Ec 123 Section 2

1. Ec 123 Section 2 • THIS SECTION • National Income Accounting • Prices • Examples: The Great Depresssion & Japan • NEXT • No class 4/14 • Section 3: The theory of output determination/dynamics Ec 123 Section 2

2. Discussion • What should be the goals of macroeconomic policies? • How should they be measured? Ec 123 Section 2

3. National Income Accounting • Gross Domestic Product (GDP) is the market value of all final goods and services produced within the territory of a country for a given time period. • all goods and services are valued at market prices • only final goods & services--no double counting • only goods and services which pass through organized markets are counted. • Gross National Product = GDP + [income by nationals from abroad] - [income by foreign nationals, produced domestically] Ec 123 Section 2

4. National Income Accounting GDP is not a measure of welfare (at least not directly): • only market activity gets counted. • places no value on leisure time. • "bads" as well as "goods" get counted: cost of wars and cleaning up disasters get counted. • ecological costs are not counted. Two ways to breakout GDP: Expenditure method and Income method Ec 123 Section 2

5. Circular Flows in the Economy Foreign Countries Foreign Borrowing Foreign Savings Imports (M) Exports (X) Income (Y) Investment (I) Firms Households Consumption (C) Govt. Spending (G) Taxes (T) Taxes (T) Govt. Transfers (TR) Savings (S) Borrowing Government Govt. Borrowing Financial Markets Ec 123 Section 2

6. Expenditure breakout of GDP GDP = C + I + G + (X-M) where • Consumption (C): consumer spending on final goods and services for current use. • Investment (I): private expenditures on new plant and capital (does not include purchase of paper assets). • Government Spending (G): federal, state and local spending of new goods and services; does not include transfer payments (ex., social security). • Net Exports (X-M): exports represent an inflow of income, imports an outflow. Ec 123 Section 2

7. Expenditures on Good & Services Foreign Countries Imports (M) Exports (X) Investment (I) Firms Households Consumption (C) Govt. Spending (G) Government Financial Markets Ec 123 Section 2

8. Income breakout of GDP Start with Y + TR = C + S + T where • Aggregate income (Y): total private income. • Government transfer payments (TR): Social security, food stamps, farm subsidies, etc. • Gross private savings (S): income put aside for future consumption by households and businesses • Taxes (T): total taxes paid to local, state and federal govt. Substitute Y = GDP into top equation and rearrange: GDP = C + S + (T-TR) Ec 123 Section 2

9. Income breakout of GDP Foreign Countries Income (Y) Firms Households Consumption (C) Taxes (T) Govt. Transfers (TR) Savings (S) Government Financial Markets Ec 123 Section 2

10. A useful manipulation Substitute the expenditure breakout for GDP to obtain: C + I + G + (X-M) = C + S + (T-TR) Implications: • A fiscal deficit must be financed by lower investment, higher private savings, or increased foreign borrowing. • An increase in savings will lead to increased investment, an increased fiscal deficit or an increase in net exports. • A decline in net exports is associated with lower domestic savings, a larger fiscal deficit, or increased investment. Ec 123 Section 2

11. Nominal versus real quantities • Nominal GDP is measured by the prices of the time under discussion: ex., nominal Japan GDP1998 = ¥498,499.3 billion • Real GDP. To make real comparisons of goods and services across time, we need to adjust for inflation. • To convert nominal to real quantities, we adjust for inflation through use of price indices. • The index number for 1998 is 103.7 (base year 1990). Interpretation: Prices in 1998 were 103.7% as high as in 1990. Ec 123 Section 2

12. Traditional Price Deflators Put another way, the GDP price deflator for 1955 (P1955) is 17.8. Then, We can construct price deflators for other items of national income accounts (investment, manufacturing, etc.), and use them to compare how these items change over time. Ec 123 Section 2

13. Japan Background “First of all, there is the problem of whether or not Japan, regardless of the political and economic system she eventually chooses, can maintain any satisfactory standard of living in the future. She cannot grow enough food to feed all her people…All she has to offer on the the world market is her own energy--manpower and energy of coal and water. With these she can transform imported raw materials into goods for re-export. The slim margin of profit from this re-export trade must be sufficient to pay for all the imports Japan must have to support her own people. To do this Japan’s export trade must be huge. But where is she to find the markets in a divided world and in a Far East disrupted by revolutions and bitterly determined not to trade with her? Japan’s situation is basically similar to England’s, but infinitely worse. She is far less richly endowed with the vital resources of coal and iron…She is less highly industrialized. She has no overseas empire to aid her, but instead a legacy of distrust and hate. And she has almost twice the population to support on her meager resources.” - Edwin O. Reischauer, The United States and Japan, 1950 Ec 123 Section 2

14. Japan: The Miracle Years • What is Japan’s development strategy? • How does Japan achieve this strategy? Ec 123 Section 2

15. Summary • GDP is a measure of economic output that is often used as a benchmark for economic policy success. • Growth in GDP can be achieved through policies changes in investment, consumption, and government spending. • Japan’s ‘miracle’ growth was fueled by rampant large-scale investment and export growth. Ec 123 Section 2