National Income is income earned in productive activity by all the factors of production: compensation of employees and the earnings of capital (profits, rental income, proprietors’ income, and net interest earnings).
Basic Definitions and Concepts: The National Income and Product counts (NIPA) are a vast accounting scheme for aggregate economic activity. In the United States they are prepared by the Bureau of Economic Analysis (BEA) of the Department of Commerce.
The Formal Accounts: A wealth of further detail and additional accounting statements are available. These include the value-added accounts, detailed accounts for specific sectors, and breakdowns of economic activity by industry
- GDP (Gross Domestic Product): The total market value of all the goods and services produced within the borders of a nation during a specified period.
- GNP (Gross National Product): The total value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-residents located in that country.
- NNP (Net National Product): It is the total market value of all final goods and services produced by citizens of an economy during a given period of time Gross National Product or GNP minus depreciation.
- Depreciation: Depreciation (also known as consumption of fixed capital) measures the amount of GNP that must be spent on new capital goods to maintain the existing physical capital stock.
The Savings / Investment Identity
We now introduce the concept of Disposable Income (DI) which consists of resources available for spending by individuals. First, add income received by individuals, which is not included as income earned in production:
- GDP is the sum of product absorbed by the consumption (C), gross private domestic investment (I), government (G), and foreign sectors (X – M):
GDP = C + I + G + (X – M)
- The net absorption by the foreign sector is exports (X) less import (M), which are included in the expenditures of the domestic sectors.>
- GDP and NI are equivalent measures of aggregate activity except for the wedge that consists of net receipts of factor income from abroad (NR), depreciation allowances (CC), and indirect business taxes (IBT). That is:
GDP + NR – CC – IBT = NI
Second, subtract those parts of NI which are not received by individuals:
- (i)transfer payments from the government (TR) and
- interest paid on the government debt (INT).
The accounts defined above measured income and output at current prices. Since prices as well as quantities change over time, nominal GDP is not a useful measure of the level of economic activity or output. We need a real measure that holds price change constant. If the quantities of final goods and services produced in period t are denoted by Qit and their prices are Pit, then (nominal or current dollar) GDP is simply . Real GDP in period 0 prices would be calculated by making the same calculation with period 0 prices. Thus, real GDP is . The ratio of nominal GDP to real GDP is called the implicit price deflator.
A price index is generally defined as a weighted average of price relatives for the individual components of the index. The price relative is simply the ratio of the current price of the ith item (Pit)
to its price in the base period (Pio). Thus the value of the index in period t is
- retained earnings (RE) note that corporate profits are equal to retained earnings (RE) plus corporate tax payments (Tc) plus dividends,
- personal and corporate tax payments (Tp and Tc, respectively), and
- interest on the government debt paid to foreigners (INF).
Thus, we have
DI = NI + TR + INT – RE – Tp – Tc – INF
OTHER MAJOR PRICE INDEXES: Consumer Price Index The Consumer Price Index (CPI) is probably the most commonly cited index. It measures the price of a representative basket of goods purchased by consumers. The purpose of the CPI is to track the price of a given basket of goods and therefore it utilizes a Laspeyres’, fixed weight calculation.
Consumer Price Index: The Consumer Price Index (CPI) is n probably the most commonly cited index. It measures the price of a representative basket of goods purchased by consumers. The purpose of the CPI is to track the price of a given basket of goods and therefore it utilizes a Laspeyres, fixed weight calculation. Economic censuses. The historical data are revised as far back as necessary when the major revision takes place
The balance of international payments is an important measure of international economic and financial activity. However, balance of payments data are notoriously difficult to measure. In the good old days, government statisticians had an easier time—they stood on the dock, observed every boat entering or leaving the harbor, and examined its cargo of goods and money (gold). Thins are not so simple these days when goods enter in thousands of sealed containers and money gets transferred electronically. Nevertheless, the statisticians are able to chart the international position of the economy.
Economists have always followed the periodic changes that occur in level of business activity. These fluctuations are called business cycles. In this section, we will briefly define the term business cycle and describe some of the data that are used to monitor business cycle development
- CAPITAL ACCOUNT BALANCE: The current account balance is conceptually the same as net foreign investment. Recall from above that NFI = X – M – INF + NR or net foreign investment is net exports plus net income received. (The presentation above ignored foreign transfers for the sake of simplicity.) The balance of payments accounts are calculated separately from the NIA so there are differences between reported current account balances and due to differences in coverage, definitions, and timing.
- Business Cycle Defined: In a free enterprise economy, plans and decisions are made independently by a large number of economic agents. From time to time, imbalances between supply and demand will emerge and agents will not always be able to make the necessary adjustments to remove the imbalance. The inability to foresee and plan for all contingencies leads, on occasion, to an accumulation of imbalances throughout the economy. Such aggregate fluctuations are called business cycles.
- Cycle Indicators: Cycle indicators are classified by their relationships to the reference cycles. That is, a measure of economic activity is termed a leading indicator if it has systematically and consistently turned down before the peaks in the reference cycles and turned up before the troughs. Similarly, lagging indicators lag the reference cycle turns and coincident indicators (usually measures of aggregate activity) follow the overall cycle.
Interest rates and exchange rates play an important role in all discussions of macroeconomics.
A bond that pays the holder $100 at maturity in N years and also pays the holder annual coupon payments of 100i where i is the coupon interest rate. The relationship between the yield to maturity, r, (which we will call the interest rate on an N year bond) and the price of the bond is:
INTEREST RATES AND EXCHANGE RATES
The yield to maturity is the interest rate that discounts the bonds payments to its price.
= price of bond
= coupon interest rate
= yield to maturity
= time to maturity
- The Real Rate of Interest: Inflation alters the purchasing value of financial assets. Therefore, it is often important to think in terms of the increase in purchasing power when holding dollar denominated financial assets—the real rate of interest.
The real rate of interest can be related to the nominal rate with the Fisher relationship (named after a famous pre-war American economist):
Nominal rate = Real rate + Inflation rate
- Real Rate of Interest: The yield curve is the relationship between time to maturity (N) and yield to maturity (r) for bonds that have the same characteristics otherwise (e.g., risk of default). The most common yield curve is for U.S. government bond rates.
- Real Rate of Interest: The exchange rate is defined as the number of units of foreign currency per dollar.
- Real Rate of Interest: The real exchange rate is defined as:
where P is the domestic and Pforeign is the foreign price level.