1. The Measurement of Income and Prices Instructor: MELTEM INCE
Lecture notes 2
Instructor: MELTEM INCE

2. Types of Investment (I)
Inventory Investment is the change in the stock of raw materials, parts, and finished products held by businesses.
Fixed Investment includes all final goods (mainly structures and equipment) purchased by businesses not intended for resale.

3. Relation of Investment and Saving
Personal Saving (S) is that part of personal income that is not consumed or paid out in taxes
Also referred to as Private Saving
Algebraically: S = (Y-T) - C (where T = Net Taxes)
Funds from savings are channeled to firms in two basis ways:
Households buy bonds and stocks issued by firms
Households deposit savings in banks and other financial institutions that in turn lend money to firms
Firms use the money channeled from savings to buy investment goods

4. Net Exports and Net Foreign Investment
Exports are goods produced within one country and shipped to another
Imports are goods consumed within one country but produced in another country
Net Exports (NX) are equal to the excess of exports over imports
Net Foreign Investment (NFI) is equal to U.S. purchases of foreign financial assets minus foreign purchases of U.S. financial assets
Interesting connection: NX = NFI

5. The Government Sector
Government Purchases (G) is the value of goods and services purchased by the government at the federal, state and local levels
Transfer Payments (F) are payments from the government to households that do not require the recipient to provide a service in return
Examples: Social Security, Medicare, and Food Stamps
Government Spending = G + F
The Government pays for its spending by collecting Taxes (R) or by borrowing and/or printing money
Net Taxes (T) = R – F
Budget Surplus = T – G

7. Deriving the “Magic” Equation
The income accounting identity states that an economy’s income must equal its expenditures:
Y ≡ E 
Now, use the fact that household income must equal household outlays (and recall that T = R - F):
Y + F = C + S + R 
Equating (1) and (2) yields the “Magic Equation”
C + S + T = C + I + G + NX
 S + T = I + G + NX

8. Interpreting the “Magic Equation”
Recall the “Magic Equation:”
S + T = I + G + NX
Leakages (S + T) describe the portion of total income that is not available for consumption
Injections (I + G + NX) is a term for non-consumption expenditures

9. Measurig National Output
Gross National Product (GNP) : The market value of all the final goods and services produced within a country during a given time period-usually a year; equal to the sum of all values added in the economy.
Potential GNP ( Y*) : The real gross national product the economy could produce if its productive resources were full employed at their normal intensity of use. Also called full-employment GNP, full-employment national income.

10. Measurig National Output
Final Goods and Services : Many goods are produced in
the economy are not classified as final goods, but
instead as intermediate goods.
Intermediate goods are produced by one firm for use in
further processing by another firm or to produce final
goods. For example; weat is an intermediate good for
bread. So that is the value added to produce final goods
and services.

11. Measurig National Output
Value added: During some stage of production is the
difference between the value of goods as they leave a
stage of product,on and the cost of the goods as they entered
that stage. Value added is the value of firm’s production –
all the inputs value which gets from other firms. Sum of
value added = wage + rent + profit +interest.

12. Example
Production level Market Value cost of intermediate good Value Added
Wheat TL TL
Flour TL TL TL
Entrepreneurship TL TL TL
Bread TL TL TL
12600 TL TL TL
As you’ve seen, the market value of bread (final good) 5000 TL. also
includes the market values of wheat, flour and entreprenurship services.
In that reason; GNP is sum of the market value of all the final goods
and services = sum of all values added.

13. Nominal GDP, Real GDP, and the GDP Deflator
Nominal GDP is the value of gross domestic product in current (actual) prices.
Real GDP is the measure of gross domestic product using prices of an arbitrarily chosen base year.
The GDP deflator is a price index that measures the aggregate economy’s price level.
Algebraically: GDP Def = Nominal GDP / Real GDP * 100
The percentage change in the GDP deflator gives a measure of the economy’s inflation rate.

14. The Expenditure Approach
Expenditure approach a method of computing GDP that measures
the amount spent on all final goods during a given period.
Expenditure categories:
personal consumption expenditures ( C): household spending on consumer goods.
Gross private domestic investment (I ) : spending by firms and households on new capital , i.e. plant, equipment, inventory etc.
Government consumption and gross investment (G ): expenditures by state and local governments for final goods and services.
Net exports (EX-IM) : net spending by the rest of the world, or exports minus imports.
GDP = C + I + G + (EX - IM)

16. The Income Approach
A method of computing GDP that measures the income
–wages, rents, ineterst, and profits- received by all
factors of production in producing final goods. Personal
income is the income received by households before
paying personal income taxes. The amount of income
that households have to spend or save is called
“disposable personal income” or after-tax income. It is
equal to personal income minus personal taxes.

18. GNP - GDP
The difference between GDP and GNP is; GDP is the market value of all the final goods and services that are produced by that nation’s production factors but GNP also includes the market value of all the final goods and services that are produced by foreigners. On the other hand; GDP measures the output located in that country.
Ex: only goods and services that are produced within a “country” as part of that country’s GDP. Toyota, a Japanese firm, produces automobiles if in Turkey, and the value of this production is part of Turkey’s GDP, not part of Japan’s GDP.

19. Growth Rate
We use estimates of real GDP to calculate teh economic growth rate. The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next.
Economic growth rate = Real GDP(t) -Real GDP(t-1) X 100
Real GDP (t-1)

20. National Income The value of a nation’s total production of goods and
services is called its “national product”. Hence when we
study national product we are also studying national
income.
National Income =Total consumption expenditure Total savings

22. National Income National income is the total amount earned by the
factors of production in the economy; it is equal to NNP
except for a statistical discrepancy.
GNP – depreciation = Net NP
Net NP – Ti = National Income

24. The Consumer Price Index (CPI)
A price index measures the price level at a given period
relative to the base period. The Consumer Prices Index
(CPI) covers price of commodities commonly bought by
households. Changes in the value of the CPI are meant
to measure changes in the typical household’s “cost of
living”. Government statisticians periodically survey a
group of households to discover how they spend their
incomes.