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National Income Accounting

The Data of Macroeconomics

National Income Accounting

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© 2003 McGraw-Hill Ryerson Limited.

National Income Accounting
In the 1930s it was impossible for macroeconomics to exist in the form we know it today
Many concepts for aggregate measurement had not yet been formulated, or were lacking rigor（缺少精确）.

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National Income Accounting
In the mid-1930s Simon Kuznets and Richard Stone began to develop the principles of national income accounting
Kuznets would later win the Nobel Prize for this work

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© 2003 McGraw-Hill Ryerson Limited.

National Income Accounting
They developed the principles of national income accounting
These are the rules & definitions for measuring macroeconomic activity
Note the challenge involved! Trying to aggregate millions of goods & services produced!

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Measuring Total Economic Output of Goods and Services
Gross Domestic Product (GDP) is the total market value of all final goods and services produced in a country’s economy in a one-year period.
Final goods & services is output purchased by end user of product
More about final goods in a few slides

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Measuring Total Economic Output of Goods and Services
An economy is the collection of all markets in the country
A market is the collection of all of the buyers and sellers of a specific good/service

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GDP vs. GNP
Gross National Product (GNP) is the aggregate final output of a country’s citizens and businesses
Note conceptual differences between GNP and GDP – one depends on location, and one depends on national citizenship, as we see in the next slide

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GDP vs. GNP
GDP measures the economic activity that occurs within a country, irrespective of who produces it.
GNP measures economic activity of the citizens and businesses of a country, irrespective of where it is produced
Today, most economists focus on GDP

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Link Between GDP & GNP
Net foreign factor income is added to GDP to create the GNP.

Net foreign factor income is income from foreign domestic factor sources, minus foreign factor incomes earned here.
To construct GNP, we take GDP & add foreign income of our citizens, subtract income of U.S. residents who are not citizens. (GNP=GDP+FI-INC)

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Calculating GDP
Calculating GDP adds up million of goods and services into single number

But we need to weight the goods and services by their value. So, each good and service must be multiplied by its market price.

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Calculating GDP
Once quantities of a good or service are multiplied by the price, we arrive at a value measure of the good or service
Note that GDP is a flow measure of economic activity – activity measured over a unit of time, such as one year.
Annual measure is most common
Other measures include quarterly

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Stocks and Flows
GDP is a measure of final output per time period – it is flow concept – data is measured over a unit of time.
In contrast, a stock is measured at a moment in time. An example is the capital stock of a country.
Flows measured over a unit of time, stocks measured at a moment in time

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GDP Measures Final Output
GDP does not measure the total transactions in the economy.
It counts final output, but not intermediate goods purchases
The reason is double-counting
We describe this below

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GDP Measures Final Output
Final output – goods and services purchased for final use.

Intermediate goods are used as inputs in the production of some other product.
Example: wheat is an intermediate product used to make bread
Grapes are an intermediate good used to make wine

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GDP Measures Final Output
Counting sale of final goods & intermediate goods is double counting.
Example: a grocery store buys milk from a dairy. Consumer buys milk from the store. We only count consumer’s purchase. Otherwise, we would double count the milk
Milk purchased by store from dairy is intermediate good

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How to Make Sure You Don’t Double Count Transactions
Two ways of eliminating intermediate goods from GDP calculations
The first is to calculate only final sales.
These are purchases made by the final user of the good.
Example: milk purchased by the consumer from the grocery store

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“Value Added” Method to Deal with Intermediate Goods
A second way is to follow the value added approach

Value added is the increase in value that a firm contributes to a product or service.
It is calculated by subtracting intermediate goods from the value of its sales.
We can calculate GDP by adding up all of the value added in the economy

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Value Added Approach – add up all value added to get GDP

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GDP Measures Current Economic Activity
Selling a used car to a neighbor does not add to GDP. The car was already counted in GDP earlier.
Selling your car to a used car dealer who sells your car to someone else for a higher price, does add to GDP.
Value added is the dealer’s services. This is current economic activity

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© 2003 McGraw-Hill Ryerson Limited.

GDP Measures Current Economic Activity
Selling a bond does not add to GDP.

The bond broker’s commission (佣金) for the sales does add to GDP. This is current economic activity.

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GDP Measures Current Economic Activity
Welfare payments, unemployment benefits, & other government transfer payments are not included in GDP.
These are transfers from one person or entity, to another, and thus are not measures of current economic activity

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GDP as Expenditure and as Income
There are two methods of calculating GDP: the expenditure approach and the income approach.
These are equal because of the national income accounting identity.
Remember: every expenditure by a consumer, is income for a seller
This is why expenditure = income

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The National Income Accounting Identity
The equality of output and income is an accounting identity in the national income accounts.
The identity can be seen in the circular flow of income in an economy.

