The Measurement and Structure of the National Economy

The Measurement and Structure of the National Economy - Generic Elective, Introductory Macro Economics - Chapter 2 (Abel and Bernanke), Introductory Macro Economics Part I - Prepared by Dr. Charu Grover Assistant Professor, Shaheed Bhagat Singh College Department of Economics 1

National Income Accounting: The Measurement of Production, Income and Expenditure Ø The national income accounts are based on the amount of economic activity that occurs during a period of time. Ø Three alternative approaches of national income accounting give the same measurements Product approach: the amount of output produced excluding used up in intermediate stages of production Income approach: the incomes received by the producers of output Expenditure approach: the amount of spending by ultimate purchases of output Ø Why are three approaches equivalent? The market value of goods and services produced in a given period (product approach) is equal to the amount that buyers must spend to purchase that (expenditure approach) and results in income generated by economic activity (income approach) The fundamental identity of national income accounting: total production = total income = total expenditure

Gross Domestic Product Ø Measured by 3 approaches Product approach Income approach Expenditure approach

Product Approach to measure GDP Ø GDP is the market value of final goods and services newly produced with in a nation during a fixed period of time. Ø Market Value - allows adding together goods and services by valuing them at their market prices Problem: some items are not sold in formal market and are ignored in calculation of GDP, example, homemaking services with in the family without pay; benefits of clean air is not bought and sold in markets. The underground economy activities (example. drug dealing, avoiding payment of taxes) are included in official GDP measures Government services that are not sold in markets are valued at their cost of production

Product Approach to measure GDP Ø New produced goods and services includes goods and services produced in the current period Example: price paid for newly constructed house is included in GDP and not sale of used house. The real estate agent services is part of GDP Ø Final goods and services Goods which are used up in production of other goods and services, i. e. , intermediate goods and services are not counted Capital goods are used to produce other goods, but are not used up in the same period that they are produced. Therefore, capital goods are final goods and are included in GDP. Inventory Investment are stocks of unsold finished goods, goods in process and raw materials changed during a given period is treated as final foods

GDP versus GNP Ø GNP = market value of final goods and services newly produced by domestic factors of production during the current period Ø GDP = market value of final goods and services newly produced within a nation during the current period Ø GDP = GNP – NFP (net factor payments from abroad) Ø NFP = Income paid to domestic factors of production by rest of the world – income paid to foreign factors of production by domestic economy

Expenditure Approach to measure GDP Ø GDP is total spending on final goods and services produced with in a nation during a specified period of time Ø GDP = C + I + G + NX

Consumption Ø Consumption is spending by domestic households on final goods and services, including those produced abroad Ø Three categories of consumption expenditure Consumer Durables Non Durable Goods such as food, clothing Services such as education, health

Investment Ø Investment includes spending for new capital goods – fixed investment and increases in firms’ inventory holdings – inventory investment Ø Two components of fixed investment Business fixed investment – spending on structures such as factories, office buildings and equipment such as machines, vehicles Residential investment – spending on construction of new houses and apartment buildings

Government Purchases of Goods and Services Ø Expenditure by the government for a currently produced good or service, foreign or domestic Ø Transfers are not counted in GDP as it is not made for exchange of current good or services Ø Interest payments on national debts are not included as government purchases

Net Exports Ø Net Exports = Exports - Imports Ø Exports are included in total spending because they represent spending by foreigners on final goods and services produced within a country Ø Imports are subtracted because consumption, investment, government spending are defined to include imported goods and services

Income Approach to measure GDP Ø It adds income received by producers including profits and taxes paid to government. Components : - 1. Compensation of Employees – income of workers excluding self employed; wages, salaries, employee benefits, employer contribution to social security 2. Proprietors Income – income of nonincorporated self employed. It includes both capital and labor income 3. Rental Income of Persons – income earned by individuals who own land or structures that they rent to others. Royalty income paid to authors is included. 4. Corporate Profits – Corporate revenue less wages, interest, rent and other costs have been paid

Income Approach to measure GDP Components : 5. Net Interest – interest earned by individuals from business and foreign sources less interest paid by individuals 6. Taxes on Production and Imports Indirect business tax such as sales and excise taxes paid by business to government Taxes on residential real estate Custom Duties Motor vehicles licenses paid by households 7. Business Current Transfer Payments (Net) – payments made by business to individuals or government or foreigners 8. Current Surplus of Government Enterprises – profits of business owned by governments

Income Approach to measure GDP Ø Adding components 1 to 8 gives National Income Ø National Income + Statistical Discrepancy = Net National Product (NNP) Ø NNP + Consumption of fixed capital = Gross National Product (GNP) Ø GNP – NFP = GDP