978-0132992282 Chapter 2 Lecture Note

Unlock access to all the studying documents.

View Full Document

3. The fundamental identity of national income accounting:

total production  total income  total expenditure (2.1)

1. GDP (gross domestic product) is the market value of final goods and services newly

produced within a nation during a fixed period of time

Data Application

The period referred to here is either a quarter or a year. You may want to show students what

2. Market value: allows adding together unlike items by valuing them at their market prices

a. Problem: misses nonmarket items such as homemaking, the value of environmental

3. Newly produced: counts only things produced in the given period; excludes things produced

earlier

4. Final goods and services

a. Don’t count intermediate goods and services (those used up in the production of other

goods and services in the same period that they themselves were produced)

b. Final goods & services are those that are not intermediate

5. GNP vs. GDP

a. GNP (gross national product)  output produced by domestically owned factors

of production

GDP  output produced within a nation

b. GDP  GNP  NFP (net factor payments from abroad) (2.2)

1. Measures total spending on final goods and services produced within a nation during a

specified period of time

2. Four main categories of spending: consumption (C), investment (I), government purchases

of goods and services (G), and net exports (NX)

3. Y  C  I  G  NX, the income-expenditure identity (2.3)

4. Consumption: spending by domestic households on final goods and services

(including those produced abroad)

a. About 2/3 of U.S. GDP

b. Three categories

(1) Consumer durables (examples: cars, TV sets, furniture, and major appliances)

5. Investment: spending for new capital goods (fixed investment) plus inventory investment

a. About 1/6 of U.S. GDP

b. Business (or nonresidential) fixed investment: spending by businesses on structures and

equipment and software

c. Residential fixed investment: spending on the construction of houses and apartment

6. Government purchases of goods and services: spending by the government on goods or

services

a. About 1/5 of U.S. GDP

b. Most by state and local governments, not federal government

c. Not all government expenditures are purchases of goods and services

7. Net exports: exports minus imports

a. Exports: goods produced in the country that are purchased by foreigners

2000s concerning the national income accounts and the data on GDP. Because the types of goods

and services people buy has changed so much in recent years, the BEA decided to modify how it

categorizes industries when it collects data on production. The new system is known as NAICS:

the North American Industry Classification System; it replaces a system called SIC: Standard

54 percent of GDP to 38 percent, while the output of service industries has increased from

35 percent of GDP to 54 percent. The SIC has not been updated to reflect the changes in the

economy. NAICS will also improve the compatibility of U.S. statistics with those in other

countries.

The disadvantage of the switch from SIC to NAICS is that data from today based on NAICS

1. Adds up income generated by production (including profits and taxes paid to the

government)

a. National income  compensation of employees (including benefits)  proprietors’

income  rental income of persons  corporate profits  net interest  taxes on

production and imports  business current transfer payments  current surplus of

2. Private sector and government sector income

a. Private disposable income  income of the private sector  private sector income

earned at home (Y or GDP) and abroad (NFP)  payments from the government sector

(transfers, TR, and interest on government debt, INT)  taxes paid to government

1. Household wealth  a household’s assets minus its liabilities

2. National wealth  sum of all households’, firms’, and governments’ wealth within the nation

3. Saving by individuals, businesses, and government determine wealth

B. Measures of aggregate saving

1. Saving  current income  current spending

2. Saving rate  saving/current income

3. Private saving  private disposable income  consumption

Spvt  (Y  NFP  T  TR  INT)  C(2.6)

4. Government saving  net government income  government purchases of goods and

services

Sgovt  (T  TR  INT)  G(2.7)

a. Government saving  government budget surplus  government receipts  government

outlays

5. National saving

a. National saving  private saving  government saving

b. S  Spvt  Sgovt

 [Y  NFP  T  TR  INT  C]  [T  TR  INT  G] (2.8)

1. S  I  (NX  NFP) (2.9)

S  I  CA (2.10)

2. Spvt  I  (Sgovt )  CA (2.11)

{using S  Spvt  Sgovt}

The uses-of-saving identity—saving is used in three ways:

a. investment (I)

1. Stocks and flows

a. Flow variables: measured per unit of time (GDP, income, saving, investment)

2. Wealth and saving as stock and flow (wealth is a stock, saving is a flow)

3. National wealth: domestic physical assets  net foreign assets

a. Country’s domestic physical assets (capital goods and land)

b. Country’s net foreign assets  foreign assets (foreign stocks, bonds, and capital goods

owned by domestic residents) minus foreign liabilities (domestic stocks, bonds, and

capital goods owned by foreigners)

1. Nominal variables are those in dollar terms

2. Problem: do changes in nominal values reflect changes in prices or quantities?

3. Real variables: adjust for price changes; reflect only quantity changes

4. Example of computers and bicycles

5. Nominal GDP is the dollar value of an economy’s final output measured at current market

prices

6. Real GDP is an estimate of the value of an economy’s final output, adjusting for changes

in the overall price level

1959; prior to that time, inflation was usually so low that nominal GNP was all that it was

thought necessary to examine.

1. A price index measures the average level of prices for some specified set of goods and

services, relative to the prices in a specified base year

2. GDP deflator  100  nominal GDP/real GDP

Data Application

3. Note that base year P  100

4. Consumer Price Index (CPI)

a. Monthly index of consumer prices; index averages 100 in reference base period

5. In Touch with Data and Research: The computer revolution and chain-weighted GDP

a. Choice of expenditure base period matters for GDP when prices and quantities of a good,

such as computers, are changing rapidly

b. BEA compromised by developing chain-weighted GDP

c. Now, however, components of real GDP don’t add up to real GDP, but discrepancy is

6. Inflation

a. Calculate inflation rate:  t1  (Pt1  Pt)/Pt  Pt1/Pt

7. Does CPI inflation overstate increases in the cost of living?

a. The Boskin Commission reported that the CPI was biased upwards by as much as one to

two percentage points per year

b. One problem is that adjusting the price measures for changes in the quality of goods is

very difficult

1. The Federal Reserve focuses its attention on the personal consumption expenditures (PCE)

price index

2. The PCE price index is superior to the CPI because it avoids substitution bias and is revised

when better data are available

3. Differences between the PCE price index and the CPI include formulas used in their

calculation, coverage of different items, and weights given to different items

4. The Fed uses the core PCE price index to measure the underlying trend in inflation

5. But the Fed forecasts both the core and overall PCE price index because the Fed needs to

keep its eye on both underlying trends but also the actual inflation rate faced by households

6. The inflation rate in the overall PCE price index tends to revert to the core measure after a

period when the two measures deviate (Fig. 2.3)

Data Application

There are many problems with price indexes; they are imperfect measures of price changes.

2003),

pp. 159–201) conclude that the overestimate of inflation in the CPI is now about 0.9 percent per

12311, June 2006).

Numerical Problems 7 and 9 give practice in calculating inflation rates.

1. Interest rate: a rate of return promised by a borrower to a lender

2. Real interest rate: rate at which the real value of an asset increases over time

3. Nominal interest rate: rate at which the nominal value of an asset increases over time

4. Real interest rate  i  (2.12)

Text Fig. 2.4 plots nominal and real interest rates for the United States since 1960

1. r  i  e(2.13)

2. If   e, real interest rate  expected real interest rate

Numerical Problem 8 provides practice in calculating real interest rates.