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The Circular Flow

Goods
Other countries
Financial markets
Government

Firms (production)

Household

Taxes

Factor services

Savings

Imports

Government Spending

Wages, rents, interest, profits

Exports

Investment

Personal consumption

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The Circular Flow

Goods
Other countries
Financial markets
Government

Firms (production)

Household

Taxes

Factor services

Savings

Imports

Government Spending

Wages, rents, interest, profits

Exports

Investment

Personal consumption

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The Expenditure Approach
The expenditure approach is shown on the bottom half of the circular flow.
Specifically, GDP is equal to the sum of the four categories of expenditures.

GDP = C + I + G + (X – IM)
Net Export (X-IM): Negative in US

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Consumer Spending
When individuals receive income, they can spend it on domestic goods, save it it, pay taxes, or buy foreign goods.
The accounts keep track of consumer spending on nondurables goods (e.g. food), durable goods (e.g. new cars), and consumer services (e.g. car repair).

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Consumer Spending
Consumption is the largest of the flows, accounting for about 2/3 of GDP.

It is also the most obvious way in which income received is returned to firms.

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Investment Spending
Gross Private Domestic Investment:
(1) Non-residential: business spending on equipment, software, non-residential structures, & inventories
(2) New residential structures (housing)
The total ranges between 15 – 19 percent of GDP in U.S.

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Gross Investment vs. Net Investment
Capital goods wear out over time

This wearing-out process is called depreciation

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Gross Investment vs. Net Investment
Economists differentiate between total or gross private domestic investment and the new investment that is above and beyond replacement investment.

Net private investment – gross private investment less depreciation.
However, it is gross investment that enters into the national accounts

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Government Expenditures
Governments also purchase goods and services, and this is in GDP
Note not all government spending is part of GDP
Transfer payments are not part of GDP, only government spending made on new goods and services（政府转账不算GDP）

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Government Expenditures
Government spending on goods and services or investment in equipment and structures
This averages around 18-20 percent of GDP in the U.S.
This includes both federal, as well as state & local government spending

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Government Expenditures
The government runs a deficit when spending exceeds tax revenue

If the government runs a deficit, it must borrow. Easiest to think of borrowing as coming from households, intermediated through financial markets

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Net Exports
Spending on foreign goods is not add to domestic production
This means that spending on imports are subtracted from total expenditures.
The reason is because this is not domestic production

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Net Exports
Exports to foreign nations are added to total expenditures.

These flows are usually combined into net exports (exports minus imports).
Note that we add exports because this is domestic production, but it will not show up in domestic expenditures

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NDP: Adjusts for Depreciation
Net domestic product (NDP：国内净产值) is the sum of consumption expenditures, government expenditures, net foreign expenditures, and investment less depreciation.
We use NDP to determine how much output is available for society after replacing depreciation of capital goods

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GDP and NDP
Net domestic product is GDP adjusted for depreciation:

GDP = C + I + G + (X – IM)
NDP = C + I + G + (X – IM) – Depreciation

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GDP and NDP
NDP is actually preferable to GDP as a measure of a nation’s domestic output
This is because NDP takes into account depreciation
NDP tells us how much output is available to society after replacing depreciated capital goods

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GDP and NDP
In the national income accounts, we call depreciation capital consumption allowance（资金消费冲减）.

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Expenditure Breakdown of GDP for Selected Countries
Nominal GDP
(billions US$) Personal consumption
(%of GDP) Gross private investment (% of GDP)
Government expenditures
(% of GDP)
Exports (% of GDP)
Imports (-% of GDP)
Country
Canada 750 58 18 19 42 -37
U.S. 10,198 69 16 18 10 -13
Brazil 760 64 21 16 10 -11
Germany 2,081 58 21 19 27 -25
Japan 4,395 60 29 10 11 -10
Pakistan 60 78 15 11 15 -19
Tunisia 21 63 28 12 42 -45
Tanzania 9 72 18 13 20 -23

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Measuring Output using the Factor Incomes Approach
The income approach is shown on the top half of the circular flow diagram
Firms make payments to households for supplying labor and capital as the factors of production.

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The Factor Incomes Approach
National income is total income earned by citizens and businesses of a country.
It consists of employee compensation, rent, net interest, corporate profits, & proprietor income (non-corporate profits)

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The Factor Incomes Approach
Wages, salaries and supplementary labor income that firms pay to workers constitute the largest component of GDP.

