Chapter 13: National Income Accounting and the Balance of Payments

National income accounting for open economy GNP = Value of all final goods & services (output) produced by a countrys factors of production and sold in a year = Market value of all expenditures on final output

Consumption by private domestic residents (c) GNP Investment by private firms (I) to increase stock of capital Government purchases (G) Current account balance (EX-IMP) net exports of output to foreigners Output = national income (NI)

Example: Doctors visit costs 75 75 is market value of the service provided 75 is also the income for the doctor

Note:

Second hand sales are not included in GNP since it does not generate income for any factor of production

Paper and ink used in the production of a book are not included in GNP, only the value of the final book (to prevent double counts)

GNP does not account for depreciation, although it lowers income of capital owners Gifts from or to abroad (= unilateral transfers) are not produced in the US, hence no output from national income

Taxes drive wedge between GNP and national income GNP overestimates NI.

Buying shares does not show up in GNP ( goods and services)

National income = GNP depreciation +unilateral transfers indirect taxes

not included in macro-economic analysis

Assumption: GNP National income Note: GDP = Gross Domestic Product = Volume of production within a countrys borders GNP = GDP + Net receipts of factor income from abroad Example: UK shareholders own factory in Spain Earning of Spanish factory in GDPspain
in GNPUK

Assumption:

GNP GDP

National Income Accounting Closed economy : Y = C + I + G Open economy : Y = C + I + G + EX IMP sales of output to domestic residents sales of output to foreign residents do not ad to GNP

Example: An economy produces 100 bushels of wheat produced and consumed by formers. Farmers consume 55 bushels and use 25 bushels to guarantee next years planting. The government buys ten bushels for the army and 10 bushels are exported. 20 bushels are used to pay for imports of 40 gallons of milk. Consumption (in terms of wheat) = (55 + 20) = 75 bushels Paid for the milk Investment = Export = Y= C +I 24 10 + G + EXP IMP Government spending = 10 (C)

(I) (G) (EXP)

100 = (55+20) + 25 + 10 + 10 - 20
Domestic spending

100

<

110

Only possible in open economy

Current account (CA) CA = EX IM > 0 Surplus < 0 Deficit Reflections of changes in output/employment Reflections of international borrowing Example: EXP :10 bushels IMP: 20 bushels Savings Closed economy: S = Y C G S=I Open economy: Y C G = I + CA S = I + CA
Domestic Investment Foreign Investment

CA- deficit: 10 bushels = Importing present consumption Exporting future consumption

An open economy can acquire wealth by building up Capital Stock (I) or by acquiring foreign wealth (CA > 0) In an open economy, one countrys savings can be borrowed by another country

Private saving Y-T = Yd = Disposable income after tax t collected from households and firms T goes to the government Closed-economy: YT=C+I+GT S = I = (Y-T)-C G + T SP + SG = SP + SG Open economy Y T = C + I + G T + CA S = I + CA = Y T C G + T SP + SG