National Accounting Introduction to Macroeconomics WS 2011 October 7 th, 2011 Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 1 / 35
Why study National Accounting? National Accounting deals with identities, i.e. the relationships outlined here hold by definition When analyzing an economy s performance it is important to define precisely what we are talking about! National Accounting provides a uniform method of assessing economic performance and thus allows cross-country comparisons UN system of National Accounts developed in 1993 (SNA93) European System of Accounts (ESA95) developed by Eurostat as a standard for members of the EU Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 2 / 35
The Structure of the Domestic Economy Households are endowed with wealth and time supply labor and capital demand final goods demand labor and capital supply final goods subsidies on production Firms profit maximizing production technology transfers demands final goods income taxes pay VAT and direct taxes on production Government supply final goods The production technology of firms is a description of how intermediate goods, capital and labor are transformed into output and is taken as given. Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 3 / 35
The Structure of International Relations Domestic Economy Primary Incomes Exports and Imports Transfers Rest of the World An economy which has no ties to the rest of the world is referred to as closed, whereas an economy with ties to the rest of the world is referred to as open. Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 4 / 35
Definition of GDP The Gross Domestic Product or GDP is a measure of economic performance of a country It records the economic activity in a country over a certain time span (e.g. in a year or a quartal) it is a flow variable It can be calculated in three equivalent ways: by looking at the production side of the economy as the value of all final goods and services which are produced in the country during the considered time period as the sum of gross value added of all productive units in the given country and in the considered time period by looking at the income side of the economy as the sum of all primary incomes which were earned in given country during the considered time period Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 5 / 35
Calculation of GDP using Sales of Final Goods IMPORTANT Intermediate goods and services are not counted since they are already included in the value (resp. price) of the final good (production costs). No double counting!!! GDP of an Economy with three Producers steel producer car producer farmer sold quantity 5 t 10 pieces 60 t market price e 20,000/t e 21,000/piece e 1,000/t wages paid e 80,000 e 70,000 e 50,000 intermediate none 5 t steele none goods used profits e 20,000 e 40,000 e 10,000 Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 6 / 35
Calculation of GDP using Sales of Final Goods - Closed vs. Open Economies Final goods are goods meant for consumption In a closed economy production and consumption of domestic agents exactly coincides (no ties to other countries) Therefore, GDP can also be calculated as the sum of all consumption expenditures of agents in this economy, i.e. as the sum of: consumption by private households (C) investment goods (I) consumption of the government (G) An Accounting Identity in Closed Economies GDP = C + I + G Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 7 / 35
Calculation of GDP using Sales of Final Goods - Closed vs. Open Economies In an open economy, domestic consumption does not coincide with domestic production because exports (X) are produced but not consumed in the domestic economy part of domestic consumption (C, I and G) is imported and thus not produced in the domestic economy (Q) In order to obtain domestic production, exports must be added to and imports must be subtracted from domestic consumption: An Accounting Identity in Open Economies GDP = C + I + G + X Q NOTE: All exports are regarded as final goods regardless of whether they are directly sold to foreign consumers or to foreign firms as intermediate inputs Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 8 / 35
Calculation of GDP using Gross Value Added Definition The gross value added of a productive unit is defined as the value of its produced output minus the value of the intermediate goods used in the production process Value Added Approach GDP = gross value added of all domestic productive units Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 9 / 35
Calculation of GDP using the Primary Income Approach Primary incomes are: the compensation of employees (labour income) profits of firms or self-employed persons return on financial assets and natural assets (e.g. land) income of the government (i.e. taxes minus subsidies) Primary Income Approach GDP = primary incomes earned in the economy Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 10 / 35