Corporate profits before taxes are also included in income, as are proprietor income (non-corporate profits)

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The Factor Incomes Approach
Rental income（租赁收入） is property income received by households. Royalties from patents, copyrights and assets, as well as imputed（归罪于） rent are included.
Interest is income received by households through lending to business firms.

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The Factor Incomes Approach
Note that gains and losses from holding inventories are not included, nor are indirect taxes, subsidies, and depreciation, as these do not represent incomes.

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Equality of Income and Expenditure
Incomes and expenditures must be equal because of the rules of double-entry bookkeeping.
However, there is a discrepancy between expenditures and incomes
This is called the statistical discrepancy
It reflects measurement errors & unreported incomes and sales

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Equality of Income and Expenditure
Subject to the caveat（终止申请) of the statistical discrepancy, the national income accounting identity allows GDP to be calculated either by adding up all values of final output or by adding up the values of all earnings or income.

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Connecting GDP to National Income
To go from GDP to national income:
Add net foreign factor income.
National income is all income earned by citizens of a nation and is equal to GNP.
To move from “domestic” (GDP) to “national” (GNP) we add net foreign factor income.
Subtract depreciation from GDP.
Subtract indirect business taxes less subsidies from GDP.

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Equality of Expenditure and Income
=
(3)
Income
(2)
Output
(1)
Expenditures
=
Corp Profit before tax

GDP

Net foreign factor income

GNP

Depreciation
Indirect taxes-subsidies
Inventory adjustment
Proprietor income
Interest and investment income
Wages and salaries

National Income

Net exports
Government expenditures
Investment
Consumption

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Other Income Terms
Other income terms are personal income and disposable personal income.
Personal income measures all income actually received by individuals.

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Other National Income Terms
Personal income (PI) is defined as:

PI = NI + transfer payments from government – corporate retained earnings – corporate income taxes – employment taxes (CPP, EI)

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Other National Income Terms
Disposable personal income is personal income minus personal income taxes and payroll taxes.

Disposable personal income is what people can spend after satisfying tax liabilities:

DPI = PI – personal taxes

Using GDP to Measure Economic Well-Being
GDP measures are used to make comparisons among countries and to measure economic well-being over time.

Comparing GDP Among Countries
The conventional approach to measuring a country’s economic well-being, or it’s standard of living, is by using Per capita GDP
This is constructed by dividing GDP by population
This is the per-person amount of ouput available in a country

Comparing GDP Among Countries
GDP counts market economic activity
Because of differences in nonmarket activities across countries, per capita GDP does not perfectly measure cross-country differences in living standards
Example: poor countries have larger fraction of output in non-market sectors

Comparing GDP Among Countries
We often compare per capita GDP using purchasing power parity (PPP)
How? Construct same market basket for two countries – measure cost in both currencies – PPP exchange rate
Use that exchange rate to compare GDPs between the two countries

Comparing GDP Over Time
GDP can rise either because economic activity is higher, or because prices rose – which is inflation.
We want to correct for inflation
We therefore construct real GDP, which is nominal output adjusted for inflation.

Real and Nominal GDP
Nominal GDP is measured using current prices
To measure living standards, we take out affect of changes in prices on GDP
Real GDP is nominal GDP adjusted for inflation.

How to Measure Real GDP
Easiest to describe measuring real GDP using method of base year prices.
This was used officially until recently
(1) Pick base year – any calendar year
(2) Measure value of all production in every year using prices in base year
(3) Add up values to get real GDP

GDP Deflator
GDP deflator in year t is defined as:

Nominal GDP(t)/Real GDP(t)
This can be used to construct inflation
Inflation between year t and year t+1 is

(Deflator(t+1)/Deflator(t)-1)*100
Deflator in base year is 1, because base year nominal and real GDP are same

Measuring Real GDP Using Base Year Prices
2000 output: 20 apples & 17 oranges
2000 prices: $5 (apples) $8 (oranges)
2016 output: 30 apples & 15 oranges
2016 prices: $6 (apples) & $7 oranges
(1) Pick 2016 as base year
(2) Measure production in 2000 and in 2016 using 2016 prices

Measuring Real GDP Using Base Year Prices
2000 Real GDP=$6*20 + $7*17 = $239
2016 Real GDP=$6*30 + $7*15 = $285
In real GDP, prices are constant, so change is due to changes in output
We can use these data to calculate real GDP growth between the two dates
19.3% growth between 2000 & 2016 100*(($285-$239)/$239)

