National Accounting and Business Cycles PDF 2024

30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Topic 4: NATIONAL ACCOUNTING AND BUSINESS C...

30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Topic 4: NATIONAL ACCOUNTING AND BUSINESS CYCLES 1 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The economic performance of a country can be described in terms of the production possibilities for different goods A single aggregate statistical indicator of economic performance, or aggregate output, would be much more useful Before 1947, such an indicator was not readily available: “One reads with dismay of Presidents Hoover and then Roosevelt designing policies to combat the Great Depression of the 1930's on the basis of such sketchy data as stock price indices, freight car loadings, and incomplete indices of industrial production. The fact was that comprehensive measures of national income and output did not exist at the time.” Richard T. Foyen To assess how a person is doing in economic terms one normally looks at her income… It turns out that we can do something similar for the economy as a whole Note however that a whole economy is better viewed as a system where various agents interact: households, firms, the government, the foreign sector 2 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi After WWII, Simon Kuznets and Sir Richard Stone (among others) developed the System of National Accounts (SNA): National Income Accounts: a logically coherent (bookkeeping) system of statistics that summarizes the aggregate economic activity at the national level Gross Domestic Product (GDP): a statistic that measures the value of the aggregate production in a given time period The basic economic intuition that informs the SNA is straightforward but nonetheless powerful: For every seller there is a buyer, or one person’s expenditure is another’s income Following in François Quesnay’s (1758) footsteps, we will now use the previous intuition to build the Circular Flow model 3 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Market for goods and services Goods and Goods and services bought services sold Households Flow of goods and services Firms Labour, land, Inputs of and capital production Market for factors of production 4 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Spending Market for Revenue goods and services Households Flow of money Firms Market for factors of Income Wages, rent, production and profit 5 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Spending Market for Revenue goods and services Goods and Goods and services bought services sold Spending of households = Value of Households final (i.e. to households) sales Firms Labour, land, Inputs of and capital production Market for factors of Income Wages, rent, production and profit 6 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Spending Market for Revenue goods and services Goods and Goods and services bought services sold Remuneration of factors of Households production = Income of households Firms Labour, land, Inputs of and capital production Market for factors of Income Wages, rent, production and profit 7 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Spending Market for Revenue goods and services Goods and Goods and services bought services sold Expenditure = Value of final sales = Households Factor payments = Income Firms Labour, land, Inputs of and capital production Market for factors of Income Wages, rent, production and profit 8 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The Circular Flow model implies that: Value of final sales = Income This suggests that GDP can be defined in several equivalent ways In particular, from the production side: GDP is the market value of all final goods and services produced within an economy during a given period of time From the income side: GDP is the sum of all incomes (profits + wages + rents + indirect taxes) generated and distributed in the economy during a given period of time 9 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The Gross Domestic Product is the market value of all final goods and services produced within an economy during a given period of time  Gross: Not accounting for depreciation of capital  Market value: Market prices are used (what people is willing to pay)  All: All items produced in the economy and sold  Final: Intermediate goods (goods used in the production of another good) are not counted, to avoid double counting 10 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The Gross Domestic Product is the market value of all final goods and services produced within an economy during a given period of time  Goods and services: Both tangible goods and intangible services  Produced: Currently produced, not including things produced in the past  Within an economy: Production within the geographical boundaries of a region  During a given period of time: Flow of income and expenditure during a given time interval 11 