0Need for the indicators in Macro analysis?
- Like the accounts of a business, national income accounts have two sides: a product side and an income side. The product side measures production and sales. The income side measures the distribution of the proceeds from sales.
- On the product side are two widely reported measures of overall production: gross domestic product (GDP), and gross national product (GNP). They differ in their treatment of international transactions.
- GNP includes earnings of U.S. corporations overseas and U.S. residents working overseas; GDP does not. Conversely, GDP includes earnings in the United States of foreign residents or foreign-owned firms; GNP excludes those items. For example, profits earned in the United States by a foreign-owned firm would be included in GDP but not in GNP.
GDP:
Gross domestic product (GDP) is a measure of all currently produced final goods and services evaluated at market prices.
- GDP includes only currently produced goods and services. It is a flow measure of output per time period—for example, per quarter or per year—and includes only goods and services produced during this interval.
- Only the production of final goods and services enters GDP. Goods used to produce other goods rather than being sold to final purchasers—what are termed intermediate goods —are not counted separately in GDP.
- However, two types of goods used in the production process are counted in GDP:
- The first is currently produced capital goods —business plant and equipment purchases. Such capital goods are ultimately used up in the production process, but within the current period, only a portion of the value of the capital good is used up in production. (In GDP, the whole value of the capital good is included as a separate item. In a sense, this is double counting because, as just noted, the value of depreciation is embodied in the value of final goods. At a later point, we will subtract depreciation to construct a net output measure)
- The other type of intermediate goods that is part of GDP is inventory investment — the net change in inventories of final goods awaiting sale or of materials used in the production process. These additions should be counted in the current period as they are added to stocks so that the timing of national product is defined correctly
GDP = Consumption + Investments + Government Spending + Net Exports
Consumption: Household sector purchases of currently produced goods and services.
- Consumer-durable goods (TV, freeze)
- Non-durable consumption goods (Food items, clothing)
- Consumer services (Medical service, haircut)
Investment: Part of GDP Purchased by the business sector and residential construction.
- Business fixed investments (for purchase of capital goods)
- Residential construction investments
- Inventory investments
Net investments = gross (total) investments - depreciation
Government purchases: goods and services that are part of the current output that goes to the government sector—the federal government as well as state and local governments. Not all government expenditures are part of GDP because not all government expenditures represent a demand for currently produced goods and services.
Net exports equal to total (gross) exports minus imports. Gross exports are currently produced goods and services sold to foreign buyers. They are a part of the GDP.
Imports are purchases by domestic buyers of goods and services produced abroad and should not be counted in GDP. Imported goods and services are, however, included in the consumption, investment, and government spending totals in GDP. Therefore, we need to subtract the value of imports to arrive at the total value of domestically produced goods and services.
Limitations:
1. Non-market Productive Activities Are Left Out
Because goods and services are evaluated at market prices in GDP, non-market production is left out (e.g. homemaker services). Intercountry comparisons of GDP overstate the gap in production between highly industrialized countries and less-developed nations, where largely agrarian non-market production is of greater importance.
2. The Underground Economy Is Left Out
Also left out of GDP are illegal economic activities and legal activities that are not reported to avoid paying taxes—the underground economy. Gambling and the drug trade are examples of the former
3. GDP Is Not a Welfare Measure
GDP measures the production of goods and services; it is not a measure of welfare or even of material well-being. GDP also fails to subtract for some welfare costs of production. For example, if the production of electricity causes acid rain, and consequently water pollution and dying forests, we count the production of electricity in GDP but do not subtract the economic loss from the pollution. In fact, if the government spends money to try to clean up the pollution, we count that too!
GDP is a useful measure of the overall level of economic activity, not of welfare.
4. If it is not a welfare measure, one would not expect GDP to measure happiness
National Income:
In computing national income, our starting point is the GNP total, not GDP. To go from GDP to GNP, we add foreign earnings of U.S. residents and firms. We then subtract earnings in the United States by foreign residents and firms.
National income is the sum of factor earnings from the current production of goods and services. Factor earnings are incomes of factors of production: land, labor, and capital.
The first charge against GNP that is not included in national income is depreciation. The portion of the capital stock used up must be subtracted from final sales before national income is computed; depreciation represents a cost of production, not factor income. Making this subtraction gives us Net National Product (NNP) , the net production measures referred
NDP - GDP - depreciation
GNP = GDP - Earnings of foreign people/company earning within-country + Earning of citizens outside country
NNP = GNP - depreciation
Personal Income
For some purposes, however, it is useful to have a measure of income received by persons regardless of source. Personal income is the national income accounts measure of the income received by persons from all sources. When we subtract personal tax payments from personal income.
