Topic 2 Flashcards
What are the national income accounts?
They are an accounting framework used in measuring current economic activity
What can economic activity be measured in terms of? (3)
The amount of output produced (Product approach)
The incomes received by the producers of output (Income approach)
The amount of spending by the ultimate purchases of output (Expenditure approach)
What is special about the three measurements of economic activity?
They give identical measurements of economic activity
How does the product approach measure economic activity?
By adding the market values of goods and services provided
What does the product approach exclude in its measurement?
Goods and services used in intermediate stages of production
What does the product approach make use of, and what is this?
The value-added concept- the value added of any producer is the value of its output minus the value of inputs it purchases from other producers
How does the income approach measure economic activity?
Adding all income received by producers’ output
What does the income approach include? (5)
Wage
Profits
Tax
Rent
Interest
What is GDP?
Gross domestic product - the total value of all final goods and services which are produced for the marketplace within a given period of time and within the nation’s borders
What does the product approach define GDP as?
The market value of final goods and services newly produced within a nation during a fixed period of time
To make 500 sheets of notebook paper, the stages of production have these costs:
1) Wood chips = £1
2) Raw paper = £1.50 (Paper mill)
3) Notebook paper = £2.25 (Office supplies manufacturer)
4) Notebook paper = £3.50 (Wholesaler)
5) Notebook paper = £5 (Retailer)
What is the addition to GDP?
1 + 0.5 + 0.75 + 1.25 + 1.5 = £5
This is the sum of all the value added between the stages of production
What are the advantages of using market values to measure GDP? (2)
Allows adding the production of different goods and services.
takes into account differences in relative economic performance
What are the disadvantages of using market values to measure GDP? (4)
Some useful goods and services are not sold in formal markets.
Non-monetary benefits, such as clean air, are not included.
Underground economy.
Government services provided do not pass through the market so they don’t have market values making it hard to estimate their values to use in GDP.
How is the underground economy accounted for in the product approach to calculating GDP?
They are partially incorporated in official GDP
What parts of the underground economy are incorporated in GDP? (2)
Legal activities hidden from the government, such as underrepresenting profits and avoiding tax.
Includes illegal activities, such as drug dealing
What does it mean that GDP only includes newly produced goods and services?
Only includes goods and services produced within their current period
What does it mean that GDP only includes final goods and services?
Goods and services that are used in intermediate stages of production are not included
So what are final goods and services?
Goods and services that are not intermediate and are products sold to its final user
What are capital goods?
Goods that itself produced and is used to produce other goods
What is gross national product?
The market value of final goods and services newly produced by domestic factors of production (can include labour and capital) during the current period
What is the difference between GDP and GNP? (2)
GDP is production taken place within a country.
Income earned abroad is included in GNP
What are net factor payments from abroad (NFP)?
Incomes paid to domestic factors of production by the rest of the world minus income paid to foreign factors of production by the domestic economy
What is the calculation of GDP using GNP and NFP?
GDP = GNP - NFP
What is net national product (NNP)?
Gross national product minus depreciation of capital
How does the expenditure approach measure GDP?
Measures the total spending on final goods and services produced within a nation during a specified time period
What four major categories are added together to calculate GDP via the expenditure approach?
Consumption
Investment
Government purchases
Net exports
How do you calculate the economy’s total output? (Y)?
Spending by buyers + Changes in firms’ inventory stocks
What is the income expenditure identity?
Y = C + I + G + X - IM
Why are imports deducted in the income expenditure identity?
To avoid double counting as they are included in consumption, government purchases, and investment.
What is included in investment in the income expenditure identity?
Unplanned changes in inventory stocks
How do you calculate aggregate demand (Yad)?
Yad = C + I^p + G + NX
What does aggregate demand not include?
Unplanned investment
Is aggregate demand a measure of GDP?
No, but it is used in the analysis of business cycles
What is consumption?
Spending by domestic households on final goods and services, including those produced abroad
How much of GDP does consumption account for?
Over two thirds
What does consumption exclude? (4)
Purchases of homes, land, used goods, and financial assets
What does consumption include? (3)
Rent on housing
Total value of housing services provided by owner occupied homes (estimates of how much the house can be rented for)
Adjusted to include an estimate of farm production retained for own consumption by farmers
What is private investment?
Includes both spending for new capital goods (planned), called fixed investments, and increases in firms’ inventory holdings, called inventory investment (unplanned)
What are the three components of private investment?
- (Planned) Business fixed investment (𝐼
𝑝): Purchases of capital goods by businesses; - Residential investment (planned): Purchases of new homes by households;
- Unplanned changes in business firms’ inventory stocks (𝐼
𝑢): Unplanned changes in stocks of unsold
goods by business firms.
To simplify analysis, what type of investment is included in the calculations of GDP?
ignore residential investment and planned changes in inventory stock
I = I^p + I^u
What percentage of GDP is investment?
