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Introduction
and
National Income and Product
Accounting (NIPA)
MBA 774
Macroeconomics
Class Notes - Part 1
National Income and Product Accounting
1
Syllabus

Information about the class is on the website:
http://public.kenan-flagler.unc.edu/faculty/browngr/macroweb/
National Income and Product Accounting
2
What is Macroeconomics?

The biggest of “big pictures”

How the whole (global) economy works

Macroeconomics examines things like
economic growth
 employment
 inflation

National Income and Product Accounting
3
Goals for Students

To learn about the major economic factors
What they are...
 How they are measured...
 What they mean (and why we care) ...


To begin developing intuition about how economic
factors are integrated

To get up-to-date with economic current events
National Income and Product Accounting
4
Course Road Map

Part 1: The “Secret Language” of Macro



Part 2: Money





What is money and why is it important?
How is monetary policy executed?
Why do markets care so much about monetary policy?
Develop a standard model of the money market.
Part 3: Foreign Exchange



learn about specific economic factors (historically and in real time)
Develop intuition for how factors are related
Understand currency trading and purchasing power parity
Develop a model for FX markets based on interest parity
Part 4: Bring It All Together

Develop an integrated model for the product and financial markets
National Income and Product Accounting
5
Why do we want this knowledge?
Answer: So we can make better business decisions!

To understand how macroeconomic conditions
affect individual companies

To understand the “business cycle” and
economic risk

To better understand financial markets and risk
National Income and Product Accounting
6
Goals for Me

To provide key knowledge and understanding about how the
macro economy affects you and your business.

To teach you efficiently

To get you excited about macroeconomics

To have you strongly agree this course is “excellent”
National Income and Product Accounting
7
Thinking Like an Economist

As scary as it sounds, thinking like an economist is
important for business decisions

Let’s run through a common example that is
important for our purposes:

Comparative advantage & gains from trade
National Income and Product Accounting
8
Comparative Advantage &
Gains from Trade (1)

Assume a simple economy with only two goods:


Let’s also assume for simplicity that there are only
two countries


Beer and Movies
The US and Canada
Now suppose that both countries can produce each
good but the US is “better” at making movies and
Canada is better at making beer.

It is pretty obvious that the countries would benefit from
trade. How and why?
National Income and Product Accounting
9
Comparative Advantage &
Gains from Trade (2)

Now let’s make the assumption that the US is better
at making both beer and movies.

Specifically, lets assume each country has 10
“units” of labor and for each unit of labor they can
produce the following:
Country
US
Canada
National Income and Product Accounting
Beer
10
3
Movies
4
3
10
Comparative Advantage &
Gains from Trade (3)

Suppose there is no international trade and each
country finds it optimal to devote 7 units of its labor
to producing beer (and therefore 3 units of labor to
producing movies). Then each country produces
and consumes the following:
Country
US
Canada
National Income and Product Accounting
Beer
7*10=70
7*3=21
Movies
3*4=12
3*3=9
11
Comparative Advantage &
Gains from Trade (4)

Now let’s allow the countries to specialize at
producing one good and trade with each other. The
US should make only beer and Canada should only
make movies (why?). National production will be:
Country
US
Canada
National Income and Product Accounting
Beer
100
0
Movies
0
30
12
Comparative Advantage &
Gains from Trade (5)

One possibility is that the US trades 25 beers for 15
movies and national consumption is then:
Country
US
Canada

Movies
15
15
Recall that previously
Country
US
Canada

Beer
75
25
Beer
70
21
Movies
12
9
What has happened? Is this realistic?
National Income and Product Accounting
13
Measuring Economic Activity


To understand the economy we must measure the
economy
There are many economic indicators



What are some you hear about frequently?
What we ultimately care most about are measures
of overall economic activity
The broadest measure is
GNP = Gross National Product
National Income and Product Accounting
14
Gross National Product (GNP)

GNP is:



the value of all final goods and services produced and
sold
a measure of a country’s economic output (size)
the sum of four components:





Consumption (C)
Investment (I)
Government expenditures (G)
Net Exports (Exports - Imports = EX - IM)
We will use this identity often:
GNP = C + I + G + EX - IM
National Income and Product Accounting
15
GNP vs. GDP