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi We pointed out that GDP does not consider the value of intermediate goods, i.e. goods used in the production of other goods, in order to avoid double counting Hence, this definition can be restated as: GDP is the sum of value added in the economy during a given period of time Value Added (VA) is defined as the value of production minus the value of the intermediate goods used in production Valued added is distributed to the factors of production: Some VA goes to workers – as wages, or labour income Another share goes to the State, as indirect taxes minus subsidies The rest remains with the firm, as capital income (i.e. rents, the remuneration of capital used in production), and profits 12 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 13 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Example Farmer Pasta maker Revenues Costs Revenues Costs Flour 300 Wages 800 Spaghetti 900 Wages 500 Eggs 600 Penne 1000 Flour 300 Eggs 600 Total 900 Total 800 Total 1900 Total 1400 Profits 100 Profits 500 Value of all final goods in the economy (pasta) = GDP = 1900 Sum of all incomes: Wages (800 + 500 = 1300) + Profits (100 + 500 = 600) = GDP = 1900 Sum of value added: VA Farmer (900 – 0 = 900) + VA Pasta maker (1900 – 900 = 1000) = GDP = 1900 14 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi “GDP is the worst measure of prosperity except for all those other forms that have been tried from time to time …” GDP is a measure of the value of production of final goods and services, not a direct measure of social welfare There are some evident problems with GDP: Usually, GDP takes only market transactions into account (ie. household production is generally ignored) GDP does not value the consumption of leisure GDP does not take externalities into account (i.e. the cost of pollution) However, the EU mandated that starting 9/2014, all member countries must count as part of the GDP all transactions for which the actions take place “by mutual agreement,” i.e. the “black” economy (prostitution, illegal drug sales, the sale of stolen property) 15 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 16 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Nominal GDP is the sum of the quantities of final goods and services produced times their current market price Market prices are used as “weights,” in order to homogenise quantities expressed in different measurement units Nominal GDP may change over time for two reasons: First, the production of most goods and services varies over time Second, the prices of most goods and services change over time If our goal is to measure production and its changes over time, we need to eliminate the effect of changing prices! That is why real GDP (RGDP) is constructed as the sum of the quantities of final goods and services times constant (rather than current) prices 17 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi RGDP is constructed as the sum of the quantities of final goods and services times constant prices; those constant prices are the prices that prevailed in some specific base year Hence, RGDP is built using a set of “weights” that remains constant over time Year 𝒕𝒕 Year 𝒕𝒕 + 𝟏𝟏 𝑁𝑁 𝑁𝑁 Nominal GDP 𝑝𝑝𝑖𝑖,𝑡𝑡 𝑞𝑞𝑖𝑖,𝑡𝑡 𝑝𝑝𝑖𝑖,𝑡𝑡+1 𝑞𝑞𝑖𝑖,𝑡𝑡+1 𝑖𝑖=1 𝑖𝑖=1 𝑁𝑁 𝑁𝑁 Real GDP (base 𝒕𝒕) 𝑝𝑝𝑖𝑖,𝑡𝑡 𝑞𝑞𝑖𝑖,𝑡𝑡 𝒑𝒑𝒊𝒊,𝒕𝒕 𝑞𝑞𝑖𝑖,𝑡𝑡+1 𝑖𝑖=1 𝑖𝑖=1 𝑁𝑁 𝑁𝑁 Real GDP (base 𝒕𝒕 + 𝟏𝟏) 𝒑𝒑𝒊𝒊,𝒕𝒕+𝟏𝟏 𝑞𝑞𝑖𝑖,𝑡𝑡 𝑝𝑝𝑖𝑖,𝑡𝑡+1 𝑞𝑞𝑖𝑖,𝑡𝑡+1 𝑖𝑖=1 𝑖𝑖=1 In the base year, RGDP = GDP! 18 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The system of “weights” corresponds to the system of relative prices observed in the base year; relative prices, however, change over time Note that we are considering here a change in relative prices, not a change in the overall price level! Variations in relative prices are the main reason for regularly changing the base year: the farther you are from the base year, the larger the distortions associated with a fixed weighting scheme Nowadays, statistical agencies construct measures called real GDP in chain-linked volumes The idea is to use systems of relative prices that change slowly over time: in this way you filter out the effect of a rapidly changing overall price level, while keeping a reasonably good system of relative prices 19 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Italy: GDP per capita (1861 - 2011) (Source: Bankitalia) 30 25 20 GDP per capita 15 10 5 0 1861 1865 1869 1873 1877 1881 1885 1889 1893 1897 1901 1905 1909 1913 1917 1921 1925 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Year Real GDP per capita (chained values, base year 2005) Nominal GDP per capita 20 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 21 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 22 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The GDP deflator, denoted 𝑃𝑃, is a price index, defined as the ratio of nominal GDP to real GDP, so that 𝑃𝑃 ≡ 𝐺𝐺𝐺𝐺𝐺𝐺/𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 The