13%-20%
How do you calculate net private investment?
Gross private investment - depreciation
What is private investment the rate of change of?
Private investment is the rate of change of the stock of capital.
I = dK/dt :
where K is the economy’s capital stock and t denotes time
What is government purchases?
Expenditure by the government for a currently produced good or service, foreign or domestic
Around what % of GDP is government purchases?
15%
What is excluded from government purcahses? (2)
Transfer payments, interest payments on national debt
What are the two components of government purchases?
Government investment and government consumption
How is government purchases different from government expenditure?
Government expenditure included transfer payments (TR)
What is net exports (NX)?
Exports minus imports
Why do we minus imports?
As otherwise there would be double counting as imports are included in consumption
What is the income approach to measuring GDP?
It is the aggregate income in the economy consisting of wages, profit, rent, and interest payments.
Alternatively, we can calculate after-profit tax where aggregate income is total wages plus total profit plus taxes.
What is a key part of the income approach to measure GDP?
National income
Nothing
Nothing
What is income from the private sector known as?
Private disposable income
What is the equation for private disposable income (Ypvt)?
Ypvt = Y + NFP + INT + TR - T
Y = GDP
NFP = Net factor payments
INT = Interest from government
TR = Transfers received from government
T = Taxes
What is the equation for net government income (Ygvt)?
Ygvt = T - TR - INT
What does Ygvt + Ypvt equal?
= Y + NFP
What are stock variables?
Variables representing a quantity at a moment in time
What are flow variables?
Variables representing a process that takes place over a given period
What is wealth?
The value of asses minus the value of liabilities
How do you calculate saving rate?
Saving / income
What is private saving?
Saving of the private sector
What does private saving equal?
Private disposable income - consumption
Why is investment not subtracted in private saving even though it is in private sector spending?
Capital goods enhance future productive capacity rather than satisfy current needs
How do you calculate private saving rate?
Private saving / private disposable income
Write the short and long equation of Spvt
Spvt = Ypvt - C
Spvt = Y + NFP + TR + INT - T - C
What is government saving defined as?
Net government income - government purchases
What is the long and short equation of calculating Sgvt?
For simplicity, what does G in this equation only include?
Sgvt = Ygvt - G
Sgvt = T - TR - INT - G
Only government consumption, not government investment.
How do you calculate national saving?
National saving = Private saving + government saving
What is the equation of national saving? (2)
S = Y + NFP - C - G
S = I + NX + NFP
In the case of a closed economy, what is the equation of national saving?
S = Y - C - G
What is private saving used for?
Used to fund new capital investment, provide the resources the government needs to finance its budget deficits, and acquire assets from or lend to foreigners.
What does the current account balance equal?
Payments received from abroad in exchange for currently produced goods and services, minus the analogous payments made to foreigners by the domestic economy
What is the current account comprised of? (3)
Net exports of goods and services
Net income from abroad
Net unilateral transfers (NUT)
Why can we substitute CA into the national saving equation?
As the equation contains the terms NX and NFP, for simplicity we do not include NUT.
S = I + CA
What happens if we subtract Sgvt from S = I + CA?
Spvt = I + (-Sgvt) + CA
Where -Sgvt is the government budget deficit
What is the equation Spvt = I + (-Sgvt) + CA called?
The uses of saving identity
What does the uses of saving identity state?
It states that an economy’s private saving is used in three ways:
- Investment
- The government budget deficit
- The current account balance CA
What is the link between private saving and the current account?
The (home) current account balance (CA). When the (home) CA is positive foreigners borrow from home private savers to finance their payments to the home country. When the (home) CA is negative, the home economy borrows from the foreign ones to cover the excess of payments made to foreign
residents over the payments received from abroad.
What is national wealth?
National wealth is the total wealth of the residents of a country
What two parts does national wealth consist of?
The country’s domestic physical assets.
Net foreign assets.
Why are domestic financial assets held by domestic residents not apart of national wealth?
Because the value of any domestic financial asset is offset by a domestic financial liability.
In what two ways can national wealth change in two ways over time?
The value of existing assets or liabilities changing.
National saving
How does acquiring foreign assets work?
When a home resident buys a foreign financial asset, they lend to a foreign country.
The financial asset is an entitlement to a future claim; thus, national wealth increases.
What are nominal variables?
Nominal variables are measured in terms of current market values
What is an advantage of using market values to measure economic activity?
It allows summing of different types of goods and services
What is the disadvantage of using nominal values?
When measuring a variable over time there will be changes in price
What are real variables?
Economic variables that are measured by prices of a base year.
What does real GDP measure?
The physical volume of an economy’s final production using the prices of a base year
How is nominal GDP and real GDP denoted?
Nominal GDP is $Yt
Real GDP is Yt
What are the two ways to calculate real GDP in terms on index numbers?