In 1991 the US joined the rest of the world by using Gross
Domestic Product (GDP) as the measure of the economy


GDP = GNP – Net Receipts of Factor Income
Net Receipts of Factor Income =
income domestic residents earn on wealth held in other countries


Example:


– payments to foreign owners of domestic wealth
So, GDP does not correct for domestic output produced by foreign
owned capital
The earnings of an Irish computer factory that is owned by Dell (US)
are counted in Ireland’s GDP and in US’s GNP.
Does not matter much in practice for US, for 2004

Receipts (329.0B) - payments (273.9B) = 55.1B (or 0.5% of GNP)
National Income and Product Accounting
16
GNP/GDP Component Detail

C = Private Consumption Expenditures




Durable goods
Nondurable goods
Services
I = Gross Private Domestic Investment

Fixed Investment





Change in Private Inventories
EX-IM = Net Exports



Nonresidential structures
Nonresidential equipment and software
Residential
Goods
Services
G = Government Consumption Expenditures and Gross Investment



Federal nondefense
Federal defense
State and local
National Income and Product Accounting
17
US GDP
($ billions, nominal)
Gross domestic product
Personal consumption expenditures
Durable goods
Nondurable goods
Services
Gross private domestic investment
Fixed investment
Nonresidential
Structures
Equipment and software
Residential
Change in private inventories
Net exports of goods and services
Exports
Goods
Services
Imports
Goods
Services
Government
Federal
National defense
Nondefense
State and local
National Income and Product Accounting
1950
294.3
192.7
Percent
100.0%
65.5%
2000
9872.9
6728.4
Percent
100.0%
68.2%
30.7
98.2
63.7
10.4%
33.4%
21.6%
819.6
1989.6
3919.2
8.3%
20.2%
39.7%
54.1
18.4%
1767.5
17.9%
48.3
27.8
10
17.8
20.5
5.8
16.4%
9.4%
3.4%
6.0%
7.0%
2.0%
1718.1
1293.1
313.6
979.5
425.1
49.4
17.4%
13.1%
3.2%
9.9%
4.3%
0.5%
0.7
0.2%
-364.0
-3.7%
12.3
10.2
2.1
11.6
9.1
2.5
4.2%
3.5%
0.7%
3.9%
3.1%
0.8%
1102.9
785.6
317.3
1466.9
1244.9
221.9
11.2%
8.0%
3.2%
14.9%
12.6%
2.2%
46.9
15.9%
1741.0
17.6%
26
19.6
6.4
20.9
8.8%
6.7%
2.2%
7.1%
590.2
375.4
214.8
1150.8
6.0%
3.8%
2.2%
11.7%
18
What Counts in GNP/GDP? (and Where?)

Which of the following are included in GNP or GDP









You buy a box of Garden Burgers at the grocery store
A farmer sells soybeans to the local silo
A car dealer sells a 1998 Ford Escort to a college student
A car dealer sells a new panel van to a florist
Compaq adds a computer to inventory
You sell your house to a couple that just moved from FL
The Federal government builds a new bridge
Texas state government pays unemployment benefits to
former Enron employees
GM imports steel for use in a new car
National Income and Product Accounting
19
What Counts in GNP/GDP?

Let’s track parts of a hypothetical product through
its production and see how it enters into the NIPA
accounts

GM imports 800 lbs. of steel from Korea for use in
manufacturing a Chevy Malibu at a cost of $1,300

GM manufactures the Malibu and sells it to a dealer in
Dallas for $12,700

The dealer sells the new Malibu to a rodeo queen for
$16,800
National Income and Product Accounting
20
Real vs. Nominal


So far we have not adjusted for inflation
Why would we need to do this?



Compare 8% growth in GDP in the US where inflation is
about 3% with Venezuela where inflation is about 18%
Unadjusted GDP is called Nominal GDP and
Inflation adjusted GDP is called Real GDP
There are two common ways of adjusting for
inflation:


Simple base year comparison
Chain-weight comparison (latest and greatest method)
National Income and Product Accounting
21
GDP Deflator

GDP Deflator is an index (standardized to
2000=100) that changes nominal GDP to real GDP
Real GDP = Nominal GDP / (GDP Deflator/100)

The percent change in the GDP Deflator is a
measure of inflation

The GDP Deflator is the broadest measure of
inflation for an economy
National Income and Product Accounting
22
What is a Recession?


