Macroeconomics: National Income Accounting (NIA)

Fundamental Concepts of Macroeconomics

• Macroeconomics looks at the big picture of an economy, examining it as a whole to understand how it functions.
• The main focus is to achieve economic growth, reduce unemployment, maintain stable prices, reduce budget deficits, balance payments, and fairly distribute income.

National Income Accounting (NIA)

• NIA is an accounting system that tracks the level of economic activity in a country.
• It measures a country's total output, income, and expenditure.

Why Study NIA?

• NIA helps measure the level of total output over a specific time.
• It explains the reasons behind the level of output.
• NIA helps in observing the economy's long-term trends.
• It provides info for creating policies and designing economic plans.

Approaches to Measure National Income (GDP/GNP)

• It is important to understand how a country's economic performance is measured, commonly referred to as GDP or GNP.
• The Gross Domestic Product (GDP) is the total value of all final goods and services produced within a country's borders in a year.
• Gross National Product (GNP) is the total value of final goods and services made by a country's domestically-owned factors of production in a year, regardless of location.

GDP and GNP Relationship

• GDP and GNP are related by the formula GNP = GDP + NFI, where NFI is Net Factor Income.
• NFI is the income received from abroad by a country's citizens minus the income paid to foreigners abroad.
• NFI can be negative, positive, or zero, depending on the balance of factor income between countries.
• If NFI is >0, then GNP is > GDP.
• If NFI is <0, then GNP is < GDP.
• Finally, if NFI =0, then GNP = GDP.

Approaches to Measuring GDP/GNP

• There are main three ways to measure GDP/GNP.
• Product/value added approach.
• Expenditure approach.
• Income approach.

Product Approach

• GDP is the total of the market value of all goods and services produced by each part of the economy.
• GDP only counts the value of final goods and services to avoid double counting.
• "Double counting" happens if the output of some firms are used as intermediate inputs of other firms.
• Ways of avoiding double counting:
  • Taking only the value of final goods and services.
  • Taking the sum of the valued added by all firms at each stage of production.

Expenditure Approach

• GDP is measured by adding up all spending on final goods and services produced in a country by everyone in the economy
• GDP = C+I+G+NE, where
  • C = personal consumption by households
  • I = gross private domestic investment
  • G = government purchases, and
  • NE = net exports.
• Personal consumption expenditure includes household spending on durable consumer goods, non-durable consumer goods, and services.
• Gross private domestic investment is the total spending of firms on plants, equipment, and inventories, as well as household spending on new houses.
• Investment has three categories:
  • Residential investment includes spending of households for new house construction.
  • Business fixed investment is the spending of firms on building and equipment used for business.
  • Inventory investment is the change in the inventories of firms.
• Government purchases of goods and services include all government spending on finished products, and direct purchases of resources less government transfer payments because these payments do not reflect current production.
• Net exports is the total value of exports less the total value of imports.

Income Approach

• GDP is calculated by adding up all the incomes earned by the factors of production that produce the national output.
• Some forms of personal income are not included in the national income.
• Transfer payments (payments to recipients who haven't contributed to production) are excluded from national income, as they are a redistribution of income.
• Transfer payments can be old age pensions, unemployment benefits, and subsidies.
• GDP is the sum of all incomes to owners of factors of production, plus some claims on the value of output (depreciation and indirect business tax), less subsidies and transfer payments.
• GDP consists of employee compensation (wages & salaries), rental income, interest income, profits (proprietors' profit plus corporate profit), indirect business taxes, and depreciation, minus subsidies and transfer payments.

Limitations of GDP Measurement

• Definition of a nation and the methods of obtaining citizenship cause a limitation.
• Stages of economic activities.
• Transfer payments.
• Underground economy can be a limitation.
• Inadequate data can be a limitation.
• Non-monetized sector causes a limitation.
• Valuation of depreciation can cause a limitation.
• Changes in price levels.
• No focus on quality causes a limitation.

Other Income Accounts

• In addition to GDP and GNP, there are other national income accounts of importance for macroeconomic analysis.
• Net National Product (NNP).
• National Income (NI).
• Personal Income (PI).
• Personal Disposable Income (PDI).
• Net National Product (NNP) is GNP minus capital consumption allowance, accounting for the capital goods used up in production. NNP is a more accurate measure of an economy's yearly output than GNP.
• National income (NI) is the income earned by resource suppliers, including land, labor, capital, and entrepreneurial ability.
• To calculate NI, indirect business tax must be subtracted from net national product.
• Personal Income (PI) is the income earned by persons/households.
• PI = NI - [social security contribution + corporate income tax + retained corporate profit] + [Public transfer payments (e.g. Subsidy) + net interest on government bond]
• Personal Disposable Income (PDI) is equal to personal income less personal tax payments.
• PDI = PI – Personal taxes
• PDI = C + S, where C = personal consumption expenditure, and S = Personal savings.

Nominal versus Real GDP

• There are ways on how to measure Nominal versus Real GDP.

Nominal GDP

• Nominal GDP is the value of all final goods and services produced in a year at that year's prices.
• If nominal GDP = ΣPiQi , where P is the general price level and Q = quantity of goods and services produced.
• Changes in nominal GDP can be due to price changes, quantity changes, or a combination of both.
• GDP that is not adjusted for inflation is called nominal GDP.