Personal Income = National Income - (Income not received by persons) + Income of person from sources other than current goods and services.
From National Income we subtract: Part of corporate profit that is not paid as a dividend (corporate profit tax payments and retained earnings). We also subtract the contribution of employee and employer for social security that goes to the government and not to people.
We have to add Government transfer payment (Social Security payments, veterans’ pensions, and payments to retired federal government workers) and government tax interest payments on issued bonds.
Personal disposable income = personal income - taxes to be paid
Most of it was spent for consumption, the household sector’s purchases of goods and services. There were two other expenditures. The first was interest paid to business (installment credit and credit card interest). The second, a very small component of personal expenditures, was transfers to foreigners (e.g., gifts to foreign relatives).
Personal saving is the part of personal disposable income that is not spent.
Some Assumptions:
- The foreign sector will be omitted. This makes GNP and GDP are thus equal. The terms GNP and GDP are used interchangeably except where we see the foreign sector.
- We assume that national income and national product or output are the same. The terms national income and output are used interchangeably throughout.
- Depreciation is ignored (except where explicitly noted). Therefore, the gross and net national product is identical.
- We assume that all corporate profits are paid out as dividends; there are no retained earnings or corporate tax payments. We assume that all taxes, including Social Security contributions, are assessed directly on households.
- Net Tax Payment = Tax payment - Government Transfers
- Personal disposable income(YD) = National Income(Y) - Net Tax Payment (T)
- GDP(Y) = C + Ir + G (The subscript ( r ) on the investment term is includedbecause we want to distinguish between this realized investment total that appears in the national income accounts and the desired level of investment spending)
- By ignoring interest paid to business: YD = Y - T = C + S (People use money to consumption and saving only)
- From 8: Y = C + S + T
- Hence GDP(Y) = C + Ir + G .= Y .= C + S + T
- This identity states that expenditures on GDP (C+ Ir + G) by definition equal dispositions of national income (C + S + T)
Measuring Price Changes: Real versus Nominal GDP
Nominal GDP, which measures currently produced goods and services evaluated at current market prices. GDP measured at current market prices will change when the overall price level changes as well as when the volume of production changes. we want a measure of GDP that varies only with the number of goods produced. Such a measure would be most closely related to employment.
The GDP measure changes only when quantities change and not the price is termed real GDP. The traditional way of constructing real GDP is to measure output in terms of constant prices from a base year.
Nominal GDP changes whenever the quantity of goods produced changes or when the market price of those goods changes; real GDP changes only when production changes. Therefore, when prices are changing dramatically, the movements of the two measures diverge sharply
The ratio of nominal GDP to real GDP is a measure of the value of current production in current prices (e.g., in 2010) relative to the value of the same goods and services in prices for the base year (2005).
Because the same goods and services appear at the top and bottom, the ratio of nominal GDP to real GDP is just the ratio of the current price level of goods and services relative to the price level in the base year. It is a measure of the aggregate (or overall) price level, which is price index.
This index of the prices of goods and services in GDP is called the implicit GDP deflator .
The ratio of nominal to real GDP is termed a deflator because we can divide nominal GDP by this ratio to correct for the effect of inflation on GDP—to deflate GDP.
Two problems arise when real GDP is measured using prices in a base year. One problem is that every time the base year changes, the weights given to different sectors are changed, and history is rewritten. A second, more serious problem involves changes in relative prices and consequent substitutions among the product categories contained in GDP. ( relative price–indued substitutions)
The chain-weighted measure of real GDP. Instead of using prices in a base year as weights, the chain-weighted measure uses the average of prices in a given year and prices in the previous year. Thus, real GDP in 2010 is calculated using 2009 and 2010 prices as weights.
The Consumer Price Index and the Producer Price Index:
Because the GDP deflator measures changes in the prices of all currently produced goods and services, it is the most comprehensive measure of the rate of price change.
The consumer price index (CPI) measures the retail prices of a fixed “market basket” of several thousand goods and services purchased by households. The CPI is an explicit price index in the sense that it directly measures movements in the weighted average of the prices of the goods and services in the market basket through time.
Another widely reported price index is the producer price index (PPI) , which measures the wholesale prices of approximately 3,000 items. Because items sold at the wholesale level include many raw materials and semi-finished goods, movements in the PPI signal future movements in retail prices, such as those measured in the CPI. Both the CPI and the PPI have the advantage of being available monthly, whereas the implicit GDP deflator is available only quarterly.
Over smaller periods, fluctuations in output and employment come primarily from variations in actual output around potential output, which is defined as the level of output that the economy could produce at high rates of resource utilization.
