(1) National Income Accounting

Question 1

What is the definition of Gross National Product (GNP) ?

Answer 1

The value of all final goods and services produced by the country’s factors of production and sold on the market in a given time period.

Question 2

What are the Factors of Production?

Answer 2

1. Land
2. Labour
3. Physical Capital

Question 3

What two things are not counted in Gross National Product (GNP)?

Answer 3

1. Intermediate Goods which are products used as input in the production of final goods, are not counted in Gross National Product.

This is to avoid double counting, only the value of final goods are counted in GNP.

2. Used Goods are not counted in GNP, as these would have been counted in GNP when first sold.

Question 4

What is the equation for GNP ?

Answer 4

GNP= C+I+G

Question 5

What is the definition of Consumption?

Answer 5

The amount consumed by private household/private sector to fulfil current wants.

Question 6

What is the size of the component Consumption?

Answer 6

For the last 70 years, US consumption fluctuated around 62 to 70% of GNP.

(Tends to be the biggest component of GNP)

Question 7

What is the definition of Investment?

Answer 7

The amount put aside by private firms to build new plant and equipment for future production/future output e.g factories or inventory stock.

Question 8

What is not the economic term for Investment?

Answer 8

Investments are NOT stocks, bonds or real estate.

Question 9

What is the size of the component Investment?

Answer 9

Investment is a more volatile component and fluctuates between 11-22% of GNP.

Question 10

What is the definition of Government Purchases?

Answer 10

The amount used by the government for consumption and investment purchases.

Question 11

What is not included in Government Purchases?

Answer 11

Transfer payments, are not included in Government Purchases as recipients of transfer payments do not provide goods and services back to the government.

Recipients use money for consumption and will be counted there.

Question 12

What is the size of the component Government Purchases?

Answer 12

Government Purchases are around 20% of US GNP.

Question 13

What is the definition of the Current Account Balance?

Answer 13

The amount of net exports of goods and services to foreigners.

Question 14

What is the importance of the Fourfold classification of GNP ( C, I, G, CA) ?

Answer 14

1. Knowing how the major categories of spending have changed may help make clear the cause of a recession or boom.
2. Thus, understanding helps provide sound policy response
3. Explains why some countries have a high level of GNP relative to population size ( rich ) whilst others are poor

Question 15

What is the definition of GDP ?

Answer 15

Total value of output produced within a country’s borders.

Question 16

How does GNP and GDP differ?

Answer 16

1. GNP corrects for for citizenship of ownership (whether it is domestic or foreign ownership) of the factors of production.
2. GDP does not correct for citizenship of ownership of factors of production.

Question 17

Classify what counts towards UK GDP/GNP and French GDP/GNP when a French Company operates in the UK ?

Answer 17

A French factory producing in the UK , would add to the UK GDP but would not add to the UK GNP. It would add to the French GNP but not the French GDP.

Question 18

What is the equation for GDP ?

Answer 18

GDP= GNP- net receipts of factor income from the rest of the world

Question 19

What is definition for Net Receipts of Factor Income from the Rest of the World?

Answer 19

Net Receipts are primarily : The income domestic residents earn on wealth they hold in other countries - the payments domestic residents make to foreign owners of wealth that is located in the domestic country.

Question 20

What type of economy

a. Small Open Economy

or

b. Big Closed Economy

is GNP more of an important measure?

Answer 20

In bigger economies such as the US tend to be closed economies and trade is less important to overall production hence GNP is a more important measure although , GNP and GDP are similar.

Question 21

What type of economy

a. Small Open Economy

or

b. Big Closed Economy

is GDP more of an important measure?

Answer 21

However, in smaller open economies, GDP and GNP difference can be significant . as this economies have more FDI which means foreign owned factors of production which would add to the domestic GDP but not GNP. Therefore, for smaller economies focus on GDP is more important.

Question 22

What is the definition of National Income ?

Answer 22

The income earned in that period by its factors of production.

Question 23

What is the equation for National Income?

Answer 23

National Income= GNP - depreciation + net unilateral transfers

*Unilateral transfers of Income are part of a country’s income but not part of its product, so must be added in.

Question 24

What is the definition for Depreciation?

Answer 24

Economic loss due to the tendency of machinery and structures to wear out as they used , reduces income of capital owner.

Question 25

What is the definition for Unilateral Transfers of Income?

Answer 25

Gifts from residents of foreign countries e.g reparations, foreign aid. It is part of a country’s income but not part of its product.

Question 26

Why do we assume GNP=National Income?

Answer 26

The difference between GNP and National Income is by no means an insignificant amount.

However in macroeconomics, there is little to say about the difference and it is of little importance for macroeconomic analysis.

