The Measurement of Income and Prices

Lecture notes 2

Instructor: MELTEM INCE

Types of Investment (I)

Inventory Investment is the change in the stock of raw materials, parts, and finished products held by businesses.

Fixed Investment includes all final goods (mainly structures and equipment) purchased by businesses not intended for resale.

Relation of Investment and Saving

Personal Saving (S) is that part of personal income that is not consumed or paid out in taxes Also referred to as Private Saving Algebraically: S = (Y-T) - C (where T = Net Taxes)

Funds from savings are channeled to firms in two basis ways: Households buy bonds and stocks issued by firms Households deposit savings in banks and other financial

institutions that in turn lend money to firms Firms use the money channeled from savings to buy

investment goods

Net Exports and Net Foreign Investment

Exports are goods produced within one country and shipped to another

Imports are goods consumed within one country but produced in another country

Net Exports (NX) are equal to the excess of exports over imports

Net Foreign Investment (NFI) is equal to U.S. purchases of foreign financial assets minus foreign purchases of U.S. financial assets Interesting connection: NX = NFI

The Government Sector

Government Purchases (G) is the value of goods and services purchased by the government at the federal, state and local levels

Transfer Payments (F) are payments from the government to households that do not require the recipient to provide a service in return Examples: Social Security, Medicare, and Food Stamps

Government Spending = G + F The Government pays for its spending by collecting

Taxes (R) or by borrowing and/or printing money Net Taxes (T) = R – F Budget Surplus = T – G

Deriving the “Magic” Equation

The income accounting identity states that an economy’s income must equal its expenditures:

Y ≡ E Now, use the fact that household income must equal

household outlays (and recall that T = R - F):

Y + F = C + S + R Equating (1) and (2) yields the “Magic Equation”

C + S + T = C + I + G + NX

S + T = I + G + NX

Interpreting the “Magic Equation”

Recall the “Magic Equation:”

S + T = I + G + NX Leakages (S + T) describe the portion of total

income that is not available for consumption Injections (I + G + NX) is a term for non-

consumption expenditures

Measurig National Output

Gross National Product (GNP) : The market value of all the final goods and services produced within a country during a given time period-usually a year; equal to the sum of all values added in the economy.

Potential GNP ( Y*) : The real gross national product the economy could produce if its productive resources were full employed at their normal intensity of use. Also called full-employment GNP, full-employment national income.

Measurig National Output

Final Goods and Services : Many goods are produced inthe economy are not classified as final goods, butinstead as intermediate goods.Intermediate goods are produced by one firm for use infurther processing by another firm or to produce finalgoods. For example; weat is an intermediate good forbread. So that is the value added to produce final goodsand services.

Measurig National Output

Value added: During some stage of production is thedifference between the value of goods as they leave astage of product,on and the cost of the goods as they enteredthat stage. Value added is the value of firm’s production –all the inputs value which gets from other firms. Sum ofvalue added = wage + rent + profit +interest.

Example

Production level Market Value cost of intermediate good Value AddedWheat 1000 TL - 1000 TL Flour 2600 TL 1000 TL 1600 TLEntrepreneurship 4000 TL 2600 TL 1400 TLBread 5000 TL 4000 TL 1000 TL 12600 TL 7600 TL 5000 TL

As you’ve seen, the market value of bread (final good) 5000 TL. alsoincludes the market values of wheat, flour and entreprenurship services.In that reason; GNP is sum of the market value of all the final goodsand services = sum of all values added.

Nominal GDP, Real GDP, and the GDP Deflator

Nominal GDP is the value of gross domestic product in current (actual) prices.

Real GDP is the measure of gross domestic product using prices of an arbitrarily chosen base year.

The GDP deflator is a price index that measures the aggregate economy’s price level. Algebraically: GDP Def = Nominal GDP / Real GDP * 100 The percentage change in the GDP deflator gives a measure of

the economy’s inflation rate.

The Expenditure Approach

Expenditure approach a method of computing GDP that measuresthe amount spent on all final goods during a given period.Expenditure categories: personal consumption expenditures ( C): household spending

on consumer goods. Gross private domestic investment (I ) : spending by firms and

households on new capital , i.e. plant, equipment, inventory etc.

Government consumption and gross investment (G ): expenditures by state and local governments for final goods and services.

Net exports (EX-IM) : net spending by the rest of the world, or exports minus imports.

GDP = C + I + G + (EX - IM)

The Income Approach

A method of computing GDP that measures the income–wages, rents, ineterst, and profits- received by allfactors of production in producing final goods. Personalincome is the income received by households beforepaying personal income taxes. The amount of incomethat households have to spend or save is called“disposable personal income” or after-tax income. It isequal to personal income minus personal taxes.

GNP - GDP

The difference between GDP and GNP is; GDP is the market value of all the final goods and services that are produced by that nation’s production factors but GNP also includes the market value of all the final goods and services that are produced by foreigners. On the other hand; GDP measures the output located in that country.

Ex: only goods and services that are produced within a “country” as part of that country’s GDP. Toyota, a Japanese firm, produces automobiles if in Turkey, and the value of this production is part of Turkey’s GDP, not part of Japan’s GDP.

Growth Rate

We use estimates of real GDP to calculate teh economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next.

Economic growth rate = Real GDP(t) -Real GDP(t-1) X 100

Real GDP (t-1)

National Income

The value of a nation’s total production of goods and

services is called its “national product”. Hence when we

study national product we are also studying national

income.

National Income =Total consumption expenditure+ Total savings

National Income

National income is the total amount earned by the

factors of production in the economy; it is equal to NNP

except for a statistical discrepancy.

GNP – depreciation = Net NP

Net NP – Ti = National Income

The Consumer Price Index (CPI)

A price index measures the price level at a given periodrelative to the base period. The Consumer Prices Index(CPI) covers price of commodities commonly bought byhouseholds. Changes in the value of the CPI are meantto measure changes in the typical household’s “cost ofliving”. Government statisticians periodically survey agroup of households to discover how they spend theirincomes.