Supplementary notes on national income accounting

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Department
Economics
Course
ECON105
Professor
Stephen Hickson
Semester
Spring

Description
National Income Accounting These notes are designed to supplement the text for national income accounting (lectures 6 and 7). They allow you to fill in some of the gaps where the text lacks a bit of detail and we don’t cover this level of detail in class. The Factors of Production From picking apples off a tree to designing and building space stations, all production requires some effort and inputs. These inputs or ‘ingredients’ are classified according to general groupings known as the factors of production, which are: 1. Land This category includes land, along with all natural resources like the sea, animals, wind and other elements. 2. Labour Human effort, rewarded with wages and salaries. 3. Capital Goods which assist in the production of other goods and services. Examples of capital items are tractors, factories, computers, buildings and high tech industrial robots. 4. Entrepreneurship Human nous and skill at organising and managing the other factors of production. Output and Growth The most widely used and conventional measure of a country’s “economic size” or national output is Gross Domestic Product (GDP). GDP is the value of final goods and services produced in a country over a specified period of time; usually a quarter (3 months) or a year. Note the use of the word ‘final’ in the above definition. It would be considered double counting if we were to include in GDP both the price of a loaf of bread and the price of its ingredients to the baker and other producers. The market price of the loaf indicates the sum value throughout all its stages of production; from the costs of the seed for the farmer through to the retailer’s profit. Gross Domestic Product can be calculated in three ways: 1. The Income Approach Adds together all of the payments received by the factors of production which contribute to GDP. Factors of production are items which cause production to be possible, historically labelled as land, labour and capital. Land includes all natural resources, while capital is equipment, machinery and tools. Note that in economics, capital is not money or equity. In our subject, capital consists of physical goods which have been produced to assist in the production of other goods or services. Also, it is worthwhile noting that modern economists sometimes include a fourth factor of production, namely entrepreneurship. This is human intelligence, vision and skill at managing and combining the other factors of production. In addition to the returns to the factors of productions, two other items are included in the income approach to ensure that this method actually measures the market value of current production. Consumption of fixed capital is the technical term for depreciation. This must be added to the sum of incomes because the “gross” in GDP indicates that depreciation has not yet been deducted (if it has, then the resulting figure is net domestic product - NDP). Indirect taxes are added to incomes as well because these are included in market prices, but do not generate income for producers (but go the government instead). For the converse reason, subsidies are subtracted. Compensation of Employees (wages, salaries etc) + Operating surplus (profits) + Consumption of Fixed Capital (depreciation) + Indirect Taxes - Subsidies = GDP at market prices, income approach. 2. The Production Approach This technique aggregates together the values added at each stage of production. In New Zealand, around 70 production sectors are subject to these calculations. Each of these sectors makes a contribution to GDP. The sum total of these contributions gives GDP for the economy as a whole. By way of example, let’s return to the bread scenario alluded to earlier. The following figures are the values of gross output (which is the product’s dollar value as it leaves the industry) and intermediate consumption (the product’s dollar value as it enters the industry). Value added at each stage is simply the difference between gross output and intermediate consumption. Gross Output Intermediate Consumption Value Added Farmer (and prior) 30c 0c 30c Miller 70c 30c 40c Baker $1.00 70c 30c Retailer (GST incl.) $1.50c $1.00 50c Value Added (total): $1.50 Note that the value added calculation equals the price of the final product (i.e. the loaf of bread). This must be the case, and ensures consistency between the production approach and the third method, the expenditure approach. For NZ data, see Scollay and St John, p 85. 3. The Expenditure Approach Adding together the expenditures on New Zealand made goods and services also provides the country’s GDP. Forms of expenditure are categorised as follows: C Final Private Consumption Expenditure. I Investment. This is business spending on capital goods (such as buildings, equipment and machinery). G Government Spending on Goods and Services. Local and central government spending on g&s, like roads, street lights and state employees’ salaries. DOES NOT include benefits and handouts, which economists call ‘transfer payments’. This is because transfer payments are not actually purchasing goods or services. X Exports of goods and services. less M Imports of goods and services. By definition these are not produced here and so can not be considered to form part of NZ’s domestic production. ΔR Change in the Value of Inventories. This records the change in value of unsold stocks, raw machinery and work in progress (and, in NZ, the change in the value of exotic forests). These commodities, though not sold, have still been produced and hence should form part of GDP. So, from the expenditure approach: GDP = C + I + G + X - M + ΔR This is an important macroeconomic identity! Note also that the compound term X - M is referred to as net exports. In practice we will disregard ΔR as its value is small and can be positive or negative. To ponder: Economists define a state of equilibrium as a situation in which the quantity (or value) of goods and services produced is equal to the quantity (or value) of goods and services consumed. Therefore, macroeconomic equilibrium implies what for the term ΔR? New Zealand’s current level of GDP is about $140 billion, which translates to a per capita figure of about $42500. Related Measures of National Income Gross National Expenditure (GNE) Is the total of expenditure in New Zealand; so includes imports but not exports. GNE = C + I + G Gross National Income (GNI) Previously known as Gross National Product, (GNP), GNI is the total value of goods and services produced by New Zealanders, rather than in New Zealand which is what GDP measures. So GNI adds the overseas returns of NZ factors of production but excludes the returns earned in New Zealand of foreign factors of production. GNI = GDP + Factor Receipts from Rest of World - Factor Payments to Rest of World = GDP + Net Factor Receipts Factor receipts/ payments include wages and salaries, profits, interest and share dividends. A foreign entity, from NZ’s perspective, is defined as non New Zealand resident, be this a person or a company. New Zealand invariably has a negative balance on its net factor receipts because more residents of NZ send their income overseas than the reverse. Some countries, like the USA, have a positive net factor receipt balance. This means that their GNDI is larger than their GDP. Net Factor Receipts is also known by the term ‘net international investment income’. Shortcomings of GDP and its Related Measures GDP and the other measures of national income we have touched
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