1. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-1 Chapter 2 National Income Accounting

2. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-2 Objectives Analyse the components of final demand in the economy Define gross domestic product and examine its relationship with other measures of output Identify the set of national income relationships Derive a model of the economy that explains the relationships between the various sectors Consider the impact of price changes on output

3. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-3 Chapter Organisation 2.1Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

4. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-4 2.1 Production Gross domestic product (GDP) is the value: –Of all final goods and services –Produced in a country –For a given period. Australian GDP for 2004 was $830 billion. Per capita GDP = $830b/20.1m pop. = $41 300 p.a. in 2004.

5. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-5 Production The production function (f) relates: –GDP (Y) to inputs called factors of production –The major factors are labour (N) and capital (K) –Y = f(N, K) Payments to factors comprise: –The wage rate (w) for N and interest rate (i) for K –These payments plus profits add to GDP –Y = (w  N) + (i  K) + profit

6. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-6 Production Gross national income (GNI): –GNI = GDP + payments from overseas to domestically owned factors of production –Overseas payments are about 3% of GNI. Net domestic product (NDP): –NDP = GDP – depreciation –Depreciation is about 15% of GDP.

7. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-7 Production Real versus nominal GDP –Nominal GDP measures the value of all final goods and services produced but it does not take account of price changes. –Real GDP measures the value of all final goods and services produced but adjusts that value to take account of price changes.

8. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-8 Chapter Organisation 2.1Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

9. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-9 2.2 Outlays and Components of Demand The expenditure measure of GDP called GDP(E) comprises: –Household consumption spending (C) –Investment spending (I) –Government purchases (G) –Foreign demand (NX) The national income identity is Y = C + I + G + NX (2.3)

10. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-10 Components of Demand

11. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-11 Consumption From Table 2.1, Australia’s household consumption was $490 billion in 2004. This comprises 61.4% of GDP. The consumption share of GDP has increased over time. The rate is lower than for the US (70%) and higher than for Japan (56%).

12. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-12 Investment Investment means additions to the physical stock of capital. This includes new construction, machinery, factories and additional inventories. Investment in human capital increases the labour force knowledge and skill. Gross investment represents total investment or the increase in capital stock. Net investment = Gross investment – Depreciation

13. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-13 Government Purchases Government spending represents purchases of goods and services. Transfer payments are not purchases. Government expenditure comprises purchases and transfers. Domestic final demand is the sum of public and private consumption and investment. Gross national expenditure (GNE) is final demand plus the increase in stocks ( change in inventories). GNE = C + I + G

14. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-14 Net Exports Net exports (NX): – Are the difference between exports and imports – Australian NX have been mostly negative. Gross domestic product (GDP) takes into account net exports. GDP = C + I + G + NX

15. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-15 Chapter Organisation 2.1Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

16. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-16 2.3 Some Important Identities An analytical model can be used to represent the set of national income relationships used in later chapters. To simplify the analysis assumptions are made to ensure that disposable income is equal to GDP. These assumptions are: – Depreciation is disregarded so that GDP = NDP. – Indirect taxes and business transfer payments are disregarded. – GDP is referred to interchangeably as income or output.

17. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-17 A Simple Economy A simple economy has two sectors. There is no government and foreign trade. Output produced equals output sold Y = C + I (2.4) Also, income is consumed or saved. Y = S + C (2.5) Therefore, I = S

18. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-18 Government and Foreign Trade The addition of the government and net exports creates a four-sector economy where: Y = C + I + G + NX (2.8) Disposable income (YD) includes transfers (TR) and is net of taxes (TA). YD = Y + TR − TA (2.9) Disposable income (YD) is consumed (C) or saved (S) YD = C + S (2.10)

19. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-19 Government and Foreign Trade Using Equations (2.9) and (2.10) to eliminate YD, substituting for C in (2.8) and rearranging, gives: S – I  (G + TR – TA) + NX(2.12) (G + TR – TA) represents the government’s budget deficit (BD). Identity (12.12) states that the excess of savings over investment (S – I) is equal to the budget deficit plus the external sector. S – I  BD + NX

20. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-20 Government and Foreign Trade S – I  BD + NX indicates important relationships between S – I, BD and NX. If S = I, then the budget deficit must be equal to the external deficit (twin deficits). If S = $1000m, I = $950m and the budget deficit is $150m, then NX must be equal to ? NX = –$100m. This reflects Australia’s budget and trade deficits in the early 1990s.

21. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-21 Chapter Organisation 2.1 Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3 Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

22. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-22 2.4 Measuring Gross Domestic Product GDP is the value of final goods and services produced. Including semi-processed goods will cause double counting. GDP is therefore the sum of value added in each production stage. GDP excludes the resale of existing commodities.

23. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-23 Measurement Problems Most household work and non-market activities such as volunteerism are not included. Pollution and environment degradation effects not included in GDP. Illegal activity and the underground economy cannot be accounted for. Government services may not be priced by the market.

24. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-24 Measurement Problems How to account correctly for improvements in the quality of goods? National accounts data is collected and frequently revised. Quarterly GDP growth figures can change by 1–2% at an annual rate. Other measures of living standards such as the human development index (HDI) can be used to supplement GDP measures.

25. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-25 Chapter Organisation 2.1 Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

26. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-26 2.5 Inflation and Price Indices Real GDP measures changes in output in the economy between different time periods by valuing goods at constant prices. Real GDP is measured in the national income accounts at the prices of 2002/03. In calculating real GDP physical output is multiplied by the prices that prevailed in 2002/03. This gives a measure of the value of current output if it had been sold at 2002/03 prices.

27. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-27 Inflation Inflation is the rate of change in prices. Australia’s inflation rate has remained around 2–3% p.a. since the mid 1990s. Two measures of inflation are the consumer price index (CPI) and the GDP deflator. (2.13)

28. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-28 Price Indices The GDP deflator is the ratio of nominal GDP to real GDP for a year. It is a broad-based price index. The consumer price index (CPI) measures: –A typical urban consumer’s cost of purchases –Based on a fixed basket of goods and services. The CPI is more narrow but includes import prices. Inflation (  ) is the rate of change in prices.

29. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-29 Chapter Organisation 2.1 Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

30. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-30 2.6 Inflation and Interest Rates Interest rates reported in the media are nominal rates. Real interest rate = nominal interest rate – (expected) inflation rate. A 10-year Treasury bond paying 5.23% p.a. with 2.3% annual inflation rate has a real return of ? Real return = 5.23% – 2.3% = 2.93%

31. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-31 Chapter Organisation 2.1Production of Output and Payments to Factors of Production 2.2Outlays and Components of Demand 2.3Some Important Identities 2.4Measuring Gross Domestic Product 2.5Inflation and Price Indices 2.6Inflation and Interest Rates 2.7Where to Find the Data

32. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz Slides prepared by Monica Keneley. 2-32 2.7 Where to Find the Data Data is available on the Internet –Australian Bureau of Statistics: www.abs.gov.au –Australian Treasury: www.treasury.gov.au –Reserve Bank of Australia: www.rba.gov.au –Resources for economists http://rfe.wustl.edu –US Bureau Economic Analysis: www.bea.doc.gov –World Bank: www.worldbank.org/data; –OECD: www.oecd.org/statistics; www.imf.org