The Basics of National Income Accounting. Macroeconomics

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1 The Basics of National Income Accounting Macroeconomics

2 National Income Accounting A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region. National Income Accounting is a branch of macroeconomics that captures the total flows of income as well as of goods and services within a certain period. Main target is the determination of the Gross Domestic Product (GDP) = Bruttoinlandsprodukt (BIP)

3 How to define GDP? Definition 1: GDP is the value of all final goods and services produced within a certain geographic region in a given period of time. Definition 2: GDP is the sum of value added within a certain geographic region and time period. Definition 3: GDP is the sum of factor incomes from economic activity within a geographic region and time period.

4 Real vs. Nominal GDP A price index of GDP The price level of all newly and domestically produced final goods and services in an economy is measured by an implicit price deflator for GDP, the GDP deflator: Nominal GDP is deflated into a real measure.

5 In terms of changes: NOTE: Unlike other price indices, the GDP deflator is not based on a fixed basket of goods and services. The basket includes all goods and services that were produced domestically. It may change with people s expenditure and reflects up-to-date consumption and investment patterns. In practice, the difference to the Consumer Price Index (CPI) is usually relatively small.

6 Gross Domestic Product (GDP) vs. Gross National Product (GNP) As we learned, GDP captures the value of all final output sold in a country in one year. GNP is defined as the value of all final goods and services produced in a country in one year, plus income earned by this country s citizens abroad, minus income earned by foreigners in the country. GDP is the total output of a region (e.g. Germany) GNP is the total output of a nation (e.g. Germans)

7 Example for German data of 2007: Gross Domestic Product (GDP) 2,422.9 billion + Net primary income received from the rest of the world + Payments from the rest of the world (Income of German citizens generated abroad) billion billion Payments to the rest of the world (Income of foreigners earned in Germany) billion = Gross National Product (GNP) 2,464.2 billion

8 The Output Approach...measures economic activity from the product side. It focuses on the value added within a country. Gross value added is the sum of all output values corrected for intermediate inputs. The table below illustrates the case of Germany in 2007: Value of output at market prices 4,479.9 billion Intermediate consumption 2,308.0 billion = Gross Value Added (at prod. costs) 2,171.8 billion + Goods taxes (VAT) net of subsidies billion = GDP (at market prices) 2,422.9 billion

9 The Expenditure Approach...is the most popular accounting method. It measures economic activity from the demand side, determining the utilisation of goods and services and the total amount of money spent. It follows the domestic (D) concept like in the following table with German 2007 data: Household consumption expenditure 1,376.7 billion + Government consumption expenditure billion + Gross investment billion + Value of exports in domestic currency 1,137.2 billion Value of imports in domestic currency billion = Gross Domestic Product (GDP) 2,422.9 billion

10 The Income Approach...calculates the total output of a nation (N) from its total income. For Germany in 2007: Compensation of employees 1,183.5 billion + Gross operating surplus (GOS) and gross mixed income (GMI) billion = National Income 1,827.1 billion + Output taxes and tariffs less subsidies billion = Net National Product (NNP) 2,105.4 billion + Depreciation billion = Gross National Product (GNP) 2,464.2 billion Net income receipts from rest of world billion = Gross Domestic Product (GDP) 2,422.9 billion

11 In terms of formulae We know from the expenditure approach that everything produced in a country in a period is consumed, in the wider sense, as private consumption, government consumption, investment, and net exports. This can be expressed in a basic formula: Approaching from the income side, we see that all income is spent on consumption, savings, or taxes. Accordingly, we receive:

12 Both are identities that have to hold all the time. We can therefore always combine them to get which can obviously be rewritten as NOTE: In a closed economy: X-M=0 Private savings are invested or pay a government budget deficit Without a government: T-G=0 Private savings are invested at home or abroad Closed economy without government: S=I!

13 From GDP to Disposable Income Gross Domestic Product (GDP) 2, billion + Income payments from the rest of the world billion Income payments to the rest of the world billion = Gross National Product (GNP) 2, billion Depreciation billion = Net National Product (NNP) 2, billion Indirect taxes and tariffs (e.g. Sales Tax, VAT) billion + Firm subsidies billion = Net National Income (NNI) 1, billion Direct taxes (e.g. Income tax) 7.54 billion Social contributions billion + Social transfers billion = Disposable income 2, billion

14 Distribution of National Income 65% 35% Gross Oper. Profits (GOP) and Mixed Income (GMI) Wages and Salaries

15 Expenditure of GDP 57% 7% 18% 18% Net income transfers r.o.t.w. Gross investment Government consumption Private consumption

16 Comparative development of GDPs Source: Christiane Clemens, Lecture notes

17 GDP as a measure of welfare? Only with certain caveats: Its absolute value gives little insight, unless the size of the population is taken into account, too. GDP per head (Ø income) is more meaningful when comparing the welfare of different countries. Aggregates fail to measure individual wealth. GDP should be complemented by a distributional measure. Neither the black market nor the informal sector and barter economies (e.g. mutual aid) are captured. Harmful activities and external effects (environmental pollution) are not considered, while their removal is.

18 Solutions to Problem Set 1 Exercise 3 a) i. National Income = 2,190 ii. GNP = 2,940 iii. NNP = 2,520 b) Aggr. Saving=I depreciation + X M = 360 Comprehension questions (false=f, true=t): 1 a) F b) F c) T d) F 2 a) F b) T c) T d) F 3 a) F b) T c) F d) T 4 a) T b) F c) T d) T 5 a) T b) F c) T d) T e) T f) F g) T 6 a) F b) F c) F d) F

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