Measuring GDP Deflator in this Example
GDP deflator = Nominal GDP/Real GDP
2000 nominal GDP = $236
2016 nominal GDP = $285
2000 deflator = $236/$239 = .987
2016 deflator = $285/285 = 1

Measuring Inflation Using GDP Deflator
Inflation between 2000 & 2016 is percentage change in GDP deflator between the two dates
This is about 1.3%, and is given by:
(100*(1/.987)-1)
(Note inflation typically measured over one year period, not 16 year period)

Base Year Prices for calculating inflation: Caveat
Caveat – real GDP growth will be weighted average of growth rates of each sector, with weights equal to base year expenditure shares
OK if shares are stable, but they are not
Example: services share has gone up over time, food share has gone down over time

Chain Weighting as an alternative to Base Year Prices
With chain weighting, the weights change over time
Real GDP growth is a geometric average of two separate fixed weight indexes. One index uses today’s prices as weights, and the other index uses yesterdays prices as weights

Limitations of Using real GDP as a Measure of Well-Being
Real GDP only measures market economic activity
It misses non-market production such as home production
Includes taking care of children, cleaning home, cooking, gardening, etc.
May be as big as 1/3 of GDP in U.S.

Limitations of Using real GDP as a Measure of Well-Being
GDP does not measure unreported economic activity such as:
Illegal drug sales and other illegal activities
Unreported sales of goods or transaction in order to avoid income and sales taxes

真实GDP不用以下方法测量：
1.违法交易
2.未上报的交易

Limitations of Using real GDP as a Measure of Well-Being
GDP doesn’t take into account changes in environment, health, or other factors that affect our quality of life
Economists interpret these omissions as unmeasured output
Example: a cleaner environment is an example of unmeasured output

Unmeasured Quality Change
Another measurement challenge is measuring changes in quality of a good

Example: Computers today are much better than in the past. It is hard for government to sufficiently account for these quality changes
If gov’t understates quality improvements, then it overstates inflation and understates real output

Example of Quality Change & Mismeasurement
100 computers built today and last year, but computers today are twice as fast
Computing power doubled – twice as much computing output was produced
Suppose price per computer doubled, & suppose gov’t misses quality change
Gov’t measures 100% inflation – but price of computing power is unchanged!

Consumer Price Index: Another Measure of Inflation
CPI is constructed by fixing a “market basket” of goods and services
Then, the Bureau of Labor Statistics collects prices for those goods monthly
Only counts prices for consumption
Fixed basket, so likely overstates inflation by assuming consumers always buy same amount of good

Measures of Labor Market Performance
Most common: unemployment rate
Ratio of number of people searching for job to the labor force
Better measure: employment rate
Ratio of number of people working to the labor force

UR_t=(#Unemployed_t)/(Labor Force_t)
UR=U/(E+U)
Labor Force_t=Employed_t+Unemployed_t

Why Employment Rate is Better
Unemployment depends on whether the individual reports they are searching for a job or not. This is unobservable, and there is not always a clear distinction.
Employment just depends on whether a person is working or not – observable.

Hours Worked: Even Better Measure than Employment
Employment measure doesn’t take into account differences in hours worked
Example: 2 workers sharing one full time job will appear as more work, compared to one full time worker
Hours worked explicitly measures how much work is being done in an economy.

Measuring the Capital Stock
Most capital stock measures are based on the perpetual inventory method（永续盘存法）
Capital today = Capital yesterday, minus depreciation, plus investment
BEA produces depreciation rates for different types of capital
BEA then adds up different types of capital into a single capital stock

Productivity (Very Important!)
Two major definitions of productivity
Labor productivity: Real GDP/Hours Worked, or Real GDP/Employment.
Total Factor Productivity: measures output growth, net of measured changes in capital and labor input growth. We will discuss this in detail in a later lecture

Conclusions
National income accounting allows us to measure output and incomes
We focus on real GDP
We can measure real GDP using expenditures, incomes, or value added
There are limitations in using GDP
CPI, labor statistics, capital, & productivity are also important statistics

Participants
Cost of Materials
Value of Sales
Value Added

Farmer
$ 0
$ 100
$ 100

Cone factory and ice cream-maker
100
250
150

Middleperson
250
400
150

Vendor
400
500
100

Totals
$ 750
$1,250
$500

ParticipantsCost of
Materials
Value of
Sales
Value Added
Farmer$ 0$ 100$ 100
Cone factory
and ice
cream-maker
100250150
Middleperson250400150
Vendor400500100
Totals$ 750$1,250$500

deflator GDP
GDP Nominal
=GDP Real

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