National Income Accounting:Important Identities

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National Income AccountingImportant Identities

• USAID Reform Project
• Dr. Brijesh C. Purohit
• November 2005

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Measuring the Production, Income, and Spending
of Nations
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• National Income Accounts
• Provide the formal structure for our macro-theory
  models
• Aggregate Demand.aggregate income..consumed or
  invested
• Aggregate Supply.Total output..paid as wages,
  interest and
• dividends
• In equilibrium.Aggregate DemandAggregate Supply
  (growth)
• InputsOutputs
• Real output
• price level
• Broad magnitudes to characterize the economy

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• Basic Measures
• Gross Domestic Product (GDP) is the value of
  final goods
• and services produced in the country within a
  given period
• Notable terms
• ?final goods
• ?Intermediate goods
• Value Added
• Past output vs. current outputs
• Measure of welfare
• Use of resources to avoid bads such as crime
• Improvement in the quality
• in the country

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• Factors of production.labor, capital, land
• ?GDP sum of payments to labor, capital, land and
  profits
• ?Gross National Product (GNP)
• GDPreceipts from abroad made as factor payments
  to domestically
• owned factors of production.

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• Net Domestic Product
• GPP minus depreciation
• Depreciation is usually 11
• NDP89 of GDP
• National Income
• NDP-Indirect taxes that Business pay
• Indirect taxes that Business pay nearly 10
• NI is nearly 90 of NDP

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PI is the total income received whether it is
earned or unearned by the households of the
economy before the payment of personal taxes.
It is found by adding transfer payments to and
subtracting social security contributions
,corporate income taxes and undistributed
corporate profits from the NI. DI is the total
income available to households after the payment
of personal taxes. It is equal to PI less
personal taxes and also equal to personal
consumption expenditures plus personal saving.
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GDP An important and versatile concept We will
see that GDP measures total income total
expenditure total output the sum of
value-added at all stages in the production of
final goods
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How to measure GDP?

• There are three approaches to the measurement of
  GDP
• spending,
• income,
• and production.

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Spending Approach

• The spending approach divides GDP into four
  areas
• households (consumption) (C)
• businesses (investment) (I)
• government (G) and
• foreigners (net exports) (X-IM).

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Investment (I) def1 spending on the factor of
production capital. def2 spending on goods
bought for future use. Includes business
fixed investment spending on plant and equipment
that firms will use to produce other goods
services residential fixed investment spending
on housing units by consumers and landlords
inventory investment the change in the value of
all firms inventories
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Investment vs. Capital Capital is one of the
factors of production. At any given moment, the
economy has a certain overall stock of
capital. Investment is spending on new
capital. Investment vs. Capital Example (assumes
no depreciation) 1/1/2002 economy has 500b
worth of capital during 2002 investment
37b 1/1/2003 economy will have 537b worth
of capital
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Stocks vs. Flows Flow Stock
More examples stock
flow a persons wealth a persons saving
of people with of new college college
degrees graduates the govt. debt the
govt. budget deficit
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A question for you Suppose a firm produces
10 million worth of final goods but only
sells 9 million worth. Does this violate the
expenditure output identity?
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Why output expenditure Unsold output goes
into inventory, and is counted as
inventory investment .
.whether the inventory buildup was
intentional or not. In effect, we are assuming
that firms purchase their unsold output.
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The income approach

• The income approach divides GDP according to who
  receives the income from the spending flow.
• In addition to aggregate income, national income
  and personal income are also used as measures of
  income.

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The income approach

• The Income Components Include
• Wages and salaries
• Corporate profits
• Proprietors income (the profits of partnerships
  and soley owned businesses, like a family
  restaurant)
• Farm income
• Rent
• Interest
• Sales taxes
• Depreciation (the amount of capital that has worn
  out during the year)

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Interest (only the interest payments made by
business firms are included and the interest
payments made by government are excluded).
Corporate profits which are subdivided into
Corporate income taxes Dividends Undistributed
corporate profits
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Three additions are made to the income side to
balance it with expenditures. 1.Indirect
business taxes are added because they are
initially income that later gets paid to
government. 2.Depreciation or the consumption
of fixed capital is added because it is initially
income to businesses that later gets deducted in
calculating profits. 3.Net foreign factor
income is added because it reflects income from
all domestic output regardless of the foreign or
domestic ownership of domestic resources.
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The production approach

• The production approach looks at GDP from the
  standpoint of value added by each input in the
  production process.
• The three approaches--spending, income, and
  production (should) result in equivalent values
  for GDP.

