Econ 111 Principles of Macroeconomics

Summer 2017

Department of Economics Chapter 24: National

College of Business Accounts
Administration
Kuwait University
 National Accounting
There is an international standards for national

accounting. Used by the U.N. since 1948 and got

updated every 10 years.

The most recent version released for 2008.

National Income measures economys
overall performance
Useful to:

Assess health of economy

Track long run path
Formulate policy
 National Accounting
The first measure that you will learn about
in the chapter is the gross
domestic product (GDP). The GDP is an
important economic statistic because it
provides the best estimate of the total
market value of all final goods and services
produced by an economy in one year.
You will also discover why GDP is a
monetary measure that counts only the
value of final goods and services and
excludes nonproductive transactions such
as secondhand sales.
National income accounting involves
estimating output, or income, for the nation's
society as a whole, rather than for an
individual business firm or family.
Note that the terms output and income are
substitutable because the nation's domestic
output and its income are equal. The value of
the nation's output equals the total
expenditures for this output, and these
expenditures become the income of those
who have produced this output. (This is
based on the idea of the circular flow model
in Ch. 2).
 Gross Domestic Product

Gross Domestic Product is the

total market value of all final goods
and services that are produced in the
economy within a period of time
(usually a year).
 Gross Domestic Product

Total market value means

GDP is a monetary measure, so
GDP of this year=[P this year x Q this
year]
Final goods and services means it
1. ignores primary and intermediate goods.
This is important to avoid multiple counting
When you buy a burger from McDonald's the
value of the burger is included in GDP
When McDonald's buys buns, meat, cheese
and salad, the value of these goods are NOT
added to GDP as their value is counted in the
burger when a consumer buys it as a final good.
Another way to avoid double or multiple
counting is to add up the value added in each
stage of production.
 Gross Domestic Product
An Example of Value Added
Value
Good Produced by Purchased by Price
Added
Trees Green Forest ABC Wood 12,000 12,000
Dream House
Wood ABC Wood 25,000 13,000
Contractor
Dream House
House Household 125,000 100,000
Contractor
Final Value 125,000
Value Added 125,000
Produced in one year means GDP is a
measure of what is produced or made in one
year, therefore:
a. secondhand sales are not included, and
b. financial transactions not included
A car produced in 2012 is included in 2012's GDP. Therefore, if a used
2012 caris sold in year 2013 we would NOT include its price in the GDP
for 2013 since it was not produced then. We WOULD include the profits
earned by the used car shop in 2013 but we would not include the
value of the car itself.
Also, the billions of dollars spent on buying and selling stocks each
day does not affect the GDP value. It is not a production but only a
transfer of ownership from one name to another.
 Gross Domestic Product

In addition to sales of used goods

and financial transactions, GDP also
excludes other items like transfers to
avoid double counting:
Public transfer payments
These are money paid by governments through programs such as old age or disability
pensions, student grants, unemployment compensationetc. Public transfer payments
is paid without asking those who receive to do work or service in order to get it.

Private transfer payments

These are money paid by people as assistance or donation or charity to other people
such as family members, relatives, neighbors or poor people.
 Gross Domestic Product

.30,000+
.12 ,000 _ 30 \

OOO
(:;3 6,000. 12

3,500-6
02,000- 3:soo
OI,000-2000
C::l soc - 1

o . ,oo'
 Two Approaches to GDP
1- Expenditure approach
Count sum of money spent buying the
final goods
Who buys the goods?
2- Income approach
Count income derived from production
Wages, rental income, interest income,
profit
Two Approaches to Measure GDP

Expenditure Income
Approach Approach
 Two Approaches to Measure GDP

1- Expenditure
approach
Count sum of money
spent buying the final
goods
Who buys the goods?
 Two Approaches to Measure GDP