Nominal versus Real GDP So far, we have used current market prices to calculate values. The GDP calculated in this way is referred to as Nominal GDP. A change in Nominal GDP can be either due to 1 changing quantities or to 2 changing prices In order to isolate the effect of changing quantities, it is possible to fix a base year and use the market prices in this year to calculate values. The GDP calculated in this way is referred to as Real GDP. Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 11 / 35
Nominal versus Real GDP Notation n... number of domistically produced goods P i t... price of good i in period t Q i t... produced quantity of good i in period t Nominal and Real GDP - Formal Definition nominal GDP t = real GDP t = n PtQ i t i i=1 n P0Q i t, i i=1 where period 0 was chosen as the base year in the calculation of real GDP. Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 12 / 35
Nominal versus Real GDP - An Example Nominal and Real GDP in a 2-period world Consider an economy with 2 final goods A and B in the time periods 1 and 2: t sales of A sales of B price of A price of B 1 10 5 e 1 e 3 2 8 6 e 2 e 3 nominal GDP real GDP Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 13 / 35
Nominal & Real GDP of the United States Figure: Nominal & Real GDP of the US after 1945 (in billions $) Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 14 / 35
Discussion of the US Data From the previous figure it can be seen that the nominal GDP of the US increases almost exponentially In particular, the nominal GDP in 2010 was approximately 65 times higher than in 1945 This vast increase is however due to both an increase in prices and an increase in the produced quantities In particular, the real GDP (i.e. the produced quantities valued at constant prices) in 2010 was only approximately 6.5 times higher than in 1945 Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 15 / 35
Nominal and Real GDP per capita Nominal and real GDP reflect the economic size of a country For cross country comparisons, nominal and real GDP per capita are more informative Nominal GDP per capita (i.e. nominal GDP divided by the size of the population) is the average income in a country Real GDP per capita (i.e. real GDP divided by the size of the population) is a measure for the average standard of living in a country Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 16 / 35
Cross Country Comparison of Real GDP per capita Figure: Real GDP per capita in 2009 U.S. Dollars Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 17 / 35
Calculation of Growth Rates When analyzing the development of nominal or real GDP over time, we often look at growth rates A growth rate puts the absolute change in a variable in relation to its initial level Formally, the growth rate of a variable x between period t 1 and period t is calculated as g x,t = xt x t 1 x t 1 Nominal and Real GDP in a 2-period world Consider an economy with 2 final goods A and B in the time periods 1 and 2: t sales of A sales of B price of A price of B 1 10 5 e 1 e 3 2 8 6 e 2 e 3 nominal GDP real GDP Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 18 / 35
Nominal GDP Growth in Austria - Data Figure: Annual Growth Rate of Nominal GDP in Austria Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 19 / 35
Real GDP Growth in Austria - Data Figure: Annual Growth Rate of Real GDP in Austria Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 20 / 35
The GDP Deflator So far, we have isolated the change in quantities. Still open: how to measure changes in prices. Definition - GDP Deflator Interpretation: GDP Deflator t = Nominal GDP t Real GDP t = n i=1 Pi tq i t n i=1 Pi 0 Qi t It measures the relative change in the aggregate price level from the base year to the current period, where the aggregate price level is a weighted average of the prices of all final goods produced in the economy in the current period. The GDP Deflator is a Paasche index: prices are weighted by their current quantities Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 21 / 35
The GDP Deflator - An Example The GDP Deflator in a 2-period world Consider an economy with 2 final goods A and B in the time periods 1 and 2: t sales of A sales of B price of A price of B 1 10 5 e 1 e 3 2 8 6 e 2 e 3 nominal GDP real GDP GDP Deflator Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 22 / 35
The GDP Deflator - Data Figure: GDP Deflator in the US Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 23 / 35
The Consumer Price Index (CPI) The GDP Deflator is not the only way to measure price changes. More frequently, price changes are measured as the changes in the costs of a specified consumer basket, i.e. as the changes in the consumption expenditures of a typical consumer. The consumer basket is fixed for some periods (standard of Eurostat: consumer basket is changed every 5 years) The CPI Index measures the relative change in the aggregate price level of all goods consumed in the economy, where the aggregate price level is computed by using the quantities specified in the consumer basket as weights (base year weights). It is thus referred to as a Laspeyres index Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 24 / 35
