NATIONAL ACCOUNTING. Government Sector

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1 NATIONAL ACCOUNTING Three different methods that must provide same result. 1) Expenditure (final G+S) 2) Income (adding factor incomes paid; gross operating surplus) 3) Value added (value added onto intermediate good by application of production process) Since circular flow of income, they should all get same result. Expenditure from h/h is funded from income and value added from all industries. Difference between real and nominal variables Eg: real wage Distinguish money supply expressed in money terms and real terms! q of G+S that can be purchases with nominal quantity of money Importance to be real variable when change in value of variables over time. Firms make decisions with real wage. Price adjustment important Money prices and relative prices Money price! rate at which G+S will exchange for money. Relative price! rate at which one product will exchange for another, derived from money price Income and Wealth Income! flow variable, flow of payment to h/h or firm. Factor income received for supplying a factor of production. Transfer income (made by govt.) with no exchange. Allows us to engage in expenditure or savings. Wealth! stock variable, money Investment and Capital Capital is a factor of production which combines with other factors to produce G+S - Range of physical items such as buildings and PPE, origin to human effort (not provided by natural resources) Finance = investment expenditure, adds to the stock of capital Government Sector Expenditure approach! add government expenditure Government is just like another entity so taxation and spending and producing G+S should be included in production no matter what measure of national output Non marketed output of govt. sector valued at cost - imputed value

2 Market prices and Basic Prices Market prices prices people pay for G+S including any indirect tax less subsidies Basic prices price producers receive and what is available to distribute as income to owners Differences is indirect taxes and subsidies Add indirect tax and subtract subsidies to Total Factor Incomes = GDP Export Import Sector Net exports is expenditure Gross National Income is the income available to national residents - Obtained by subtracting net primary income receivable from non-residents from GDP - Measure of income available to domestic residents from productive activity of factors of production that they own, domestic or overseas. GDP GDP market value of final G+S produced in an economy over a given period of time, before allowing for depreciation of capital Value measure, common measuring rod of money price Nominal! values output in prices of current period, change in output Real! adjusts for price change, output revalued in prices of a base year to give GDP at constant prices - Important to look at change in value of a variable over time to care about real variables Australia uses Chain Volume Measure Constant Prices - Prices of given year chosen to re-price output of every subsequent period - Issue: adding value of output in money prices; relative prices are likely to change over time - Choose new base year to be more accurate Chain Volume Measure Laspeyeres - Prices of each pair of adjacent years, real GDP index applied to real GDP in reference year - Estimates of real GDP in each period are obtained by linking period to period indexes Marketed Output GDP only includes market transactions Understates national output: omits charitable work, unpaid household work, black / cash market Non Productive Transactions No newly produced goods and services, does not include second hand product or existing assets

3 Unless value of new service associated with purchase of existing asset GDP includes imputed value for rent for owner occupied dwellings Standard of Living Need same currency, so use current market exchange rate BETTER: convert GDP data to currency of another currency using PPP exchange rate Real GDP is common measure of material wellbeing; real GDP / head - Issues: not perfect measure of output as the flaws above - Only measures change in material well-being, ignores others that impact living standards o Distribution of income, composition of output, negative externalities, quality of life Other measures: Human Development index (level of standard of living) with real GNI per head, average life expectancy, education Measures of Australia progress: society measures of health, crime, family etc Genuine Progress indictor environmental Advantages of GDP Timely release of data gives us good indication of standard of living Market prices: reflects opportunity costs Can be targeted by govt. policies to achieve levels of standard of living Disadvantages of GDP Includes activities that are transacted in the market Omits externalities Ignores productive effort required to produce G+S (but then poor quality of life) INFLATION CPI, Producer Price level, National Accounts (Price deflator, GDP Chain Price Index) Headline rate! between 2-3% on average over the business cycle; weighted av of expenditure class Underlying rate! influence of volatile items has been removed for a longer measure of inflation Trimmed man! leave out classes that experience highest and lowest inflation (middle 70) Consumer Price Index Measure of average price change of a representative basket of G+S purchased by a typical metropolitan household Tradeables (influenced by ER) and Non tradeables higher on average, RBA target this Will overstate rate of inflation through biases " Introduction of new goods when quality of G+S improves, shouldn t recognise as price increase as it naturally requires higher costs to have better stuff " Substitution bias weights only change 5 years, when price of product rises, consumers usually buy cheaper product but CPI has set basket of goods

4 Not necessarily the cost of living. ABS has other measures, which increased at higher rate than CPI Seasonally Adjusted and trend Trend! smooth data beyond one year; average of current period seasonally adjusted and previous 6 quarters Seasonally adjusted: original adjusted for any systematic / known influence of the time of year which impact the target variable Producer Price Index Price change of intermediate goods or goods purchases by firms from other firms Significance: feeds into cost of production, may be a leading indicator of CPI National Accounts Measures GDP implicit Price deflator " Index number form: Nominal GDP / Real GDP GDP Chain price Index " Measure of price changes for all those final G+S entering into GDP (Laspeyres Price) " With the same quantity of goods, what is the total price change? " Includes final consumer and capital goods, produced domestically Trends Inflation was 3.0% for 12 months to June Quarter 2014 Currently 2.3% Lower than recent peaks but not seasonally adjusted! annualise quarterly data and in target range We need to consider range of variables that influence behaviour of inflation to predict future Inflation Wage Spiral Inflation often leads to a spiral! higher wage claims, higher inflation, continues Efficiency losses will be more apparent Undesirable effects on the distribution of income Raises real interest rate Deflation

5 Does not reduce REAL GDP 1) Distribution of Incomes Consequences of Inflation " Money income does not all increase at same rate as prices. " Reflects different bargaining strengths of different people / industries " Inflation may increase proportion of real income taken as tax (pushed to higher tax brackets) 2) Inefficiency in Resource Allocation " Markets responds to movements in relative prices " Signalling mechanism! general price level rises, sellers cannot identify whether should sell more or just price increase " Output can be foregone when firms do not take advantage of higher AD " Difficulty to plan in long term when volatile inflation " Shifted out of production of different goods, change of preferences 3) Redistribution of Wealth 4) Uncertainty " From lenders to borrowers " Real value of loan will fall, as the gap between inflation rate and interest rates smaller " Impacts consumer and business confidence " Reduced consumption expenditure and investment " Reduces AD, decline in GDP, unemployment rises 5) Wealth effect on Consumption " Inflation reduces real value of money assets " h/h maintain desired wealth/income ratio " Leads to more savings and GDP falls 6) International Competiveness " Inflation reduces IC because export prices rises relative to trade partners " Increased demand for imports " Deterioration of trade balance and AD falls, so real GDP falls 7) Interference with financial markets 8) Menu Costs " Encourages hedging assets at expense of investing in productive assets " Interferes with transforming h/h savings to investment funds for firms 9) Shoe Leather costs (hold less currency)