2- Income
approach
Count income
derived from
production
Wages, rental
income, interest
income, profit
Will come back
later to this
 1- Expenditure Approach
From an expenditure perspective, GDP is composed of four
expenditure categories: personal consumption expenditures (C),
gross private domestic investment (Ig), government purchases (G),
and net exports (Xn).
These expenditures become income for people or the government
when they are paid out in the form of employee compensation, rents,
interest, proprietors' income, corporate profits, and taxes on
production and imports.
GDP can be calculated from national income by making adjustments
to account for net foreign factor income, a statistical discrepancy, and
depreciation. In national income accounting, the amount spent to
purchase this year's total output is equal to money income resulting
from production of this year's output.
 1- Expenditure Approach

Durable Consumer Goods

Durable goods are goods that can be used over a long duration of time.
Examples of durable consumer goods include washing machines,
refrigerators, cars, and ovens.

Nondurable Consumer Goods

Non-durable goods are goods that are consumed immediately or in a
short duration of time. Examples include food, gasoline, newspapers,
and magazines.

Consumer Expenditures for Services

Services include medical treatment, education, lawyers, haircut, and
dry cleaning .
 1- Expenditure Approach

+ Gross Private Domestic Investment ( Ig )

Machinery, equipments, and tools
All construction
Changes in inventories

Gross vs. Net Investment

Net Private Domestic Investment
Net Private Investment = Ig consumption of fixed capital or depreciation
In = Ig - d
 1- Expenditure Approach
Gross private domestic investment (Ig) is the sum of the spending
by business firms for machinery, equipment, and tools; spending by
firms and households for new construction (buildings); and the
changes in the inventories of business firms.
1. An increase in inventories in a given year increases investment that
year because it is part of the output of the economy that was produced
but not sold that year; a decrease in inventories in a given year decreases
investment that year because it was included as part of the output from a
prior year.
2. Investment does not include expenditures for stocks or bonds or for
used or secondhand capital goods (because they were counted as part of
investment in the year they were started).
3. Gross investment exceeds net investment by the value of the capital
goods worn out during the year (depreciation). An economy in which net
investment is positive is one with an expanding production capacity
because the stock of capital goods increases.
Gross vs. Net Investment
Gross Investment
- Depreciation
= Net Investment

Net
Gross Investment
Investment
Depreciation
Increased
Consumption
Stock of and Stock of
Capital Government Capital
Spending
January 1 Years GDP December 31
 1- Expenditure Approach

GDP (Y ) is the sum of the following:

Consumption (C)
Investment (I)
Government Purchases (G)
& Net Exports (NX)
Where NX = Exports - Imports
Y = C + I + G + NX
Personal Consumption Expenditure ( C)
+ Gross Private Domestic Investment ( Ig )
+ Government Purchases ( G ):
Expenditures for Goods & Services
Expenditures for Social Capital
Does NOT include Government Transfer Payments

+ Net Exports ( Xn)

Net Exports (Xn) = Exports (X) Imports (M)
GDP = C + Ig + G + (X M)
Government purchases (G)
Government purchases (G) are the expenditures made by
all levels of governments (federal, state, and local) for final
goods from businesses, and for the direct purchases of
resources, including labor.

1. The government purchases are made to provide public

goods and services, and for spending on publicly owned
capital (public goods such as highways or schools).

2. Transfer payments made by the government to

individuals, such as Social Security payments, are not
included in government purchases because they simply
transfer income to individuals and do not generate
production.
Net Exports ( Xn)
Net exports (Xn) in an economy are calculated as
the difference between exports (X) and imports (M).