National Bureau of Economic Research (NBER)
determines official dates for the “business cycle”
A committee of top economists called the “Business
Cycle Dating Committee” makes the call:
“A recession is a significant decline in activity spread
across the economy, lasting more than a few months,
visible in industrial production, employment, real income,
and wholesale-retail trade. A recession begins just after
the economy reaches a peak of output and employment
and ends as the economy reaches its trough.”

For details on the recent recession see:
http://www.nber.org/cycles/recessions.html
National Income and Product Accounting
23
Real US GDP Growth
(1929-2003, annual, purple indicates year with NBER recession)
20%
15%
10%
5%
0%
-5%
-10%
National Income and Product Accounting
24
04
20
99
19
94
19
89
19
84
19
79
19
74
19
69
19
64
19
59
19
54
19
49
19
44
19
39
19
34
19
19
29
-15%
Real US GDP Growth
(1988-present, quarterly, purple indicates quarter with NBER recession)
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
National Income and Product Accounting
25
:Q1
06
20
:Q1
05
20
:Q1
04
20
:Q1
20
03
:Q1
02
20
:Q1
01
20
:Q1
00
20
:Q1
99
19
:Q1
19
98
:Q1
97
19
:Q1
96
19
:Q1
95
19
:Q1
94
19
:Q1
93
19
:Q1
92
19
:Q1
91
19
:Q1
90
19
:Q1
89
19
19
88
:Q1
-4.0%
Contributions to Real GDP %Change
Gross domestic product
Personal consumption expenditures
Durable goods
Nondurable goods
Services
Gross private domestic investment
Fixed investment
Nonresidential
Structures
Equipment and software
Residential
Change in private inventories
Net exports of goods and services
Exports
Imports
Government
Federal
National defense
Nondefense
State and local
National Income and Product Accounting
2001
0.8
1.7
2002
1.6
1.9
2003
2.7
2.1
2004
4.2
2.7
2005
3.5
2.5
0.4
0.4
1.0
0.6
0.5
0.8
0.6
0.6
0.9
0.5
0.9
1.3
0.4
0.9
1.2
-1.4
-0.4
0.6
1.8
1.0
-0.5
-0.5
-0.1
-0.4
0.0
-0.9
-0.8
-1.1
-0.6
-0.5
0.2
0.4
0.5
0.1
-0.1
0.2
0.4
0.1
1.5
0.9
0.1
0.9
0.6
0.4
1.3
0.9
0.1
0.8
0.4
-0.3
-0.2
-0.7
-0.5
-0.7
-0.3
-0.6
0.4
-0.2
-0.5
0.2
-0.6
0.8
-1.5
0.7
-1.0
0.6
0.8
0.5
0.4
0.3
0.2
0.2
0.1
0.4
0.4
0.3
0.1
0.4
0.5
0.4
0.1
0.1
0.4
0.3
0.0
0.1
0.2
0.1
0.0
0.2
26
Last Time Was Different
(contributions to US GDP growth around 2001 recession)
5.00
4.00
3.00
2.00
1.00
0.00
-1.00
-2.00
-3.00
-4.00
C (incl Residential)
I (excl Residential)
19
99
:Q
1
19
99
:Q
2
19
99
:Q
3
19
99
:Q
4
20
00
:Q
1
20
00
:Q
2
20
00
:Q
3
20
00
:Q
4
20
01
:Q
1
20
01
:Q
2
20
01
:Q
3
20
01
:Q
4
20
02
:Q
1
20
02
:Q
2
20
02
:Q
3
20
02
:Q
4
20
03
:Q
1
20
03
:Q
2
-5.00
National Income and Product Accounting
27
Global GDP in USD (2004)
Rank
1
2
3
4
5
6
7
8
9
10
Country
United States
Japan
Germany
China (Ex. Hong Kong)
United Kingdom
France
Italy
Canada
Brazil
Spain
All Countries
European Monetary Union
OECD (30 Rich Countries)
Rest of World
GDP (bln)
10,764
4,933
1,956
1,715
1,578
1,415
1,114
789
655
655
35,111
6,476
26,526
8,585
GDP/Capita
37,323
38,811
23,710
1,319
26,796
23,818
19,243
25,464
6,495
15,898
5,756
17,114
23,193
1,732
(calculated using market exchange rates)
National Income and Product Accounting
28
Problems with Product Accounting

