Macroeconomics Essentials: National Income Accounting, GDP and Economic Models

National Income Accounting

National income accounts: an accounting framework measuring current economic activity based on the amount of economic activity that occurs during a period of time, which can be measured in terms of the amount of output produced, income received by producers of output, and the amount of spending by the ultimate purchasers of output.

Product approach: measures economic activity by adding the market values of goods and services produced, excluding any goods and services used in intermediate stages of production. The value added is the value of its outputs minus the value of the inputs it purchases from other producers.

Income approach: measures economic activity by adding all income received by producers of output.

Expenditure approach: measures activity by adding the amount spent by all ultimate users of output.

The three approaches are equivalent: they must always give the same answer. The market value of a good and the spending on that good are always the same, so the product and expenditure approaches must give the same measure. Total expenditure must equal total income generated.

Gross Domestic Product (GDP)

Product approach measures GDP: GDP is the market value of final goods newly produced within a nation during a fixed period of time.

Market value: goods are counted in GDP at their market values, at the price at which they are sold.

Newly produced goods: GDP includes only goods that are newly produced within the current period, and excludes purchases or sales of goods that were produced in previous years.

Final goods: goods that are not intermediate goods and are the end products of a process.

Intermediate goods: those used in the production of other goods in the same period that they were produced.

GNP: the market value of final goods newly produced by domestic factors of production during the current period.

Expenditure approach: measures GDP as the total spending on final goods produced within a nation during a specific period of time.

Components of GDP

Categories: C, I, G, and NX. Y = C + I + G + NX (income-expenditure identity).

Consumption: spending by domestic households on final goods, including those produced abroad. Can be durable, nondurable, and services.

Investment: includes new capital goods and increases in firms' inventory holdings.

Three differences between investment and capital: replacement goods replace all goods; net fixed capital and inventory.

Fixed investment has two components:

• Residential investment: construction of new houses and buildings.
• Business fixed investment: spending by businesses on structures and equipment.

Government: spending on goods and services to provide public services, which includes any expenditure by a government for a currently produced good or service, foreign or domestic.

Net exports: exports minus imports. Goods produced within a country that are purchased by foreigners; imports are goods produced abroad that are purchased.

Income approach: calculates GDP by adding all incomes received by producers, including profits and taxes. National income is the sum of compensation of employees, corporate profits, rental income of persons, proprietors' income, net interest, current surpluses, and current transfer payments. Also describe other items.

Statistical discrepancy: data on income are compiled from different sources than data on production.

Depreciation: the value of capital that wears out during the period over which economic activity is being measured.

Real GDP: an economic variable measured by prices of a base year as a real variable. Real GDP measures the physical volume of an economy's final production using the prices of a base year. Nominal GDP is the dollar value of an economy's final output measured at current market prices.

Production and Labor Markets

Production function: inputs of a production process, two main factors: labor and capital. Y = AF(K, N).

Marginal product of labor (MPN): additional output produced by each additional unit of labor.

Supply shocks: change in an economy's production function.

Factors that shift the labor demand curve: changes in a real wage are represented as movements along a labor demand curve. Changes in real wage don't cause a labor curve to shift, but it shifts when responses to factors change the amount of labor that firms want to employ at any given level of real wage. A supply shock shifts the MPN curve upward or to the right.

Aggregate labor demand: sum of all the labor demands of all the firms in an economy. The factors that determine the aggregate demand for labor are the same as for individual firms.

Supply of labor: determined by individuals or members of a family making a joint decision. Aggregate supply of labor is the sum of the labor supplied by everyone in an economy.

Real wages and labor supply: real wage is the amount of real income that a worker receives in exchange for giving up one unit of leisure. The tendency of workers to supply more labor in response to a higher reward is called the substitution effect of a higher real wage. The tendency of workers to supply less labor in response to becoming wealthier is the income effect of a higher real wage.

Labor supply curve: any factor that changes the amount of labor at a given level of the current real wage shifts the labor supply curve.

Labor market equilibrium: requires that aggregate quantity of labor demanded equal aggregate quantity of labor supplied.

Equilibrium level of employment: is achieved after complete adjustment of wages and prices, known as the full employment level of employment.

Full employment output: level of output that firms in an economy supply when wages and prices have fully adjusted.

Unemployment

Measuring unemployment: employed, unemployed, and not in the labor force.

Discouraged workers: people who have become discouraged by lack of success at finding a job and stop searching. Other unemployed workers leave the labor force to enroll in some activity outside the labor market.

How long are people unemployed? The period of time that an individual is continuously unemployed is called an unemployment spell. The length of that time that an unemployment spell lasts is called duration. Most unemployment spells are short in duration, two months or less.

Frictional unemployment: unemployment that arises as workers search for suitable jobs and firms search for suitable workers. There are enough jobs in an economy, but companies can't find the right workers, an increase in young people entering the labor market, the problem of frictional search and discovery.

Structural unemployment: different circumstances in an economy that are reducing traditional jobs, technical changes in a sector of the economy. People who have lost their jobs aren't prepared to get a new job (long-run problem). The long-term and chronic unemployment that exists even when the economy isn't in recession is called structural unemployment.

Natural rate of unemployment: quantity of people who can't find a job due to the circumstances of the economy. The rate of unemployment that prevails when output and employment are at full-employment level, reflecting unemployment owing to frictional and structural causes.

Okun's law: the gap between an economy's full-employment output and its level of output increases by 2 percentage points for each percentage point the unemployment rate increases.