Xn is equal to the expenditures made by foreigners

for goods and services produced in the economy
minus the expenditures made by the consumers,
governments, and investors of the economy for
goods and services produced in foreign nations.
GDP = C + Ig + G + (X M )
Xn = X M

GDP = C + Ig + G + XN
 Change in Inventories

If (+) must be added even if it is not

purchased

If ( ) must be deducted because it

means that part of purchase was
produced in a previous period of time
 Change in Inventories
Any new inventories must be added even if it is not
sold during the year.
Any withdrawal from the inventories must be
deducted because it means that part of purchase
was produced in a previous period of time
Inventories are investment because they are goods produced
but held in storage in hope of later sales. Firms also store raw
materials, intermediate goods and spare parts that they need
during the production process. Goods held in inventories are
counted in the year produced, not the year sold or used by.
It should be counted in GDP by adding any additions to
inventories minus the withdrawals from the inventories.
 Change in Inventories

Year 2010 2011 2012

Final Sales 1020 950 970
Change in Inventories 40 + 50 + 80
GDP 980 1000 1050
 U.S. GDP Components 2011
Government- :::-- Net exports
purchases -$576.9
$3,030.2 billion
billion

Investment -
$1,914.6
billion

Consumption
$ 10,726.4
billion
 Kuwait GDP by Expenditure
in Million KD 2000 2008
Expendi
2008 2007 2006 2005 2004 2003 2002 2001 2000 ture

16023.1 14245.1 12513.9 11292.5 10033.2 9379.2 8676.9 7482.4 7290.3 C

5004.2 4563.1 4094.5 3706.6 3478.1 3281.2 2929.4 2528.5 2485.2 C gov.

11018.9 9682 8419.4 7585.9 6555.1 6098 5747.4 4953.9 4805.1 C pri.

7532.3 6820.7 4696.4 3450.4 2623.4 2373 1852.7 1461.7 1213 Ig

Ch. In
- 85.5 65.3 425.2 562.1 - 132.4 68.9 21
Inven

26434 20661 19316 15094 9970 7432 5171 5490 6534 X

10202 9226 7122 6669 5672 4917 4243 3803 3488 M
39787.4 32586.3 29469.6 23593.2 17516.7 14267.2 11590 10700 11570.3 Total
 Computation of GDP by the income approach
requires adding the income derived from the
production and sales of final goods and
services. The six income items are:
a. Compensation of employees (the sum of
wages and salaries and wage and salary
supplements, such as social insurance and
private pension or health funds for workers).
Income b. Rents (the income received by property
owners). This rent is a net measure of the
Approach difference between gross rent and property
depreciation.
c. Interest (only the interest payments made by
financial institutions or business firms are
included; interest payments made by
government are excluded).
d. Proprietors' income (the profits or net income
of sole proprietors or unincorporated business
firms).
 e. Corporate profits (the earnings of
corporations). They are distributed in the
following three ways: as corporate income
taxes, dividends paid to stockholders, and
undistributed corporate profits retained by
corporations.
f. Taxes on production and imports are added
because they are initially income for households
Income that later gets paid to government in the form of
taxes. This category includes sales taxes, VAT
Approach taxes, business property taxes, license fees,
and custom duties.
The sum of all of the above six types
equals national income (employee
compensation, rents, interest,
proprietors' income, corporate profits,
and taxes on production and imports).
 1- Compensation of Employees
2- Rents
3- Interest
4- Profit
Proprietors Incomes
Income Corporate Profits
Approach Corporate Income Taxes
Dividends
Undistributed Corporate Profits
5- Taxes on Production & Imports:
- Sales Tax, Custom Duties, VAT
.., etc.
 GNI (or GNP)
Gross National Income Gross
national Income (GNI) is total income
earned by a nations permanent
residents (called nationals).
Differs from GDP by including income
that local citizens earn abroad and
excluding income that foreigners earn
inside.
Net Foreign Factor Income (NFFI)
 Net Foreign Factor Income (NFFI)

Net Foreign Factor Income is the

difference between payments received
from national investment abroad and
payments made to foreigners who are
producing in domestic market.
This amount is the difference between
the gross domestic product and the
gross national product.
* To obtain GNI: add NFFI to the GDP
when NFFI is positive and deduct it from
the GDP when NFFI is negative.
 Net Domestic Product
NDP = GDP Depreciation