Using a base year as an index.
Using the GDP price index/ GDP deflator
How do you calculate a real value in t using a price index?
(Nominal value in t / price index in t) x 100
What is a GDP deflator?
A measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.
How do you calculate the GDP deflator?
GDP deflator = [Nominal GDP / Real GDP] x 100
What are the differences between the CPI and the GDP price index? (2)
a. The GDP price index must also include the prices of goods purchased by the government, investment goods purchased by businesses, and exports, which are purchased by foreigners.
b. The GDP price index leaves out prices of used goods and imports, both of which are included in the CPI.
How is the consumer price index calculated?
CPI calculated by sending people out each month to find prices of a common basket of consumers goods and services.
CPI = (Cost of basket that month x 100) / Cost of basket in reference-based period
How do you construct real GDP using the chained $ method?
Look at slides/ macro core concepts
Look for all ways to calculate real GDP
What is an advantage of the chained $ method of constructing real GDP?
it produces growth rates of real GDP that are invariable to the choice of base period.
What is a price index?
A measure of the average level of prices
How do you calculate an index number?
It = [Value of measure in period t / Value of measure in base period] x 100
What is the inflation rate?
Inflation rate is the percentage rate of increase in the price index per period.
What is the price level P?
Price level (P) is the average level of prices in the economy (measured wither by the CPI or the GDP deflator)
How do you calculate the inflation rate (π)?
Change in price / Base price
What are the three uses of real GDP?
- In the SR sudden changes in real GDP can alert us to the onset of a recession or a too rapid expansion that can overheat the economy
- Real GDP per capita (yt) is used to measure LR growth rate of the economy’s output (g)
- Average standard of living as output per capital: real GDP divided by the population
How do you calculate real GDP per capita (yt)?
yt = Real GDP / Population
Outline the problems with GDP
- Quality changes
- The underground economy
- Nonmarket production
- Environmental quality and resource depletion
- Poverty and economic inequality
- Other aspects of economic wellbeing
Why does GDP work well in determining the economic performance the SR?
The distortion in GDP measurement caused by each of the aforementioned problems is likely
to remain fairly constant from quarter to quarter
Is GDP per capita a good index of development?
We do not discredit human development, but we must take per capita income very
seriously.
Read slides
How do you calculate real GDP if you have prices and quantities from the base year and the year after?
Real GDP(t+1) = Quantities from (t+1) x price from (t)
How do you calculate the inflation rate from two deflator values from consecutive years?
Inflation rate = [(Deflator(t+1) - Deflator(t)) / Deflator(t)] x 100
What is the concept of present value?
£1 paid to you from one year from today is les valuable than the £1 paid tou you today
What is the principal when referring to a debt instrument?
The principal is the initial size of the debt
When is a debt paid back to the lender?
At the maturity date
When a loan is issued, what must the borrower pay back?
The principal at the maturity date and interest is paid
How do you calculate the interest rate for a one year period?
Interest paid / principal
How do you calculate the future value of a single cash flow?
FV = CF x (1+ r)^n
How do we calculate present value of a single cash flow?
PV = CF / (1 + r)^n
What is a coupon bond?
A coupon bond pays the owner of the bond a fixed interest payment every year until the maturity date, when a par value of the bond is repaid
What is a perpetuity bond?
A bond with no maturity date and no repayment of principal
What is a discount bond?
A bond that is bought at a price below par value and is repaid at maturity date
Does a discount bond pay interest?
No, it just pays off he face value at the maturity date
What is the yield to maturity?
It is the interest rate that equates the present value of all cash flow payments received from a bond with its value at the market today (Pb)
How do you calculate the yield to maturity (r) of a discount bond?
Pb = Face value (F) / (1 + r)^n
What is the relationship between price a yield?
They are negatively related
What is a nominal interest rate?
An interest rate where inflation is not accounted for
What is a real interest rate?
The rate at which the real value of an interest-bearing asset changes over time
How do we calculate the real asset value?
Real asset value = Nominal asset value / Price level
If you let z = x*y, what approximation holds true?
%Δ z = %Δ x + %Δ y
Assume that w = x / y , what is an approximation of the growth rate?
%Δ w = %Δ x - %Δ y
How do you calculate the real interest rate using an approximation?
What is this equation called?
Real interest rate = nominal interest rate - inflation rate
The Fisher equation
What are borrowing and lending decisions based on?
The expected or ex ante real interest rate (r^e); this is the nominal interest minus the expected inflation rate (π^e)
What is the fisher equation for expected interest rate?
r^e = i - π^e
What is the ex-post interest rate (r)?
The interest rate that is adjusted for actual chnages in the price level
What is the Fisher equation for the ex-post interest rate?
r = i - π
What is most interest income subject to?
Income taxes
How do you calculate after-tax real interest rates?
r = i(1 - t) - π^e