NIPA accounting can be misleading and difficult in
practice

Problems include:






Black market
Household production
Fixed capital replacement (e.g., from a disaster)
Certain government services (e.g., national security)
Externalities (e.g., environmental impact)
Quality / technology adjustment (e.g., automobiles)
National Income and Product Accounting
29
Social Welfare

We have talked about how to measure the
economy but not how to directly measure the wellbeing of consumers

How might the two differ?

We could use a “social welfare function”

Examples


Add up the “utility level” of all consumers (called ‘classical
utilitarian’)
Minimum of all consumers (Rawlsian)
National Income and Product Accounting
30
National Income

We have defined GDP in terms of production of
goods and services

We can also think about GDP in terms of national
income (Y). Why?

Economists often assume Y=GDP but there is a
slightly different precise definition of national
income
National Income and Product Accounting
31
National Income
GNP
less: Consumption of Fixed Capital (Depreciation)
= Net National Product
less: Indirect Business Tax
less: Business Transfer Payments
less: Statistical Discrepancy
plus: Subsidies less current surplus of government
= National Income
To keep things simple we will always assume
GDP=GNP=National Income (unless otherwise stated).
National Income and Product Accounting
32
US National Income
Or looking at it the other way:
USD (bln)
9,707.8
Percent
100%
Compensation of Employees
6,203.0
Proprietors' Income
846.9
Rental Income
164.2
Corporate Profits
1,069.9
Net Interest Income
583.2
Taxes on Imports and Production
788.7
Net Subsidies & Other
52.0
63.9%
8.7%
1.7%
11.0%
6.0%
8.1%
0.5%
National Income
(percentages do not add to 100% because of rounding errors)
National Income and Product Accounting
33
Inflation Measures


Price indexes are used to measure inflation
The three most common price indexes are


GDP deflator
Consumer price index (CPI)



Prices of finished or retail goods and services
Index set to 100 for base year(s), currently 1982-1984 average
Producer price index (PPI)


Measures the cost of a given basket of crude goods (raw
materials), intermediate goods, or finished goods (3 indices)
Constructed from prices at the level of the first significant
commercial transaction
National Income and Product Accounting
34
U.S. CPI Percent Change
(From 12 Months Prior, All Urban Consumers)
15.0%
12.5%
10.0%
7.5%
5.0%
2.5%
0.0%
National Income and Product Accounting
35
05
20
00
20
95
19
90
19
85
19
80
19
75
19
70
19
65
19
60
19
55
19
19
50
-2.5%
Recent CPI and CPI ex. Food & Energy
(Percent Change from 12 Months Prior)
7.0%
6.0%
CPI- All Items
5.0%
CPI Excluding Food and Energy
4.0%
3.0%
2.0%
1.0%
National Income and Product Accounting
36
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
89
19
88
0.0%
Components of PPI
(Index Levels—not percent change, Monthly)
220
Finished
200
Intermediate
Crude
180
160
140
120
100
National Income and Product Accounting
37
20
06
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
80
Employment and Wages

Another important measure of the economy is
employment and labor income (wages + benefits)

The most common measure of the number of jobs
in the US is called “nonfarm payroll employment”