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Below is a list of domestic output and national
income figures for a given year. All figures are
in billions. Determine the major national
income measures by both the expenditures and
income methods.
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Simple Economy..No govtno foreign trade
Cconsumption Iinvestment Ssaving Y
Income Output producedoutput sold Y
CI.(1) IS YCS(2)
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Introducing govt. in the above identity G govt.
purchases of goods and services TAall
taxes TRtransfers to private sector (including
interest) NXnet exports (exports-imports) YDdisp
osable income YCIGNX.(3) YDYTR-TA..
(4) YD CS(5) CSYTR-TA
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• LEAKAGES (Withdrawals (W)   (T S IM) out of
  the system must equal INJECTIONS (J)  (G I
  X) for the circular flow to balance (be in
  EQUILIBRIUM).
• Withdrawals T S IM Injections G I
  X can be broken down to three important
  balances in the economy
• T - G  the Government's Budgetary Balance
• S - I  the Private Sector's Saving/Investment
  Balance
• IM - X  the Country's Trade Balance (current
  account of Balance of Payments)

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CYD-SYTR-TA-S..(6) Consumption is
disposable income less saving Or consumption is
equal to income plus transfers less taxes and
saving Using RHS of (6) in (3) YCIGNX.(3
) Y (YTR-TA-S) IGNX S-I(TR-TAG)NX
(7) Govt. budget deficit,I.e., total govt.
expenditure consisting of govt. Purchases of
goods and services(G) plus govt. transfer
payments (TR) Minus amount of taxes (TA)
received by govt. equals excess of private saving
over investment and net exports
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The budget deficit, trade, saving and
investment(in Rs. Billion) Saving (S)1000
1000 1000 1000 Investment(I)1000
850 900 950 Budget Deficit(BD)..0
150 0 150 Net Exports (NX)0
0 100 -100
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Exercises? Q.1 What would happen to GDP if the
govt. hired unemployed Workers, who had been
receiving amount TR in unemployment Benefits,
as govt. employees and now paid them TR to do
nothing? Explain. Q.2In the national income
accounts, what is the difference between a)A
firms buying an auto for an executive and the
firms paying the Executive additional income to
buy the automobile herself? b)Your hiring your
spouse (who takes care of the house) rather than
having him or her do the work without
pay? c)Your deciding to buy an Indian car rather
than a German car?
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3. The following is information from the national
income accounts for a hypothetical
country GDP 6, 000 Gross investment
800 Net investment
200 Consumption 4, 000 Government
purchases of goods and services 1,
100 Government budget surplus 30 What
is a. NDP? d. Disposable personal income? b.
Next exports? e. Personal saving? c.
Government taxes minus transfers?
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GDP and GDP deflator We would like to convert
different goods quantities and prices into one
single quantity of composite good and one
general price level. How? We use the concepts
of nominal GDP, real GDP and GDP deflator to
achieve such aggregation.
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Real vs. Nominal GDP GDP is the value of all
final goods and services produced
domestically. Nominal GDP measures these values
using current prices . Real GDP measure these
values using the prices of a base year.
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Real and Nominal GDP
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Real GDP and living standard Changes in
nominal GDP can be due to changes in
prices changes in quantities of
output produced Changes in real GDP can only
be due to changes in quantities, because real
GDP is constructed using constant
base-year prices. Therefore, changes in real
GDP measure changes in living standard.
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GDP Deflator While real GDP captures living
standard, cost of living is measured by general
price level. One measure of the general price
level is the GDP Deflator, defined as GDP
deflator 100 Nominal GDP /Real GDP
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Measuring the Cost of Living Inflation refers
to a situation in which the economys
overall price level is rising. The inflation
rate is the percentage change in the price level
from the previous period.
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Exercise The following table shows nominal GDP
and an appropriate price index for a group of
selected years. Compute real GDP. Indicate in
each calculation whether you are inflating or
deflating the nominal GDP data
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CPI vs. GDP deflator prices of capital goods
included in GDP deflator (if produced
domestically) excluded from CPI prices of
imported consumer goods included in CPI
excluded from GDP deflator the basket of
goods CPI fixed GDP deflator changes
every year
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International Comparisons of GDP

• In any attempt to compare GDP between countries,
  some account must be taken of differences in
  prices.
• Adjustment for GDP based on exchange rates makes
  some improvement in the comparison of GDP
  figures.
• However, if we wish to determine the value of
  GDP in another country, some information on the
  price differences of goods is needed.

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Purchasing power parity exchange rates attempt
to adjust exchange rates for differences in the
prices of goods across borders through the use
of a ratio of price indexes. The exchange rate
is adjusted to reflect this ratio
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• Once this adjustment is made, international
  rankings of countries
• based on GDP or per capita GDP tend to fluctuate
  
• as exchange rates vary, while the corresponding
  prices do not.
• Despite their variability due to exchange rate
  fluctuations,
• purchasing power parity exchange rates provide a
  better basis
• for international comparisons than an adjustment
  based
• solely on exchange rates.