The Consumer Price Index - An Example Formally, the CPI can be expressed as: CPI = m j=1 Pj tq j 0 m j=1 Pj 0 Qj 0 where m is the number of goods in the consumer basket and t = 0 is the base year. The CPI in a 2-period world Consider an economy with 2 final goods A and B in the time periods 1 and 2: t sales of A sales of B price of A price of B 1 10 5 e 1 e 3 2 8 6 e 2 e 3 nominal GDP real GDP CPI Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 25 / 35
GDP Deflator or CPI? - A Comparison Both the GDP Deflator and the CPI are index numbers, i.e. they are one in the base year and measure price changes relative to the base year. The GDP Deflator and the CPI are different since: (i) they capture the price change of a different set of goods (ii) different weights are used in the computation of the aggregate price level Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 26 / 35
GDP Deflator or CPI? - A Comparison ad (i): ad (ii): imports do not enter the GDP Deflator (recall imports are not part of domestic GDP), but they may constitute an important part of domestic consumption and be included in the CPI exports enter the GDP Deflator (are produced in the domestic economy), but not the CPI Laspeyres indices (such as the CPI) use base year quantities as weights. However, usually consumers will consume less of a good which becomes more expensive compared to other goods (see your micro classes) Hence, Laspeyres indices usually overestimate the true increase in prices experienced by a consumer Paasche indices (such as the GDP Deflator) use current quantities as weights usually underestimate the true change in prices experienced by a consumer Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 27 / 35
The Inflation Rate Definition The inflation rate is the growth rate of the price level between two periods. It is usually denoted by π t. Calculation of the inflation rate using price indices Let PI t be any price index in period t, then the inflation rate from period t 1 to period t is given by: π t = PI t PI t 1 PI t 1 Clearly, the inflation rate from the base year to period t is simply given by PI t 1. Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 28 / 35
GDP Deflator or CPI? - Data The following figure shows the yearly inflation rate calculated for both the GDP Deflator and the CPI using data from the US: Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 29 / 35
GDP Deflator or CPI? - Data From this data we can see the following: Most of the time the inflation rates calculated according to the two price indices are moving very closely together Most of the time the inflation rate calculated according to the CPI (Laspeyres index) is higher In the late 70s the inflation rate calculated according to the CPI increases considerably more than the inflation rate calculated according to the GDP Deflator. This can be explained with an increase in the price of imported goods (such as oil) compared to the goods produced in the US (2 nd oil price shock) Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 30 / 35
From Gross Domestic Product to Net Domestic Product A part of investment is undertaken to replace depreciated capital (e.g. damaged machines,...), but does not increase firms productivity (it only preserves the status quo) If these investments are not included in the calculations of economic performance, one obtains Net Domestic Product (NDP) instead of GDP Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 31 / 35
Gross National Income/Gross National Product Some of the primary incomes within the given economy/country are earned by non-residents of this country (e.g. people who work abroad, shareholders who receive dividends from foreign firms,...) The Gross National Income (GNI) is the sum of all primary incomes earned by residents of the given country or equivalently: GNI = GDP - balance of all primary incomes paid to the rest of the world where the balance of primary incomes paid to the rest of the world is given by the primary incomes which are earned in the domestic economy but paid to non-residents minus the primary incomes residents of the domestic economy receive from the rest of the world Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 32 / 35
GDP vs. GNP - Data Figure: GDP and GNP of the US in Billion $ Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 33 / 35
GDP vs. GNP - Data Figure: GDP and GNP of Austria in Billion e Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 34 / 35
Can GDP (per capita) be used as a measure of welfare? GDP does not include illicit work, work done at home (stay at home mums and dads,...) GDP per capita gives the average income in an economy. If the income distribution is very unequal, this is not informative. GDP is only a monetary measure: things such as leisure, security, clean environment,... are not included Public goods can only be valued with their production costs and not with the true benefit for the population Introduction to Macroeconomics (WS 2011) National Accounting October 7 th, 2011 35 / 35