Tuesday, June 16, 2009

The Language of Macroeconomics: The National Income Accounts

Paraphrasing Macroeconomics: Understanding the Wealth of Nations. By David Miles, Imperial College, and Andrew Scott, London Business School. Chichester, UK: John Wiley & Sons, 2005

Chapter 2
The Language of Macroeconomics: The National Income Accounts

2.1 What Do Macroeconomists Measure?

At the foundation of macroeconomics is a concern with human welfare[, but it] is notoriously hard to calculate, particularly in macroeconomics where the relevant measure is the welfare of society as a whole. Even if we could accurately measure individual welfare, how can we compare levels of happiness across individuals and construct an aggregate measure?

Rather than try and directly measure welfare, macroeconomists take a short cut. They focus on the amount of goods and services—the “output”—produced within an economy. The justification for this is simple—if an economy produces more output, then it can meet more of the demands of society. Using output as a measure of welfare [now begs] many questions[, since there is no consensus on values and half of the population worries about the environment, inequality, etc.]

These questions suggest that output will only be an approximation to wider concepts of welfare ... But producing more output should enable a society to increase its standard of living.

2.2 How Do Macroeconomists Measure Output?

> Real vs Nominal output

Chained weights

GDP deflator = Nominal GDP/Real GDP

Real GDP focuses on how production in the economy changes by using constant prices. Nominal GDPchanges because of changes in production and changes in prices.

2.3 Output as Value Added

Value added is the difference between the value of the output sold and the cost of purchasing raw materials and intermediate goods needed to produce output.

2.4 National Income Accounts

Output, income and expenditure

AD: aggregate demand
AS: aggregate supply

AD = Y output + M imports = C + I + G + X, or Y = C + I + G + (X-M) (net exports)
I = Ik gross fixed capital formation (the new capital stock installed) + Iinventories (output not sold)

Is it true that AD = AS = Y? No:

Desired AD = C + Id + G + X, Id = Ik + Iidesired
Actual AD = C + Ia + G + X, Ia = Ik + Iiactual

---------> Actual AD = AS = Y

GDP can be measured either as value of output produced, the income earned in the economy by capital and labor, or the expenditure on final products.

> GDP or GNI?

GNI = GDP + remittances_nationalcompanies + remittances_nationals + Foreign aid you receive - remittances_foreigncompanies - remittances_foreignindividuals - Foreign aid you give to others

2.5 How Large Are Modern Economies?

Comparing countries' GDP via exchange rates

Comparing countries' GDP taking into account PPP

GDP per capita

2.6 Total Output and Total Happiness

GDP measures economic activity, but is a good measure of standard of living?

There are two separate issues lurking here. The first is a measurement one—is GDP correctly measured (which is not) and, if not, does this reduce its ability to approximate the standard of living? Some see corrections to make:

Families frequently have money earners and people that provide services (cooking, child caring, elderly caring, administration). Purchasing these services and goods in the market is a substantial amount. For 2000, the U.K. Office of National Statistics estimates that compared with GDP of £892bn, household production provided services that would have been worth £693bn if purchased through the market with childcare accounting for £220.5bn.

Another measurement problem for GDP is environmental pollution and the destruction of natural resources.

The second is a conceptual one—even if it is properly measured, does GDP really capture our concepts of welfare? For economists, measures of aggregate output are still the dominant indicators of the standard of living, but alternative measures have been suggested: Human Development Index (HDI).

Although there are these patterns of outliers, the overall correlation remains strong—GDP seems a useful approximation for even broader measures of welfare.


FAST ANWSERS, not checking the literature

1. (Section 2.2) “[An economist] is someone who knows the price of everything and the value of nothing.” (Adapted from George Bernard Shaw.)

Besides mediocre economists, who damage the profession with badly communicated opinions, there are truths (the state of knowledge at least) that are inconvenient for others to hear, and this knowledge seems too cold, rational and unsensitive to the needs of the poor. If 90 pct of the people had an economic education probably the number of bleeding hearts would diminish. Or not.

2. (2.3) Coffee beans cost only a few cents when imported. But to buy a coffee at a coffee bar costs far more. What does this tell you about value added?

3. (2.3/2.4) Try to explain to someone who had never thought about measuring the value of economic activity why the output, income, and expenditure ways of measuring national production should give the same answer. It helps to think of a simple economy producing only two or three different things.

4. (2.5) Would you expect that a country where the share of wages and salaries in GDP was falling, and the share of profits and interest was rising, to be one where consumption as a percent of national income was also shifting? Why? Would you expect the distribution of income to
become more unequal? Suppose the trends were due to demographic shifts, more specifically to a rapidly aging population. Would this change your answers?

5. (2.5) Do you think it is easier to evaluate the relative welfare of different generations of people in one country (by comparing per capita GDP over time), or to compare the relative standards of living in different countries at a point in time (by converting current per capita GDPs into a common currency)?

6. (2.5) How would you treat the activities of criminals in GDP accounting? What about the activities of the police force?

.1 Parasites
.2 A waste of resources, a tax on the economy.

7. (2.6) The Beatles claimed that “I don’t care too much for money, money can’t buy me love.” (Shortly after first making this claim they joined the ranks of the richest people in the world.) Does their claim undermine the use of GDP to measure welfare?


For another day.

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