chapter 15 macroecon

National Income Accounting

  • National Income Accounting: The system used to measure the aggregate income and expenditures for a nation.

Gross Domestic Product (GDP)

  • GDP Definition: The market value of all final goods and services produced within a nation during a specific period, typically a year.

  • Importance of GDP: Indicates how well a country's economy is performing.

Transactions Excluded from GDP

  • Secondhand transactions

  • Nonproductive financial transactions

Secondhand Transactions

  • Examples:

    • Sale of a used car

    • Sale of a previously constructed home

Nonproductive Financial Transactions

  • Examples:

    • Private gifts

    • Buying and selling stocks and bonds

    • Making transfer payments

Transfer Payment

  • A government payment to individuals for which no goods or services are currently produced in exchange.

Final Goods

  • Finished goods and services produced for the ultimate user.

Intermediate Goods

  • Goods and services used as inputs in the production of final goods.

  • Exclusion from GDP: To avoid double counting and inflating GDP.

    • Including intermediate goods would count items multiple times.

    • National income accountants must exclude intermediate goods to accurately reflect final goods value.

Circular Flow Model

  • A diagram illustrating the exchange of money, products, and resources between households and businesses.

Flows and Stocks

  • Flow: A rate of change in a quantity over a period (e.g., dollars per year).

    • Examples: Income and consumption.

  • Stock: A quantity measured at a specific point in time.

    • Examples: Inventory of goods, amount of money in a checking account.

Approaches to Calculating GDP

  • Expenditure approach

  • Income approach

Expenditure Approach

  • The national income accounting method that measures GDP by adding all spending for final goods during a period of time.

  • Four Components of Expenditures:

    • Personal consumption expenditures (C)

    • Gross private domestic investment (I)

    • Government consumption expenditures and gross investment (G)

    • Net exports (X – M)

Personal Consumption Expenditures (C)

  • Household spending on:

    • Durable goods (last beyond three years; e.g., automobiles, appliances, furniture)

    • Nondurable goods (consumed in less than three years; e.g., food, clothing, gasoline)

    • Services (intangible transactions; e.g., recreation, medical treatment, education)

Gross Private Domestic Investment (I)

  • Private sector spending on capital assets expected to yield future profits.

  • Two Components:

    • Fixed investment expenditures for newly produced capital goods

    • Change in business inventories

Government Consumption Expenditures and Gross Investment (G)

  • Value of goods and services purchased by government at all levels, measured by their costs.

Net Exports (X – M)

  • The difference between exports and imports.

Exports (X)

  • Spending by foreigners on U.S. domestically produced goods.

Imports (M)

  • The dollar amount of U.S. purchases of goods produced abroad.

Formula for GDP (Expenditure Approach)

  • GDP = C + I + G + (X - M)

    • Where:

      • C = Personal consumption expenditures

      • I = Gross private domestic investment

      • G = Government consumption expenditures and gross investment

      • X = Exports

      • M = Imports

Income Approach

  • The national income accounting method that measures GDP by adding all incomes during a period of time.

  • Includes compensation of employees, rents, net interest, and profits

Compensation of Employees

  • Income earned from wages, salaries, and supplements paid by firms and government to labor suppliers.

Rental Income

  • Rent and royalties received by property owners for the use of their assets.

Profits

  • Composed of:

    • Proprietors’ income: Income earned by unincorporated businesses (self-employed proprietorships and partnerships).

    • Corporate profits: Income earned by stockholders of corporations.

Net Interest

  • The difference between interest income earned and interest payments.

Indirect Business Taxes

  • Taxes levied as a percentage of the prices of goods sold (e.g., sales taxes, excise taxes, customs duties).

Depreciation

  • Allowance for the portion of capital worn out during GDP production.

Formula for GDP (Income Approach)

  • GDP = \text{Compensation of employees} + \text{Rents} + \text{Profits} + \text{Net interest} + \text{Indirect taxes} + \text{Depreciation}

GDP as an Imperfect Measure

  • Excludes:

    • Nonmarket transactions

    • Distribution, kind, and quality of products

    • Quality of life

    • The underground economy

    • Economic bads

Nonmarket Transactions Exclusion

  • Reasons:

    • Imprecise data collection for unpaid services.

    • Difficulty in determining which activities to include.

Quality of Products

  • GDP is a quantitative measure, not qualitative.

Quality of Life

  • GDP may understate national well-being by not accounting for leisure time, life expectancy, infant mortality, literacy rate, and other quality-of-life variables.

Underground Economy

  • If the underground economy is substantial, GDP understates the economy's performance.

Economic Bads

  • GDP overstates national well-being because costs of negative by-products are not deducted.

Alternative Measures for GDP

  • Measure of Economic Welfare (MEW)

  • Genuine Progress Indicator (GPI)

  • Human Development Index (HDI)

  • Happy Planet Index (HPI)

Other National Income Accounts

  • National income (NI)

  • Personal income (PI)

  • Disposable personal income (DI)

National Income (NI)

  • The total income earned by resource owners (wages, rents, interest, and profits).

  • Formula:

    • NI = GDP - \text{Depreciation}

Personal Income (PI)

  • The total income received by households available for consumption, saving, and taxes.

Disposable Personal Income (DI)

  • Income households have to spend or save after paying personal taxes.

Nominal vs. Real GDP

  • Nominal GDP: Value of final goods based on current prices.

  • Real GDP: Value of final goods based on prices from a selected base year.

GDP Chain Price Index

  • Measures changes in the prices of final goods relative to a base year (also called GDP price index or GDP deflator).

Formula for Real GDP

  • Real \ GDP = \frac{Nominal \ GDP}{GDP \ chain \ price \ index} \times 100