Consumption and Saving

Effect of changes in income: current income is an important factor affecting consumption and saving. MPC: fraction of additional current income that is consumed in the current period.

Effect of changes in future income: today's decision can depend not only on current income, but also on the income that one expects to earn in the future.

Change in real interest rate: we hold the real interest rate fixed when we examined the effects of changes in current income, expected future income, and wealth.

Desired capital stock: amount of capital that allows a company to earn the largest expected profit. Managers can determine the profit-maximizing level of the capital stock by comparing the cost and benefits of using additional capital. The benefit of having an additional unit of capital is the marginal product of capital, MPK.

User cost of capital (U.C.): expected real cost of using a unit of capital for a specified period of time.

Goods market equilibrium: the goods market is in equilibrium when the aggregate quantity of goods supplied equals the aggregate quantity of goods demanded. Y = C^d + I^d + G.

Solow model: examines an economy as it evolves over time. In order to analyze the effects of labor force growth as well as changes in K, we assume that the population is growing and that at any particular time a fixed share of the population is of working age. We assume that population and work force grow at a fixed rate n.

Steady state: situation in which the economy's output per worker, consumption per worker and capital stock per worker are constant.

Increase in population: workers are entering the labor force more rapidly than before. These new workers must be equipped with capital. Thus, to maintain the same steady-state capital-labor ratio, the amount of investment per current member of the work force must rise. Per capita capital will decrease and the Solow model suggests that we increase our capital to maintain equilibrium between population and capital.

Global productivity: Cobb-Douglas: a particular form of the production function. It is widely used because it has many attractive characteristics.

Permanent income theory: income should affect consumption only through the PVLR. Thus permanent changes in income, lasting for many periods, may have much larger effects on C than temporary changes in income. As a result, temporary income increases would be mostly saved, and permanent income increases would be mostly consumed.

Three reasons to save:

• Life-cycle saving (Modigliani): significant part of saving is intended to pay for retirement. However, it doesn't reflect other important aspects of a consumer's lifetime I and C patterns. Income is changing constantly, so we have to smooth our C.
• Bequest: consumer plans to spend all of his wealth and income during his lifetime, leaving nothing to heirs. In reality, many people leave bequests to children, charities, and so on. To the extent that consumers desire to leave bequests, they will consume less and save more than when they simply consume all their resources during their lifetimes.
• Ricardian equivalence: changes in income or wealth affect desired consumption only to the extent that they affect the consumer's PVLR. Holding current and future government purchases constant, a change in current taxes doesn't affect the consumer's PVLR and thus shouldn't affect desired consumption or desired national saving. Maintain welfare in the future, cover dissaving in the future.

Money and Monetary Policy

Money: assets that are widely used and accepted as payment.

Functions:

• Medium of exchange: money permits people to trade at less cost in time and effort, also raises productivity and allows people to specialize.
• Unit of account: basic unit for measuring economic value.
• Store of value: way of holding wealth.

Monetary aggregates: because assets differ in their "moneyness," a single measure of money in an economy is likely to be completely satisfactory. For this reason, in many countries economists use several different measures of the money stock. In the USA, two monetary aggregates are M1 and M2. M1 is based on currency and balances held in checking accounts. M2 is M1 plus other assets such as savings deposits.

Money supply: amount of money available in an economy. The supplier is the central bank.

• 1st goal, social goal: to maintain stable general price level steady over time.
• 2nd goal: to improve the results of the activity.

Expected return: rate of return an asset is the rate of increase in its value per unit of time.

Risk: uncertainty about return an asset will earn.

Liquidity: capacity of an asset to be exchanged for goods, services, and so on. Because it is accepted directly in payment, money is a highly liquid asset.

Time to maturity: period of time in which the asset is finishing its return and the value.

Demand for money: quantity of monetary assets that people choose to hold in their portfolios. Will depend on expected return, risk, liquidity and time to maturity of money and other assets. M^d = P * L(Y, i).

Fisher equation: relationship between inflation and both real and nominal interest rate. Money only affects price. Change in money with any change in V, P or Q makes change in price.

Price index: measure of the average level of prices for some specified set of goods and services.

Consumer price index: measures prices of consumer goods.

Interest rate: rate of return promised by a borrower to a lender.

Real interest rate: on an asset is the rate at which the real value of the asset increases over time.

Consumption and saving: an individual's decision about how much to consume is closely linked to another important economic decision, how much to save. In microeconomics we focused on the aggregate levels of consumption and saving. We define a national level of desired consumption, the aggregate quantity of goods and services that households want to consume. This level is obtained by adding the desired consumption of all households.

Price Indices and Inflation

P.I:

1. Total base year: Σq × p: m.v.
2. q × p of 1st year in total × 100 = w.
3. PI = (Σw × p / Σw × P(base year)) × 100.

Inflation rate: 1st year = base year. 2nd: ((P.I actual − P.I prior) / P.I prior) × 100 = %.

Real GDP: 1st year: MV = nominal GDP. 2nd: (MV actual / PI) × 100.

Growth rate: ((Real GDP − Real GDP last year) / Real GDP last year) × 100.

GDP deflator: (MV / PI) × 100.

GDP: C + G + I + (X − M).

GDP income = Σ compensation of employees + proprietors' income + corporate income + rental income of persons + net interest + business current transfer payments + current surplus of government enterprises, discrepancy, depreciation, net factor payments.

GDP_mp: GDP_fc + T.

NDP: GDP − CFK.

GNP: GDP + NIFA.

NNP: NDP + NIFA.

MPN: MPN: number of abroad − number of arrival. MR = MP × P.