Real GDP

• Real GDP is the value of final goods and services produced in a given year at the prices of base year.
• Real GDP is the adjustment of GDP for inflation. GDP Deflator,
• Real measure of inflation is also known as the GDP deflator.
• The GDP deflator is the ratio of nominal GDP to real GDP in a given year.
• It reflects the happenings to the overall level of prices in the economy.
• GDP deflator = (Nominal GDP/Real GDP) * 100
• If the real and nominal GDP values are exactly the same, the GDP deflator in the base year is always 100.

The Consumer Price Index (CPI)

• The CPI measures the average change in prices paid by consumers for a representative basket of goods and services.
• Compares the current and base year cost of a basket with the same items.
• CPI = (ΣPt * q0)/(ΣP0 * q0). Pt = today's price. P0 Base year prices. q0= the base year quantities.

CPI versus the GDP Deflator.

• Key difference is that GDP deflator measures the prices of all goods made whereas CPI measures the prices of only the goods purchased by customer
• An increase in price show up if good are bought by government ( for GDP deflator ) but not if by consumer (in CPI)
• GDP only includes the good that were domestically made and not imported ones whereas CPI includes all goods even imported
• GDP deflator allows good change whereas CPI assigns weights and the good stay the same

The Business Cycle

• The business cycle refers to the recurring ups and downs in a country's economic activity.
• Ups and downs occur in the level of output and employment over time.
• Sometimes total output levels increase, and other times they decrease.
• Economic activity will fluctuate like the level of unemployment.

Boom/peak

• 1st Phase It is a phase in which the economy is producing the highest level of output in the business cycle.
• marks the end of economic expansion
• In this phase, economy's output is growing faster than its long-term (potential) trend and unsustainable.
• unemployment is low;
• Business good,
• period of prosperity.

Recession/contraction

• 2nd Phase It is economic performance declines.
• Total output declines, national income falls,
• Business generally decline.
• Unemployment Problem rises.
• Recession becomes particularly severe, become depression or trough.
• This period cause hardship on business and citizens.

Trough/Depression

• 3rd Phase It is the lowest point in a business cycle.
• marks the end of a recession
• It’s the beginning of economic recovery/expansion.
• excessive amount of unemployment
• Idle productive capacity

Recovery/Expansion

• 4th Phase economy starts to grow or recover,
• more resources are employed in the production process
• output increases
• unemployment level diminishes
• national income rises.
• expansion of the economy reaches its maximum and becomes peak.

Unemployment and Inflation

• Main problems of Unemployment: group of people who are specified age and searching job but dont have.
• Unemployment measured by two group.
• in the labour force and Those are outside the labour force.
• The labor force includes people of people within a specified age group ( over 14) but formally 18 who are employed and available for work
• Children <14 and pensioners are not included as actively looking
• labour force = Employed + Unemployed
• Types of unemployment:

Frictional unemployment

• Is the brief period of unemployment experienced due to: seasonality or voluntary job changes.
• Entering or re-entering the labor force.
• Voluntary switching of jobs in search of better jobs
• Entrance to the labor force E.g. A student immediately after graduation

Structural unemployment

• mismatch between the skills or locations of job seekers and the specific requirements or locations of the vacancies.
• Could be from change or tec

Cyclical unemployment

• absence of vacancies: due to deficiency in demand for commodities/ the low performance of the economy to create jobs.

Measurement of rates of unemployment

- Total unemployment = Frictional + Structural + Cyclical unemployment
- Natural level of unemployment = Frictional unemployment + Structural unemployment

= Total unemployment - Cyclical unemployment - Natural rate of unemployment = Natural unemployment /labor force - Unemployment rate = total unemployment / labor force

Inflation

• The sustainable increase in the general or average price levels for commodities.
• increase price must be a sustained one.
• Increase must happen at a general level ( not just individual goods offset by others.
• Rate pt=price index and t = time
• Rate Of inflation = Pt-Pt-1 / Pt-1 *100

Causes of inflation

• The causes of inflation are generally classified into two major groups: demand pull and cost push inflation.
• Demand-pull inflation is the result of increasing rapid demand.
• Push inflation happens from continues decline

The Economic effects of inflation

-Inflation reduces real money balance
-Banks can change their nominal interest rates

Trade deficit and budget deficit

Government purchases of goods and services include all government spending on finished products, and direct purchases of resources less government transfer payments because.

• Any of the amount the government spend is called ``budget deficit Trade deficit The national income accounts identity shows that net capital outflow always equals the trade balance.
• If S-I and NX is +VE then we call it trade surplus and account of trade
• However if S-I and NX is -VE then it trade deficient meaning the income from trade is low so the nation is running an account deficient
• S - I and NX are 0 then trade is said to be balance

Macroeconomic policy instruments

• Policy measures are geared at achieving moderate inflation rate, keeping unemployment rate low, balancing foreign trade,

Monetary policy Monetary policy refers to the adoption of suitable policy regarding the control of money supply and the management

Government is responsible for monetary policies

• if the interest rate on funds lowers firms borrow more Fiscal policies involve the utilization of tools such taxation borrowing to affect overall activities
• both aggregate and supply change under physical policies Taxes subsidies are main implementers

function of fiscal policy is to:

• determine exactly how government funds will be allocated.
• relate issues of taxation and spendings
• implemented through
• Fiscal policies implement the use of subsides budget and progressive taxation
• True economic growth occurs when various projects are