Also frequently reported is the “unemployment rate”
number of people seeking jobs
=
number of people in the labor force
National Income and Product Accounting
38
US Unemployment Rate
(Percent)
12
10
8
6
4
2
National Income and Product Accounting
39
20
00
20
04
19
88
19
92
19
96
19
80
19
84
19
68
19
72
19
76
19
60
19
64
19
48
19
52
19
56
0
US Non-Farm Payrolls (1,000s)
136,000
135,000
134,000
133,000
132,000
131,000
130,000
129,000
128,000
Ja
n-9
9
Ju
l-9
9
Ja
n-0
0
Ju
l-0
0
Ja
n-0
1
Ju
l-0
1
Ja
n-0
2
Ju
l-0
2
Ja
n-0
3
Ju
l-0
3
Ja
n-0
4
Ju
l-0
4
Ja
n-0
5
Ju
l-0
5
Ja
n-0
6
127,000
National Income and Product Accounting
40
Adjusted US Unemployment Rate
10
9
8
7
6
5
4
Unemp-Reported
Unemp-Using Population Growth
National Income and Product Accounting
Ju
l-0
5
Ja
n-0
6
Ju
l-0
4
Ja
n-0
5
Ja
n-0
1
Ju
l-0
1
Ja
n-0
2
Ju
l-0
2
Ja
n-0
3
Ju
l-0
3
Ja
n-0
4
3
41
Civilian Labor Force Participation Rate
67.5
67.3
67.1
66.9
66.7
66.5
66.3
66.1
65.9
65.7
Ju
l-9
9
Ja
n-0
0
Ju
l-0
0
Ja
n-0
1
Ju
l-0
1
Ja
n-0
2
Ju
l-0
2
Ja
n-0
3
Ju
l-0
3
Ja
n-0
4
Ju
l-0
4
Ja
n-0
5
Ju
l-0
5
Ja
n-0
6
Ja
n-9
9
65.5
National Income and Product Accounting
42
What’s Happened Here?
134,000
133,000
142,000
Payroll Survey (left scale)
Household Survey (right scale)
140,000
138,000
132,000
136,000
131,000
134,000
132,000
130,000
130,000
128,000
Ma
r-0
Ju 1
n-0
Se 1
p -0
De 1
c-0
Ma 1
r-0
Ju 2
n-0
Se 2
p -0
De 2
c-0
Ma 2
r-0
Ju 3
n-0
Se 3
p -0
De 3
c-0
Ma 3
r-0
Ju 4
n-0
Se 4
p -0
De 4
c-0
Ma 4
r-0
Ju 5
n-0
5
129,000
National Income and Product Accounting
43
Current Account

Current Account (CA) is defined as the difference
between Exports (EX) and Imports (IM)
CA = EX - IM



CA < 0 is defined as current account deficit
CA > 0 is defined as current account surplus
How does CA relate to


Foreign indebtedness?
Intertemporal consumption patterns?
National Income and Product Accounting
44
US Exports, Imports, & CA Deficit
(Quarterly, Percent of GDP, 2000 Dollars)
20.0%
Imports
Exports
CA
15.0%
10.0%
5.0%
0.0%
-5.0%
National Income and Product Accounting
45
20
05
20
00
19
95
19
90
19
85
19
80
19
75
19
70
19
65
19
60
19
55
19
50
-10.0%
Balance of Payments

Three types of transactions are recorded in the
balance of payments

Current Account Transactions: transactions that involve
the export or import of goods or services


Financial Account Transactions: transactions that involve
the purchase or sale of an asset


Such as exporting computers or consulting services
Such as money, stocks, bonds, factories, government debt, land,
or collectibles.
Capital Account Transactions: everything else

acquisition or disposal of nonproduced, nonfinancial, and some
intangible assets (debt forgiveness, transfer of trademarks, etc)
National Income and Product Accounting
46
US Balance of Payments (2000)
Exports
Goods
Services
Income Receipts
Imports
Goods
Services
Income Payments
Net Unilateral Transfers
Current Account Balance
Capital Account
US Assets Held Abroad
Official Reserve Assets
Other Assets
Foreign Assets Held in US
Official Reserve Assets
Other Assets
Financial Account Balance
Statistical Discrepancy
National Income and Product Accounting
Credits
1,314.9
713.1
307.4
294.4
Debits
-1,778.1
-1,260.7
-256.3
-261.1
-67.4
-530.7
-3.1
-283.4
1.5
-284.9
829.2
248.6
580.6
545.8
-12.0
47
Current Account and Net Foreign Wealth
National Income and Product Accounting
48
Current Account and National Savings

National Savings (S) is defined as the portion of
national income not devoted to consumption or
government expenditures. So,
S=Y-C-G
S = (C + I + G +EX - IM) - C - G
S = I + EX – IM
S = I + CA
National Income and Product Accounting
49