MacroEcon

Government Budget Balances
• Governments collect tax revenue from individuals and businesses and
use that money to finance the purchase of government provided
goods and services. Some of the spending is on public goods such as
national defense, health care, and police and fire protection
• The government also transfers money from those better able to pay to
others who are disadvantaged, such as welfare recipients or the
elderly under social insurance programs
• If government were to collect more in tax revenue than it spent on
programs and transfers, then it would be running a budget surplus
• Many governments tend to spend and transfer more than they collect
in tax revenue. In this case, they run a government budget deficit that
needs to be paid for or financed in some manner:
• The government can issue treasury bills and bonds and thus
borrow money from the private market
• Print additional money

Measuring the Size of the Economy:
Gross Domestic Product
● Gross domestic product (GDP) - the value of the output of all
final goods and services produced within a country in a given
year.
• Measures the size of a nation’s overall economy.
● An economy's GDP can be measured by either:
• the total dollar value of what consumers purchase in the
economy.
• the total dollar value of what the country produces.

GDP Measured by Components of Demand
● Who buys all of a country’s production?
● Demand for production can be divided into four main parts:
• consumer spending (consumption)
• business spending (investment)
• government spending on goods and services
• spending on net exports

Net Export Component
● The GDP net export component, or trade balance, is equal to the
dollar value of exports (X) minus the dollar value of imports (M).
● Trade balance - the gap between exports and imports.
• Trade balance = (X – M)
● Trade surplus - when a country’s exports are larger than its
imports; calculated as exports – imports.
● Trade deficit - when a country’s imports exceed exports;
calculated as imports – exports.

GDP Using Demand
● Based on the four components of demand, GDP can be
measured as:
GDP = Consumption + Investment + Government + Trade balance
OR
GDP = C + I + G + (X – M)

GDP Measured by What is Produced
● Production can be divided into five main parts:
• Durable goods - long-lasting good like a car or a refrigerator.
• Nondurable goods - short-lived good like food and clothing.
• Services - product which is intangible (in contrast to goods)
such as entertainment, healthcare, or education.
• Structures - building used as residence, factory, office
building, retail store, or for other purposes.
• Change in inventories - good that has been produced, but
not yet been sold.
● Every market transaction must have both a buyer and a seller, so
GDP must be the same whether measured by what is demanded
or by what is produced.

The Problem of Double Counting
● Final goods and services - output used directly for consumption,
investment, government, and trade purposes.
• Goods at the furthest stage of production at the end of a year.
-vs.-
● Intermediate goods - output provided to other businesses at an
intermediate stage of production, not for final users.
• Excluded from GDP calculation.
● Double counting - output that is counted more than once as it
travels through the stages of production.
• A potential mistake to avoid in measuring GDP.
● GDP is the dollar value of all final goods and services produced in
the economy in a year.

Adjusting Nominal Values to
Real Values
● Nominal value - the economic statistic actually announced at that
time; not adjusted for inflation.
-vs.-
● Real value - an economic statistic after it has been adjusted for
inflation.
● Generally, the real value is more important.

Calculating Real GDP
Real GDP = Nominal GDP
Price Index / 100
● Notes:
• Price index is the same as GDP deflator.
• For simplicity, the price index is traditionally published after
being multiplied by 100 in order to get an integer number.
• So, remember to divide the published price index by 100 when
doing the math.
• Whenever a real statistic is computed, one year (or period) is
called the base year (or base period).
• The base year is the year whose prices we use to compute the
real statistic.

Tracking Real GDP over Time
● Governments report GDP growth as an annualized rate.
• When analyzing growth in a quarter, the calculated growth in
real GDP for the quarter is multiplied by four when it is
reported (as if the economy were growing at that rate for a full
year).
● Recession - a significant decline in national output/GDP.
● Depression - an especially lengthy and deep decline in output.

Business Cycles: Economic Ups and Downs (II)

International Investment Position
• A country’s international investment position (IIP) is like a balance sheet in
that it shows the total holdings of foreign assets by domestic residents and
the total holdings of domestic assets by foreign residents at a point in time
• In the International Monetary Fund’s (IMF) financial statistics, these are
listed as domestic assets (foreign assets held by domestic residents) and
domestic liabilities (domestic assets owned by foreign residents)
• Asset holdings include both debt and equities. Debt involves an obligation
to repay principal and interest, whereas equities involve either profit or
loss to the foreign asset holder
• The international asset position of a country consists of stock variables
since it records the total value of assets at a point in time
• A country’s net international asset position may be in surplus, deficit, or
balance. If the IIP is negative, we say the country is a debtor country. If
the IIP is positive, we say the country is a creditor country

Short-Term Movements in the
Business Cycle and the Trade Balance
● In the short run, whether an economy is in a recession or on the
upswing can affect trade imbalances.
● A recession tends to make a trade deficit smaller, or a trade
surplus larger.
● While a period of strong economic growth tends to make a trade
deficit larger, or a trade surplus smaller.

The Pros and Cons of Trade Deficits
and Surpluses
● For countries, there is no economic merit in a policy of abstaining
from participation in financial capital markets.
● It can make economic sense for a national economy to borrow
from abroad, as long as it wisely invests the money in ways that
will tend to raise the nation’s economic growth over time.
• Examples: U.S. in mid-1800s and South Korea in 1970s.
● A borrower nation can find itself in trouble if it does not invest the
incoming funds from abroad in a way that leads to increased
productivity.
• Examples: Mexico, Brazil, and some African nations in the
1970s and 1980s.

Final Thoughts about Trade Balances
● Trade deficits can be a good or a bad sign for an economy, and
trade surpluses can be a good or a bad sign also.
● Even a trade balance of zero - which just means that a nation is
neither a net borrower nor lender in the international economy -
can be either a good or bad sign.
● The fundamental economic question is not whether a nation’s
economy is borrowing or lending at all, but whether the particular
borrowing or lending in the particular economic conditions of that
country makes sense.

How to Evaluate Trade Imbalances
• An evaluation of a country’s trade imbalance should begin by
identifying the country’s net international asset or investment
position
• The investment position is like a balance sheet in that it shows the
total holdings of foreign assets by domestic residents (domestic
assets) and the total holdings of domestic assets by foreign
residents (domestic liabilities) at a point in time
• The international asset position of a country consists of stock
variables while the financial account balance consists of flow
variable
• A country’s net international investment balance may either be in a
debtor position, a creditor position, or in balance

There are four possible situations that a country might face:
1. A debtor nation with a trade deficit,
2. A debtor nation with a trade surplus,
3. A creditor nation with a trade deficit,
4. A creditor nation with a trade surplus