Economics for CED

1. Economics for CED Noémi GiszpencSpring 2004Lecture 6: Macro: Measurementof the National Economy April 6, 2004

2. 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. Economics for CED: Lecture 6, Noémi Giszpenc

3. 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. Economics for CED: Lecture 6, Noémi Giszpenc

4. 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” Economics for CED: Lecture 6, Noémi Giszpenc

5. 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 Economics for CED: Lecture 6, Noémi Giszpenc

6. 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! Economics for CED: Lecture 6, Noémi Giszpenc

7. 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. Economics for CED: Lecture 6, Noémi Giszpenc

8. 3 ways to measure • BEA collects data from numerous sources: IRS, surveys, customs, etc. • Constructs GDP using 3 methods: • The expenditure method • Income method • Value added method • In theory all 3 measures should give same value for GDP, but there are statistical discrepancies. Economics for CED: Lecture 6, Noémi Giszpenc

9. 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) Economics for CED: Lecture 6, Noémi Giszpenc

10. 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) Economics for CED: Lecture 6, Noémi Giszpenc

11. 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. Economics for CED: Lecture 6, Noémi Giszpenc

12. The income method • This method attempts to add up the net income of all employees and businesses, before taxes. Economics for CED: Lecture 6, Noémi Giszpenc

13. 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 Economics for CED: Lecture 6, Noémi Giszpenc

14. 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: • Will country be better able to produce in future? • How many people must that production support? • Does it actually support all those people? How? Economics for CED: Lecture 6, Noémi Giszpenc

15. 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 Economics for CED: Lecture 6, Noémi Giszpenc

16. 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… Economics for CED: Lecture 6, Noémi Giszpenc

17. 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 Economics for CED: Lecture 6, Noémi Giszpenc

18. 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: • More stuff produced • Prices rise with no change in quality • Prices rise with increase in quality • BEA treats the last two differently. This will be the topic of the next lecture! Economics for CED: Lecture 6, Noémi Giszpenc