GDP deflator tracks the change in prices of all domestically produced final goods and services, i.e. of all the components of domestic GDP (𝐶𝐶 + 𝐼𝐼 + 𝐺𝐺 + 𝑋𝑋 − 𝑀𝑀) The GDP deflator can be quite loosely interpreted as the general price level in the economy (with some caveats) An obvious limitation of the GDP deflator is that it measures the change in prices of produced goods, but not necessarily that of consumed goods Evidently, many goods are imported from abroad, while many locally produced goods are exported Hence, the GDP deflator’s dynamics does not properly capture the evolution over time of the cost of living 23 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The Consumer Price Index (CPI) measures the general level of prices that consumers have to pay for goods and services, including consumption taxes The CPI is based on a carefully constructed representative basket of consumption goods, whose prices are sampled at regular intervals (typically every month) The representative basket excludes exports (which are consumed by foreign residents) but includes imports Changes in the total cost of this representative basket capture the evolution of the cost of living, i.e. the purchasing power of money Inflation (deflation) is defined as an increase (decrease) in the general price level, usually measured over a year Inflation can be computed using both the GDP deflator and the CPI, even if the latter is generally preferred 24 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 25 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The working-age population conventionally comprises all people aged between 15 and 64 years Employment is the number of people who have a job (formal definition) (Involuntary) unemployment is the number of people who do not have a job but are actively looking for one (formal definition) The labour force is the sum of employment and unemployment We define the following rates: employment employment rate ≡ working−age population unemployment unemployment rate ≡ labor force labor force participation rate ≡ working−age population 26 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Those who do not have a job and are not looking for one are counted as not in the labour force This happens also to discouraged workers, unemployed people who give up looking for a job and therefore are no longer formally counted as unemployed Other important labour-market statistics are the average duration of unemployment and the youth unemployment rate 27 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi 28 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Economic growth is NOT a smooth process: 29 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The NBER defines a recession like this: “During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year” The movement from boom, to recession, and back to boom is known as business cycle The business cycle affects not only GDP, but also its components: Consumption and investment tend to comove (i.e. to be positively correlated) with GDP Consumption is typically slightly less volatile than GDP Investment is definitely more volatile than GDP The unemployment rate, and other labour market statistics, react enthusiastically to the business cycle too 30 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Consumption and investment comove with GDP Consumption is less volatile than GDP, investment more so 31 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The so-called “Okun’s law” refers to a robust empirical regularity: changes in the rate of growth of GDP are negatively correlated with the rate of unemployment 32 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi The high correlation of current consumption with current income seems surprising, at first sight The existence of well-functioning financial markets should allow individuals (and firms, for that matter) to smooth consumption through our lifetime, reducing the influence of current income 33 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Ezio receives exogenous incomes in both periods, denoted 𝑦𝑦𝑖𝑖 : the point 𝑑𝑑 identifies the endowment point Ezio is allowed to lend and borrow at the rate 𝑖𝑖; his initial optimal choice, denoted 𝑒𝑒, overlaps with 𝑑𝑑 𝑐𝑐1 𝑐𝑐1 𝑦𝑦1 𝑐𝑐0 + ≤ 𝑦𝑦0 + 𝑒𝑒 = 𝑑𝑑 1 + 𝑖𝑖 1 + 𝑖𝑖 𝑦𝑦1 𝑦𝑦0 𝑐𝑐0 34 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi Suddenly, and unexpectedly, Ezio’s current income drops to 𝑦𝑦0′ The ability to borrow allows Ezio to reduce the income shock’s impact on current consumption (i.e. to smooth consumption) 𝑐𝑐1 𝑒𝑒 = 𝑑𝑑 𝑦𝑦1 𝑑𝑑 ′ 𝑒𝑒𝑒 ∆𝑐𝑐0 𝑦𝑦0′ 𝑦𝑦0 𝑐𝑐0 35 30545 - Foundations of Economic Sciences © 2024 Marco Maffezzoli – Università Bocconi If Ezio was NOT allowed to borrow (i.e. if he was credit constrained), the income shock’s impact would be much larger For credit-constrained individuals the correlation between current income and current consumption tends to be quite high 𝑐𝑐1 𝑒𝑒 = 𝑑𝑑 𝑦𝑦1 𝑒𝑒 ′ = 𝑑𝑑 ′ ∆𝑐𝑐0 𝑦𝑦0′ 𝑦𝑦0 𝑐𝑐0 36