Therefore, for purposes of the text, National Income= GNP and will be used interchangeably, ( but in technically it is an identity (National Income ≡ GNP) and not an equality)

Therefore, due to assumptions

1. GNP a country generates over some time period must equal its national income.
2. The reason for equality is that money spent to purchase goods or services automatically ends up in someones pocket. For example if a doctors visit cost $75 ( raises GNP by $75) but the $75 dollars paid by a doctor raises his or her income (raises national income by $75)

Question 27

What is the National Income Identity in closed economy?

Answer 27

Y= C+I+ G

1. Y= GNP
2. C=Consumption
3. I=Investment,
4. G=Government Purchases

Assumed that all final goods or services are consumed or invested ( new plant, equipment or add to inventory) by the country’s citizens or purchased by its government.

Question 28

What is the National Income Identity in an Open Economy?

Answer 28

1. Y= C+I+ G+ EX - IM
   
   2. Y= C+I+ G+CA
   3. Y= A + CA
   4. Y= GNP
   5. C=Consumption
   6. I=Investment
   7. G=Government Purchases
   8. EX= Exports
   9. IM= Imports
   10. CA= Net Exports= Current Account Balance
   11. A = C+I +G = Domestic Absorption

In an open economy, goods and services can flow across national borders, so the GNP identity for open economies shows how the national income a country earns is divided between sales to domestic residents and sales to foreign residents. The value of imports must be subtracted from total domestic spending, while the value of exports must be added to it.

Question 29

What are Exports?

Answer 29

Goods or services produced in one country being sold in another country.

Question 30

What are Imports?

Answer 30

Goods bought from another country.

Question 31

Are Net Exports and Current Account exactly equal ?

Answer 31

Net Exports and Current Account balance are not exactly equal ( it is an identity in technicality), however net exports is the most important component of the Current Account Balance

Question 32

What is the equation for domestic absorption and what is the definition?

Answer 32

1. Equation: C+I+G

2. Definition : Domestic residents total spending

Question 33

What FOUR things that can be inferred when a country is running an Current Account Deficit?

Answer 33

1. Imports > Exports, countries imports spending> export earnings
2. Also means, a countries domestic expenditure (domestic absorption : C+I+G) exceeds output, therefore why importing a lot
3. A country can only finance their current account deficit by borrowing from foreign countries.
4. A country with a current account deficit must be increasing its net foreign debts by the amount of the deficit. Therefore, the net foreign asset position deteriorate.

Question 34

What FOUR things that can be inferred when a country is running an Current Account Surplus?

Answer 34

1. Exports > Imports, countries export earnings > import spending.
2. Also means, a countries output exceeds domestic expenditure (domestic absorption : C+I+G) , therefore why importing less.
3. A country finances the current account deficit of its trading partners by lending to them, foreign countries pay for imports not covered by exports by issuing IOUs which they will eventually have to redeem.
4. The net foreign wealth of a surplus country rises by the amount of the surplus . Therefore, the net foreign asset position improves.

Question 35

What is the equation and definition of Saving in a closed economy?

Answer 35

1. Equation: S= Y-C-G
   1. S= National Savings
   2. Y= Output
   3. C=Consumption
   4. G= Government Purchases
2. Definition: Savings are the portion of output not devoted to household consumption and government purchases.

Question 36

What is the relationship between Investment and National Savings in a closed economy?

Answer 36

1. The Equation of National Saving in a Closed Economy: S= Y-C-G
2. If you rearrange the identity, Investment too equals: I= Y-C-G
3. Therefore, S=I, (national saving must equal investment)
   
   1. For a firm to be able to invest, it needs savings to finance the investment.

Question 37

How can countries finance investment in a closed economy?

Answer 37

In a closed economy, countries can finance investment only by saving.

Question 38

What is the equation of saving in an Open Economy?

Answer 38

1. S=I+CA

Domestic investment and foreign investment are two different ways a country can use current account savings to increase future income

Thus, not all current account deficits are the same. Borrowing to improve one’s future may be very useful, while borrowing for pure consumption does not lead to tangible future benefits.

Question 39

How can countries finance investment in a open economy?

Answer 39

In open economies, countries can finance investment by savings or by acquiring foreign wealth.

Question 40

Explain how you can raise investment and foreign borrowing in an open economy by not changing saving?

Answer 40

It is possible to raise investment and foreign borrowing without changing saving. You can use imports materials from a foreign country and borrow foreign funds to pay for them. The transaction raises a countries current account deficit by an amount equal to the increase in investment. Therefore savings does not have to change, despite investment rises.

Question 41

What is Net Foreign Investment?

