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NATIONAL INCOME ACCOUNTINGCOMPONENTS OF GDP - MEASURING INFLATION

MD Siyam HossainMD Siyam HossainBangladesh Institute of Business & Technology.Bangladesh Institute of Business & Technology.Narayangonj,DhakaNarayangonj,DhakaDhaka,BangladeshDhaka,Bangladeshwww.facebook.com/mdsiyamhossain

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1. COMPONENTS OF DEMAND

Analysis of demand for output Output is split into components of aggregate demand Analysing domestically produced goods and services Total demand for domestic output is made up of following

four components: Consumption spending by households (C), Investment spending by businesses and households (I) Government’s (federal, state, and local) purchases of

goods and services (G) Foreign demand (NX)

The four components and the total output is expressed into following identity:

Y= C+ I+ G+ NX (1) It (1) is called national income accounting identity

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2. CONSUMPTION

Main component of demand is consumption spending by household (Table-1)

Consumption includes spending on anything (e.g. food to golf lessons)

It also involves consumption spending on durable goods (e.g. automobiles)

Such spending normally regarded as investment rather than consumption

Table – 1: Components of demands 2003

Components of GDP $ Billions Percent (%)

Consummations 5 139.00 68.1

Investment (domestic) 1 096.00 14.5

Government Sector 1 409.00 18.7

Net Export - 119.0 -1.3

Total GDP 7 545.00  100%

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Division of GDP in the USA from 2003 shows that:

Consumption made 68.1% of GDP in USA in 2003

Share of Investments is 14.2%

Share of government sector is 17.7%

And Share of Foreign Demand is 1.1%

Share of the components are not constant

They vary from period to period and country to country

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Division of GDP in Japan from 2003 shows that:

Japan consumes a far smaller share of GDP than USA

Rising share of consumption in USA in 1980s was important reasons for poor economic performance

Higher consumption means: Less investment

Larger trade deficits

Lower saving

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3. GOVERNMENT

Government spending includes: National defence expenditures Costs of road expansion by state and local

governments Salaries of government employees Government spending is referred as purchases of

goods and services Government makes also transfer payments Transfer payments are social security benefits and

unemployment benefits These are payments made to people without any

service in exchange

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4. INVESTMENT Investment means additions to the physical stock of capital Investment does not include buying bond or stock of a firm

Investment includes: Building of machinery Construction of factories and offices Additions to a firm's inventories Investment increases ability to produce output in future Human capital embodied knowledge and ability to produce Investment in education is regarded as investment in human

capital However, personal educational expenditures as consumption But public educational expenditures as government investment

spending

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Classification consumption or investment spending:

In national income accounts:

Individual's purchase is consumption expenditure

Purchase of store is inventory investment

Investment is indicated as ‘gross’ because from investment depreciation is not deducted

Net investment is gross investment minus depreciation

Actually, investment includes investment in human capital

Official national income accounting counts only additions to physical capital stock as investment

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5. NET EXPORTS ‘Net exports’ account for domestic spending on

foreign goods and foreign spending on domestic goods

When foreigners purchase our goods, their spending adds to the demand of our domestic goods

When we purchase foreign goods has, it decreases demand for our domestic goods

So, difference between exports and imports is a component of total demand for our goods

[Difference between exports and imports is ‘Net Export’]

US net export is negative since the 1980s It means a deficit of balance-trade (Table-1) In some years net exports have been close to zero

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7. SOME IMPORTANT IDENTITIESLet us introduce some notations and

conventionsIt will be followed throughout the book

We simplify our analysis making following assumptions:

Disposable income equals GDP (Yd = Y)No difference between gross investment and net

investmentIt has neither a government nor foreign tradeLet us denote C for consumption and I for

investment spendingLet output produced equals output sold

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Hence, we can write: Y= C + I (2) Identity (2) shows the allocation of income

Let us establish a relationship among saving, consumption, and GDP:

Let output produced is either consumed or saved Hence, we can write: Y = C + S (3) This (3) shows the components of demand

