

• Construction: Composed of 700 different items adjusted yearly, focusing on consumer expenses but lacking owner-occupied housing costs.

Page 35: CPI Calculation

• Formula:

  • $CPI_t = rac{ ext{Cost of basket at } t}{ ext{Cost of basket at base year}} imes 100$

Page 36: Comparison of GDP Deflator and CPI

• Differences:

  • GDP deflator includes government investment while CPI only considers household consumption.

  • CPI includes prices of imported goods; GDP deflator does not.

Page 37: Limitations of CPI

• Concerns:

  • Not automatically updated with innovation, may not accurately measure inflation due to quality changes and new goods.

Page 38: Unemployment Metrics

• Components of Unemployment Rate:

  • $ext{Unemployment Rate} = rac{ ext{Unemployed}}{ ext{Labour Force}} imes 100$

Page 39: UK Labour Market Dynamics

• Trends (2011-2022): Provides insights into employment rates, unemployment rates, and economic inactivity.

Page 40: Neoclassical Model of Income Distribution

• Introduction: Understanding of macro variables sets the stage for models that determine GDP and income distribution between labor and capital.

Page 41: Declining Labour Share

• Observation: Labour's share of non-farm business sector output has decreased from 68% to approximately 52% from 1947 to 2016.

Page 42: Production Function Overview

• Definition: Captures the relationship between inputs and outputs in production.

• General Form:

  • $Y = F(K, L)$

  • Where $Y$ is output (GDP), $K$ is capital, and $L$ is labor.

  • Often expressed using a Cobb-Douglas function: $Y = F(K, L) = K^αL^β$

Page 43: Diminishing Returns Concept

• Key Property: Output changes regarding input alterations show diminishing returns to each input.

  • rac{ ext{∂F}}{ ext{∂K}} > 0 and rac{ ext{∂^2F}}{ ext{∂K}^2} < 0

Page 44: Returns to Scale in Production

• Definition: Indicates how output changes as inputs increase proportionally.

• Mathematical Representation:

  • $F(rK, rL) = r^kY$

• Scenarios:

  • Constant returns to scale ($k=1$), increasing returns ($k>1$), and decreasing returns ($k<1$).

Page 45: Application of Euler’s Theorem

• Explanation: States that if a function is homogeneous of degree k, it can be expressed through its partial derivatives.

  • $kF(x<em>1, x</em>2, ext{…}, x<em>n) = rac{ ext{∂F}}{ ext{∂x</em>1}}x<em>1 + rac{ ext{∂F}}{ ext{∂x</em>2}}x_2 + ext{…}$

Page 46: Application in Production Function

• Formula:

  • $kF(K, L) = rac{ ext{∂F(K, L)}}{ ext{∂K}} K + rac{ ext{∂F(K, L)}}{ ext{∂L}} L$ when assuming constant returns to scale ($k=1$).

Page 47: Factor Payments in Competitive Markets

• Assumption: Input factors compensated for their marginal product earnings.

• Wage (w) and Return on Capital (r):

  • $w = MPL imes P$

  • $r = MPK imes P$

Page 48: Exhaustion of Income Theorem

• Conclusion: Total economy income equals the sum of payments to labor and capital based on marginal productivity models.

Page 49: Predictions from the Neoclassical Model

• Cobb-Douglas Function Assumption: Labor and capital shares are constant, which do not reflect real-world observations.

Page 50: Model Interpretation Issues

• Considerations:

  • Increasing power of US firms and the nature of technological changes, including automation affecting low-skilled labor.

Page 51: Summary of Key Learning Objectives

• Understanding what GDP measures

• Significance of using RGDP over NGDP for evaluating economic performance

• Common methods of measuring inflation

• Definition of unemployment

• Intro to neoclassical income distribution model