Concept summary Chapter 5
Macroeconomics | © John Petroff; contributors: Albertus Rafael Kendista Wantah Source: PEOI |
INTRODUCTION
The purpose of this topic is to study how the gross national
product
is measuring the economic activity of a nation. The concept is
defined and explained. The components are analyzed in the
expenditure and the income approach, and the two are reconciled.
Adjustments for inflation are presented. The concept is compared
to other measures of economic welfare.
NATIONAL INCOME ACCOUNTING
National income accounting is used to determine the level of
economic activity of a country. Two methods are used and the
results reconciled: the expenditure approach sums what has been
purchased during the year and the income approach sums what has
been earned during the year.
Just as firms need to know how well they are doing, so does a country. National income accounting provides the statistics to determine if the economy is encountering difficulties. |
GROSS NATIONAL PRODUCT
The gross national product is the sum total of all final goods
and
services produced by the people of one country in one year. The
GNP
is a flow concept. It can be calculated with either the
expenditure approach or the income approach. The GNP excludes
intermediate goods, second hand sales as well as financial
transactions. The GNP is a money amount and must be adjusted for
changes in the value of money.
GROSS DOMESTIC PRODUCT
The gross domestic product is the sum of all the final goods and
services produced by the residents of a country in one year.
Summing the production of residents (rather than nationals as
in GNP) gives often a more accurate picture of the level of
activity in a country.
The difference between GDP and GNP is net unilateral transfers
and
factor income of foreigners.
INTERMEDIATE GOODS
Intermediate goods are goods which are made part of some final
good. For instance, tires are intermediate goods when they are
part of a car. Tires are final goods when they are sold
separately as replacement parts. Incorporating intermediate goods
to form a final good adds value to that good.
VALUE ADDED
GNP can be calculated by adding up all the value added from the
intermediate goods (the result is exactly the same). Countries
with tax systems based on value added taxes prefer this method.
EXPENDITURE APPROACH
GDP can be calculated as the sum of all expenditures: personal
consumption expenditure (C), gross private domestic investment
(Ig), government purchases (G), and net exports (Xn).
GDP = C + Ig + G + Xn.
The expenditure approach sums all that is purchased: in a sense, it is equivalent to the income approach because purchases are only possible if income is present. |
PERSONAL CONSUMPTION EXPENDITURE
Personal consumption expenditure is what households buy (except
houses). It is made of durables (cars, appliances), nondurables
(clothing, food) and services (haircuts, doctor visits, airline
tickets). A convention is made on nondurables to be all items
which last less than a year, including clothing. Nondurables
expenditure is the most stable component of personal consumption
expenditure.
GROSS PRIVATE DOMESTIC INVESTMENT
Gross private domestic investment is made of 1) new
construction, 2) new capital (machines, trucks and equipment),
and 3) changes in inventory. It excludes investment made by
government and investment made outside the country. New
construction includes all forms of new building, be it for
rental purpose or for private residential purpose. Changes in
inventory captures the goods produced in one year and sold in
future years.
CAPITAL CONSUMPTION ALLOWANCE
Capital consumption allowance is the part of new capital
produced during one year, which is needed to replace the capital
used up during that year. It is also known as depreciation.
Capital consumption allowance (CCA) is equal to the difference
between gross investment (Ig) and net investment (In):
CCA = Ig - In.
NET INVESTMENT
Net private domestic investment is equal to gross private
domestic investment less capital consumption allowance. It is
the most sensitive component of GDP. When it is negative it
implies that the capital stock is being depleted and production
has to be decreasing. Economic growth is implied in a positive
net private domestic investment.
GOVERNMENT PURCHASES
Government purchases combine all goods and services bought by
all forms of government: form paper clips to bridges and
hospitals. This does not include government payment for work
or any transfer payment.
NET EXPORTS
Net exports is the difference between total exports and total
imports. It is equal to the trade or merchandise balance of
payments. When imports exceed exports (and the balance of
payments is in deficit), the amount shown as net exports is
negative.
INCOME APPROACH
The income approach sums all income derived from productive
activities.
NET NATIONAL PRODUCT
Net national product (NNP) is equal to gross national product
minus capital consumption allowance:
NNP = GNP-CCA.
Net domestic product is likewise
NDP = GDP - CCA
(As above, the difference between NNP and NDP is net factor
income
and unilateral transfers to foreigners.)
NATIONAL INCOME
National income (NI) is equal to net national product minus
indirect business taxes:
NI = NNP - (ind business taxes)
National income is also equal to the sum of salaries, rent, interest, profit and proprietors' income.
National income is the sum of all forms of gross income, similar to the gross salary appearing in a paycheck of an employee, that is before various taxes and other deductions are taken out. |
INDIRECT BUSINESS TAXES
Indirect business taxes are all the various sales and excise
taxes.
PERSONAL INCOME
Personal income (PI) equals national income net of transfer
payments. Transfer payments added to national income are: social
security and pension payments, welfare and unemployment
payments. Transfer payments deducted from national income are:
social security contributions, undistributed corporate profits
and corporate income taxes.
TRANSFER PAYMENTS
Transfer payments are additions and subtractions to national
income to obtain personal income. Additions include social
security retirement payments, unemployment benefits and welfare
payments. Subtractions include social security contributions,
corporate income taxes and undistributed corporate profits.
DISPOSABLE INCOME
Disposable income (DI) equals personal income less personal
income taxes. Disposable income is distributed between personal
consumption expenditure and saving.
REAL GDP
Real GDP is GDP adjusted for inflation (or change in value of
money). The unadjusted GDP is known as nominal or current GDP.
The adjustment consists in dividing current GDP by a price index
(also known as a deflator).
GNP adjusted for inflation is said to be real in the same way as what a paycheck can buy in various goods and services, is the real purchasing power of that salary. |
PRICE INDEX
A price index is constructed by taking the weighted average of
the prices of a basket of goods in a given year divided by the
weighted average of the prices of the same basket in a base
year. A well known price index is the consumer price index or
CPI.
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