Economics for CED Noémi Giszpenc Spring 2004 Lecture 6: Macro: Measurement of the National Economy April 6, 2004

Economics for CED

Noémi GiszpencSpring 2004

Lecture 6: Macro: Measurementof the National Economy

April 6, 2004

4/06/04 Economics for CED: Lecture 6, Noémi Giszpenc

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• Before Adam Smith… there was François Quesnay (1694-1774), physician in the court of Louis XV– Argued that the wealth of a nation lies in

the size of its net product– The “natural state” of economy conceived as balanced

circular flow of income between economic sectors (and thus social classes) which maximized the net product.

• In these concepts, Quesnay saw analogies to the circulation of human blood and the homeostasis of a body.


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Simon Kuznets (1901-1985)• Life’s work was collection and

organization of the national income accounts of the U.S.

• Prior to WWI, measures of GNP (gross national product) were rough guesses.– No government agency collected data to compute GNP; neither did any private

economic researcher.

• He broke GNP down by industry, final product, & use.

• Measured the distribution of income between rich & poor.

• Helped the U.S. Dept of Commerce standardize GNP measurement.

• Wanted the dept to measure the value of unpaid housework. – The department refused, and still does.


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International Relations and Economic power

• “In that setting we tend to think about three different concepts of power: (1) military power, (2) political power, and (3) economic power. Ultimately, the first two of these depend on the third for their strength.”– G. Edward Schuh, “Remarks on Economic Power”


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WWII and GDP

• A well established predictor of military victory in “great power” warfare is GDP (Gross Domestic Product).

• The GNP index was originally devised to measure the mobilization of arms production during WW II


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What is Robinson Crusoe's National Income?

• His income is what he produces:– coconuts he gathers,– fish he catches,– objects he makes, furniture & tools.– a stockade.

• He allocates production between:– Consumption goods & services– Capital goods (tools, fishing raft)– Government (stockade).

• Moral of the story: – Crusoe's opportunities to consume, invest, and defend are

limited by his ability to produce!


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Measuring national income

• Bureau of Economic Analysis (BEA) responsible for national income and product accounts (NIPA)

• 2 main measure of national income:– Gross domestic product (GDP)

• Measures production in the country• Data quality better

– Gross national product (GNP)• Measures income accruing to country’s residents

– Difference between GDP/GNP is small (~1%) for US. Can be bigger for small countries.


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3 ways to measure

• BEA collects data from numerous sources: IRS, surveys, customs, etc.

• Constructs GDP using 3 methods:1. The expenditure method

2. Income method

3. Value added method– In theory all 3 measures should give same value

for GDP, but there are statistical discrepancies.


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The expenditure method

GDP = consumption + investment + government purchases + net exports

• Consumption: spending by households on:– New durable goods– Non-durable goods– Services

• Investment: spending by firms on:– Fixed investment: plant, equipment

• Divided into residential (new housing) & non-residential

– new inventory (decreases in inventory are minuses)


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Expenditure method continued

• For investment: Note that we do NOT include spending on materials (including intermediate processed goods) or labor.– Doing so would be double counting

• Government purchases: gov’t spending on: goods and services– Not equal to total gov’t spending, because it does

not include transfer payments• If gov’t buys cheese and gives away, count,

if gov’t gives money for person to buy cheese, don’t count. (but then count the cheese purchase)


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Expenditure method continued

• Net exports = exports of goods and service to the rest of the world, minus imports

• All of these should add up to the total spent--and therefore purchased from the country--during the time period.– Therefore should also add up to the total earned

during the time period--the national income.


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The income method

• This method attempts to add up the net income of all employees and businesses, before taxes.

Composition of national income, 1995, $billions

Wages & salaries 4,209 } labor’s share, 73%

Owner’s income 478

}profit’s share, 27%

Rental income 122

Corporate profits 589

Net interest earned 401

National income 5,799


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The value-added method

• Value added by a firm is the difference between the revenue a firm earns by selling its products and the amount it pays for the products of other firms it uses as intermediate goods.– Example: firm buys $1,000 of wheat, mills and bakes

it using $1,000 of labor. The firm sells the bread for $2,500, making $500 profit. The value added is $1,500 ($2,500 - $1,000).(Income is $1,000 to labor plus $500 profit.)(Expenditure is $2,500 by consumers of bread.)

• Only last measures for whole economy; 1st 2 just for firm


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Size does matter, but…

• What raw GDP tells us is limited.• Only shows what was produced by entire

country in one time period.• Doesn’t answer:

1. Will country be better able to produce in future?

2. How many people must that production support?

3. Does it actually support all those people? How?


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1. Costs of production

• The “gross” in GDP/GNP means that these are measures before costs (such as depreciation) are counted.– Adding in depreciation yields Net national

product--a more accurate (but less precise) measure

– Depreciation of capital reduces ability to produce later

• Especially important from point of view that wealth is created by both man-made capital and natural capital


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2. Population

• The same GDP/GNP divided among more or fewer people can mean very different things about residents’ quality of life or purchasing power– So we talk about per capita GDP when we

are measuring “average income” in nation– This may not be the best way to measure

national standard of living…


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3. Inequality

• The same GNP distributed differently has very different meanings for economic welfare.

• Remember from last class on insurance, most people have a diminishing marginal utility of wealth: – therefore we can fairly safely assume that

a more equal distribution produces more utility than an unequal one


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How does GNP change over time?

• You may have noticed that value of GNP is measured in dollars, not stuff.

– Measured using prices of goods&services.

• Therefore GNP can go up in three ways: 1. More stuff produced

2. Prices rise with no change in quality

3. Prices rise with increase in quality• BEA treats the last two differently. This will be

the topic of the next lecture!

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Economics for CED Noémi Giszpenc Spring 2004 Lecture 6: Macro: Measurement of the National Economy April 6, 2004