Answer 41

Current account surplus obtained by saving that funds another country investment is called Net Foreign Investment. When one country lends to another country to finance investment then part of the income generated by the investment in future years must be paid back to the lender.

Question 42

What is the equation and definition of Private Saving?

Answer 42

1. Equation : Sp=Y-T-C
   1. Y-T = Disposable income
   2. Y= National Income
   3. T= Net Taxes collected from households and firms by the government
   4. C= Consumption
2. Definition: Part of disposable income that is saved rather than consumed.

Question 43

What is the equation and definition of Public Saving?

Answer 43

1. SG = T-G
   1. T= Net Tax Revenue
   2. G= Government Purchases
2. Definition: Part of Tax Revenue that is saved rather than used for government purchases.

Question 44

How does Public Saving differ from Private Savings, which two policy objectives does Government want to achieve?

Answer 44

1. Government saving decisions are often made with an eye to achieve policy objectives

    1. Policy objectives 1:  Internal Balance: 
            - A situation in which the consumption in an economy roughly equals production. That is, external balance occurs when what is spent and what is produced in the economy are never too far from being even. Internal balance may be characterised by both full employment and low inflation,.
   
        2. Policy objectives 2:  External Balance: 
           - A situation of BALANCE OF PAYMENT EQUILIBRIUM that, over a number of years, results in a country spending and investing abroad no more than other countries spend and invest in it.

Question 45

How are National Saving, Private Saving and Public Saving linked?

Answer 45

1. Private Sector Saving + Government Saving = National Saving

    1. National Saving : S=Y-C-G
    2. S=Y-C-G=(Y-T-C)-(T-G)= Sp+ SG

Question 46

Rewrite the National Income Identity in the form that relates:
- Private Saving to Domestic Investment, Current account surplus and Government saving

Answer 46

1. S=Sp + SG =I + CA
   2. Sp= I + CA -SG
   3. Sp=I + CA-(T-G)
   4. Sp=I+CA+ (G-T)

Equation shows that Private Saving takes 3 forms:
1. I= Investment in Domestic Capital
2. CA= Purchase of Wealth from Foreigners
3. -(T-G) /(G-T)=Purchases of government’s newly issued debt/ Government Budget Deficit
-Government saving preceded by a minus sign.
-Government Budget Deficit measures the extent to
which government is borrowing to finance its expenditures.

Question 47

Explain the concept of Twin Deficits

Answer 47

Many people talk about government budget deficits and current account deficits as being twin deficits. The identity ( Sp=I+CA+ (G-T)) shows that there is indeed a relationship between the two. All else equal (for I and Sp), a reduced government budget deficit therefore should expect to see an increase in current account surplus as the result to the fiscal change by roughly the same amount.

Conversely, an increased government budget deficit therefore should expect to see a decrease in the current account surplus as the result to the fiscal change by roughly the same amount.

Question 48

What two reasons that explain why the Twin Deficit theory may not hold and instead have an offset effect?

Answer 48

Reasons why the Twin Deficit theory may not hold and instead have an offset effect
1. The Offset Effect: The case where Government Budget Deficit falls but Current Account Surplus remained about the same and shows little change

	1. Reason 1: When changes in the Government Deficits lead to bigger changes in Private Saving and Investment Behavior.  Ricardian Equivalence Theory of Taxes and Government Deficits argues governments lower their deficits through higher taxes thereby increasing  government saving will induce the private sector to lower its own saving. 

Conversely, when government cut taxes and raises it deficit, consumers anticipate that will face higher taxes later to pay off the resulting government debt. In anticipation they raise their own (private) saving to offset the fall in government saving.

	2.Reason 2: However Economist statistical data suggest that Ricardian equivalence does not hold exactly in practice . Most economist would attribute no more than half the decline in Case Study European Private Saving due to Ricardian effects. The lowering of private saving in Europe can be due to the values of European Financial Asset rising in the late 1990 which was fueled by optimism of the beneficial economic effects of the planned common currency.

Question 49

What type of economies may be effected by Twin Deficit?

Answer 49

Twin deficits can be a problem for emerging economies which need public sector investment thus government run large budget deficit to finance such as they have low level of saving and therefore suffer from current account deficits.

Question 50

Can it be fully determined the cause of current account change using the identity (Sp=I+CA+ (G-T) ?

Answer 50

Private Saving, Investment, The current Account, government deficit are jointly determined variables, we can never fully determine the cause of current account change using the identity above.

Nonetheless the identity provides an essential framework for thinking about the current account and can furnish useful clues. . But with the tool of the national accounting equation, we see that there are links between the variables. To be more definite about causes and welfare implications, we need to build more theoretical tools.