Topic 2: National Income Accounting and GDP

Question 1

Gross Domestic Product

GDP

Answer 1

Most common measure for economic activity–not well-being
GDP affects a country’s well-being but it is an imperfect measure of a country’s well-being

Accounting rules
- National Income and Product Accounts (NIPA) used by the United States System of National Accounts used by the United Nations
– country comparisons

GDP: “domestic” based on geography

Question 2

Three Approaches to Measure GDP

Answer 2

Identical monetary value for GDP but different insights about economy’s structure:

1. Product
2. Expenditure
3. Income

Insights include:

• Mix of economic activities (agriculture, production, services, etc.)
• Enjoyment of goods and services and international trade

Question 3

Product Approach

Answer 3

SUPPLY SIDE
Focus on production activities in economy

DEF:
GDP is the market value of all final goods, services, and inventories newly produced within a country during a given period of time

Question 4

Product Approach shortcomings

Answer 4

1. misses non-market activities (home production, shadow economy)
2. misses externalities - environmental and health qualities, does not capture portions of well-being
3. misses depletion of natural resources - sustainability - depletion of natural wealth (asset vs. income from asset)
4. Good provision and services provided by government based on cost (it can over or under estimate)

• Final goods, services, and inventories implies only “value added” in the specific period - does not include interdiate goods such as hard drives
• Newly produced excludes previous economic activity
  ( Building and renovation of house but not buying house or activities for selling inventories but not inventories themselves Example: Car produced in 2019 but sold in 2020)
• Within country - focuses on economic activities in the geographical boundaries and ignores origin of factors of production (labor, capital, etc.)

Question 5

Gross National Product

GNP

Answer 5

“national” based on ownership of inputs

Example: international workers and multinational firms

• GDP represents output produced within a country, while GNP represents output produced by a country’s factors of production; the difference is net factor payments from abroad

For the United States there’s little difference, but for countries that have many citizens working abroad, there may be a big difference – i.e., GDP < GNP.

For countries that attract a lot of foreign direct investment
the effect would be reversed – i.e., GDP > GNP.

Question 6

Net Factor Payments

NFP

Answer 6

Net factor payments (NFP) are the difference between domestic income realized abroad and foreign income realized domestically

NFP=GNP−GDP

NFP > 0: more income flowing in (Turkey, Egypt)
NFP < 0: more income flowing out (Ireland)

Question 7

Net Domestic Product

NDP

Answer 7

Net domestic product (NDP) is the difference between GDP and depreciation of capital

Better measurement but challenges to agree on depreciation rates across countries (differences in capital, tax policies, etc.)

Question 8

Expenditure Approach

Answer 8

DEMAND SIDE:

• Focus on use of economic output in economy
• GDP is the total spending on all final goods and services produced within a national economy during a fixed period of time
• Spending by households, firms, governments (and other countries)

KEY ELEMENTS:
-CONSUMPTION of goods and services by domestic households, including Imports

• INVESTMENT by firms for capital goods, all construction of housing, andfirms’ inventoriesI
• GOVT spending is in exchange for goods and services (local, state, federal), excluding transfers
• NET EXPORTS are the difference between exports and imports

Question 9

Income Approach

Answer 9

Focus on distribution of income in economy

“GDP is the income generated within a national economy during a fixed period of time.”

Income in various sources:

Compensation of employees (with benefits)
Net interest
Proprietors’ income
Business current transfer payments
Rental income of persons
Current surplus of government enterprises
Corporate profits
Taxes on production and imports.

Question 10

Flow vs Stock

Answer 10

GDP is a flow variable

Flow variable is measured per unit of time (period)
ex: Income, saving, consumption, investment, exports, imports, inflation, taxes

Stock variable is measured at a point in time (date)
ex: Wealth, capital, employment, prices, price levels, tax rates

Question 11

Economic Growth

Answer 11

Growth rates are used to evaluate changes in economic activity and GDP over time

• Comparison across two time periods (years, quarters, months)
• Economic growth rate (relative change in GDP) eliminates level and currency differences

Logarithmic transformations are used to linearize GDP data, which simplifies the illustration of growth
rates and for different countries.

Question 12

Nominal GDP vs Real GDP

Answer 12

NOMINAL
- Uses current period’s prices and current period’s quantities
- Nominal GDP is computed using current prices and changes because of variations in both quantities and
prices.

REAL

• Uses base period’s prices and current period’s quantities
• Base year is a choice – suppose 2017?
• Real GDP is computed using constant prices and changes because of variations in quantities only

OVERALL
GDP growth rates can be transformed from shorter time intervals to longer time intervals or from longer
intervals to shorter intervals

Question 13

Exchange Rates

Answer 13

Market currency exchange rates or PPP exchange rates are used to compare economic activity across
countries

• Exchange rates are used to classify countries into different income groups
• Exchange rates allow for transformation

Types:

• Market for currencies
• Market for goods and services

Question 14

PPP

Answer 14

Purchasing Power Parity (PPP)

• Basket of goods and services and is the local price of an item
• PPP is used to compare the standard of living in different countries