Economics for CED

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Economics for CED

• Noémi GiszpencSpring 2004Lecture 6 Macro
  Measurementof the National Economy
• April 6, 2004

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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)

• Lifes 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 countrys 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
• The expenditure method
• Income method
• 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 govt spending on goods
  and services
• Not equal to total govt spending, because it
  does not include transfer payments
• If govt buys cheese and gives away, count, if
  govt gives money for person to buy cheese, dont
  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.

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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.
• Doesnt 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?

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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 goodsservices.
• 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!