From (2) and (3), we have: C + I = Y = C + S (4) I = S (5) It means (5), in a simple economy investment equals saving Let analysis this conclusion More is saved more is invested More consumption means less investment Less consumption means more investment

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3. REINTRODUCING GOVERNMENT AND FOREIN TRADE

Let us now introduce government and external sector in model above consideration. Let us denote:

Government purchases G and taxes by TA Transfers to the private sector (including interest) by TR Net exports (Exports - Imports) by NX So, output produced is either consumed, invested, used by govt or

saved Y = C + I + G + NX (6) Let us introduce the concept of output and disposable income We know that output equals disposable income Disposable income could be used either for consumption or

investment YD = C + S (7) Disposable income (YD) is equal to income plus transfers less

taxes (TA)

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That is disposable income is increased by transfers and reduced by taxes, hence:

YD = Y + TR – TA (8) Disposable income is allocated for consumption and saving That is combining identities (7) and (8), we have C + S = YD = Y + TR- TA (9) C + S = Y + TR TA (10) C = Y + TR TA S (11) Consumption is equal to income plus transfers less tax and

saving

From equation (6) and equation (10), we have: C + S = Y + TR TA C + S = C + I + G + NX + TR TA [Y = C + I + G + NX] S I = (G + TR TA) + NX (12)

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Case-I: If saving equals investment, then maximum possible investment

is achievedIn this case, government spending and net export is zeroIt means, there is no government spending

And either there is no foreign trade or trade is balancedNet export could be zero, if there is no foreign trade or trade-

balance is zero However, government spending could never be zero

Case-II By unchanged government spending, investment could be

increased by increasing export In this case, more and more export enables import of more and

more capital goods that ensure growth

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Conclusion

Investment could be increased by: Minimizing government spending

Promoting Export that enables more and more import of capital goods

Cutting more and more tax

Increasing consumption cutting tax

Supporting income through social and other supports

All of these steps supports consumption and saving that foster growth

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4. BUDGET, TRADE, SAVING AND INVESTMENT Let us explain impact of government spending and net export on

investment with a fictive example (Table-2)

Row-2 In 2001 saving was $1000 and there is no BD and TBD

Saving $1000 was fully invested

If there is no BD and TBD, saving is fully invested

Table – 2: Budget, Trade, Saving and Investment (Billions Dollars)

Year NI Consumption Saving Investment BD NX

2001 4000 2000 1000 1000 0 0

2002 4000 2000 1000 850 150 0

2003 4000 2000 1000 900 0 - 100

2004 4000 2000 1000 750 150 - 100

2005 4000 2000 1000 950 150 100

2006 4000 2000 1000 1050 50 100

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Row-3

In 2002 there was no TBD, but BD from $100

So, a part of savings was eaten up by BD

Hence, investment decreased to the amount of BD, $100

If there is BD but no TBD, a part of saving is eaten up by BD

Row-4

In 2003 there was no TBD, but a BD from $100 (-$100)

That means, a part of savings was used for import

Hence, investment decreased to the amount of TBD, $100

If there is BD but no TBD, a part of saving is eaten up by BD

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Row-4 In 2004 there was BD from $150 and TBD from $ 100

So, a part of savings was used for BD and TBD

Investment was reduced by BD and TBD $250 ($150+$100)

If there is BD and a TBD, investment is reduced to amount BD and TBD

Row-6 In 2005 there was BD from $150 and TBS from $ 100

So, savings was increased by TBS of $100

But the increased savings/income ($1100) that could be invested was reduced by BD of $150

So, investment was only $950 ($1100+$150)

If there is BD but a TBS, investment is reduced to amount BD but increased by the TBS

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Row-7

In 2005 there was BD from $50 and TBS from $ 100

So, savings was increased by TBS of $100

But the increased savings/income ($1100) that could be invested was reduced by BD of $50

So, investment was only $1050 ($1100+$50)

If there is BD but a TBS, investment is reduced to amount BD but increased by the TBS