Midterm Topic 2 Flashcards
National Income Accounting
framework that is used to measure current economic activity
Challenges and solutions to economic activities
- common measures for different activities (solution: transforming economic activities into monetary values)
- common measurement across time (solution: adjustment in the baskets of goods and services that are used to measure economic activities)
- common measurement for different countries (solution: exchange rates)
- mismeasurement for economic activities in home production, other unmeasurable labor (solution: estimate size of informal sector/report time in home production)
Fundamental Identity of National Accounting
three alternative approaches of measuring economic activity in a national economy (product approach, income approach and expenditure approach) all provide an identical GDP value. However, each approach provides a different insight for the structure of the economy and its economic activities.
Product approach
amount of output produced (also “value added”) –“supply side”
Over a long period of time, the product approach is perceived as advantageous,
Expenditure approach
the amount of spending by purchases (consumers, producers, government, other countries)–“demand side”
Income apporach
the incomes generated by production (labor income, capital income, taxes)
GDP (product approach)
Gross Domestic Product–market value of all final goods, services, and inventories newly produced within a national economy during a fixed period of time.
Shortcomings of market value (observed prices for goods and services)
It affects a country’s well-being but it is an imperfect measure of a country’s wellbeing:
- misses non-market activities
- misses the value of environmental quality and health (GDP only one factor of many to describe ‘wellbeing’ and ‘quality of life’)
- does not account for resource depletion (reduction in the ‘natural’ wealth of a nation
- government services are valued according to production needs.
Newly produced
only goods and services produced in the specific period are counted. Past economic activity is ignored; only looks at what economic value has been added during the time period of interest.
final goods and services
not intermediate goods (goods used up to produce final goods and not included in GDP). [Capital goods are final goods, not used up in a given period and provide input for multiple periods]
inventories
unsold finished goods and include ‘goods in process’ (intermediate goods that are turned into final goods in the future) and raw materials.
Gross National Product (GNP)
measures the market value of all final goods and services newly produced by a country’s national citizens and firms during a fixed period of time.
Formula for GDP and GNP
GDP = GNP - NFP
Net factor payments
difference between the payments to domestically owned factors located abroad (income realized abroad by nationals) and the payments to foreign factors located domestically (income realized domestically by foreigners). If NFP > 0, domestic factors earn relatively more abroad than foreign factors in the economy.
GDP (income approach)
income generated within a national economy during a fixed period of time.
GDP (expenditure approach)
GDP is the total spending on all final goods and services produced within a national economy during a fixed period of time.
income expenditure equality
Y = C + I + G + NX [NX = X - IM]
[left hand side illustrates supply (production) of goods and services and right hand side describes the demand for goods and services]
Consumption
spending by domestic households including those produced abroad. includes durable goods (cars, electronics), nondurable goods (food, clothing), and services (transportation, health).
investment
spending for new capital goods plus inventory investments. includes business fixed investments of equipment, etc., residential construction, firms’ inventory holdings and raw materials.
Government Purchases
expenditures by local, state, and federal governments in exchange for goods and services. transfer payments (Social security, welfare programs, etc.) are not included.
exports
goods produced in the country that are purchased by foreigners
imports
goods produced abroad that are purchased by nationals.
net exports
difference between exports and imports (X - IM)
net domestic product (NDP)
gross domestic product minus depreciation
NDP = GDP - Depreciation
Depreciation
value of capital that wears out over the specific time period
flow variable
measured per unit of time–take place over a given time interval (days, months, quarters, years) and cannot be measured a specific point in time (now, today, tomorrow). (include GDP, investment, savings, income)
stock variable
measured at a given point in time (i.e. capital, wealth, employment, account balances).
nominal GDP
calculated with current prices and current quantities of the time period
real GDP
calculated with prices of a defined base year and current quantities of the time period
price and growth illusion
when GDP increases, but prices are also increasing, it’s hard to tell whether economic activities are driving the growth of increased prices are. (why real GDP is used)
exchange rates: currency market
disadvantage is that rates fluctuate over time because of monetary and fiscal policies as well as short term speculation in currency markets
used to classify countries into different income groups
exchange rates: international trade
goods and services that are traded internationally (i.e. amount of money needed to import a car from Europe in comparison with two currencies). Challenge: emphasizes goods and services that are traded internationally and underestimate goods not traded internationally.
exchange rates: Purchasing Power Parity
using a basket of goods and services that includes relevant goods and services. (define a basket, estimate expenditures for each country of the basket, calculate exchange rate: PPP(AB) = PA / PB
provides more stable assessment of economic activities and reduces bias of non-traded goods.
used to compare the standard of living in different countries.
Why log?
GDP as an exponential path. Log of GDP can approximate exponential growth path with changing slope with a changing slope as a linear growth path with a constant slope. (Logs linearize GDP data)
GDP: axis shows absolute GDP value, slope shows absolute change in GDP.
Log of GDP: axis shows base value for GDP, slope shows relative change in GDP (as percent value)
Another advantage: it simplifies the illustration of GDP for countries that differ in absolute values. easier to compare countries with high and small absolute values.
growth rates
used to evaluate changes in economic activity over time.