National Income
NI = NDP (+ , ) Net Foreign Factor Income
& Statistical Discrepancy
 Statistical Discrepancy
When GDP is calculated using the income approach it
might differ from the GDP that is calculated using the
expenditure approach. This difference is known as
statistical discrepancy.
We should add this statistical discrepancy to the GDP
that is calculated using the income approach to make it
equal to the GDP that is calculated using the expenditure
approach.
 Personal Income
PI = NI Indirect Tax
Social Security Payment
Corps Income Tax
Undistributed Profit
+ (Add) Public Transfer Payments
 NDP Deduct Depreciation
NI (+, ) Net Foreign Factor Income
& Statistical Discrepancy
PI Deduct
Indirect Tax
Social Security Payment
Corps Income Tax
Undistributed Profit
Add Public Transfer Payments
 Disposable Income
Deduct Personal Tax
Income Tax
Property Tax
DI = C + S
Gross Domestic Product (GDP) 10,000
Consumption of fixed capital -1,000
Net Domestic Product (NDP) 9,000
Statistical Discrepancy 0
Net foreign factor income + 500
National Income (NI) 9,500
Taxes on production & imports - 400
Social security payments -700
Corporate income taxes -200
Undistributed corporate profits -140
Public Transfer payments +1,400
Personal Income (PI) 9,460
Personal Income Taxes -1,160
Disposable Income (DI) 8,300
 NOMINAL GDP vs. REAL GDP
This section of the chapter shows you how to
calculate real GDP from nominal GDP.
This adjustment is important because nominal
GDP is measured in monetary units, so if accurate
comparisons are to be made for GDP over time,
these monetary measures must be adjusted to
take account of changes in the price level.
A simple example is presented to show how a GDP
price index is constructed. The index is then used
to adjust nominal GDP to obtain real GDP and
make correct GDP comparisons from one year to
the next.
 NOMINAL GDP vs. REAL GDP
Nominal GDP is the total output of final goods and services
produced by an economy in 1 year multiplied by the market prices
when they were produced.
Prices, however, change each year. To compare total output over
time, nominal GDP is converted to real GDP to account for these
price changes.
There are two methods for deriving real GDP from nominal GDP.
The first method involves computing a price index. This price index
is a ratio of the price of a market basket in a given year to the price
of the same market basket in a base year, with the ratio multiplied
by 100. The base year is a reference year for a price index series.
The price index in the base year is set at 100. If the market basket of
goods in the base year was $10 and the market basket of the same
goods in the next year was $15, then the price index would be 150
[($15 /10) 100].
The second method: To obtain real GDP, divide nominal GDP by the
price index expressed in hundredths. If nominal GDP was $16,244.6
billion and the price index was 104.5, then real GDP would be
$15,547.0 billion [$16,244.6 billion /1.045].
 NOMINAL GDP vs. REAL GDP
Nominal Values cause problems:
Deflate GDP when prices rise
Inflate GDP when prices fall
Therefore we need to calculating Real GDP
NOMINAL GDP vs. REAL GDP
 GDP Shortcomings
This section looks at the shortcomings of GDP as a measure of
total output and economic well-being. These shortcomings are:
a. It excludes the value of nonmarket final goods and services that are
not bought and sold in the markets, such as the unpaid work done by
people on their houses.
b. It excludes the amount of increased leisure enjoyed by the people.
c. It does not fully account for the value of improvements in the quality
of products that occur over the years.
d. It does not measure the market value of the final goods and services
produced in the underground sector of the economy because that
income and activity are not reported.
e. It does not record the pollution or environmental costs of producing
final goods and services.
f. It does not measure changes in the composition and the distribution
of the domestic output.
g. It does not measure noneconomic sources of wellbeing such as a
reduction in crime, drug or alcohol abuse, or better relationships among
people and nations.
That is all for Chapter 24