National Income and Product Accounts

Motivation

We begin by studying the system of National Income and Product Accounts, referred to

as NIPA. A thorough understanding of the NIPA is needed to complete Step 3 of the

calibration method. Recall that Step 3 of this method was Defining Consistent Measures.

Recall that the calibration method requires that one be able to compare data in the NIPA

with data generated by the model. A model, by definition, is an abstraction of reality. As

such, the data generated by the model typically will not have the level of detail as that

found in NIPA. For example, often we will study a model of a closed economy where

there is no interaction or trade between countries. In the real world, countries trade with

each other, and the quantity of trade will be listed under the categories of Net Exports in

NIPA. There will be no imports or exports in a closed economy model. Consequently,

we will need to make some adjustments to the NIPA, namely a reorganization of the

expenditure categories so that the model and the data can be compared.

I. Output Side
A. Type of Goods- Consumption, Investment and
Intermediate Goods

Conceptually, there are three types of goods that any economy produces: Consumption,

Investment and Intermediate Goods.

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Consumption Goods

Consumption Goods and Services are things that are consumed by people. If the good

(say an apple) or the service (say dry cleaning) is consumed individually, it is referred to

as private consumption. Some goods and services are consumed collectively by people.

These are called Public Consumption or Government Consumption. Some examples of

these types of goods and services are police services, fire services, judicial services and

public education.

Investment Goods

Investment goods or capital goods are goods that enhance future productivity. These

goods are to be used in the future to produce other goods and services. A key feature of

these goods is that they are durable, namely, they are not completely used up in the

production process. Investment goods take the form of new machines and new

equipment. They also take the form of new structures such as a new factory building and

a new house.

Intermediate Goods

Intermediate goods and services are completely used up in the production of another

good or service in the period. An example of an intermediate good is a bag of flour that

is bought by a baker to make bread. What is left in the cooking process is the loaf of

bread; the flour that was used to make the loaf is no longer on the shelf.

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A household may also buy a bag of flour to make a loaf of bread. Even though the flour

bought by the household is completely used up in the process, it is not an intermediate

good. Instead, the flour bought by the household is a final good, more specifically, a

consumption good. This leads to an important point. For a good to be classified as an

intermediate good, it must be purchased by a business.

Examples of Goods Purchased by Businesses

• Computer (Investment Good)

• Desk (Investment Good)
• Car Bought for Firm Use (Investment Good)
• Car leased by a firm for its sales force (Intermediate Good)
• Pencils (Intermediate Goods)

Final Goods

Final goods are defined to be both consumption goods and investment goods.

I.b Aggregate Measures of Output

An economy’s output in a given period is the value of the final goods it produces in the

period. The value of the intermediate goods and services produced by an economy are not

included in its output. The reason for this is that the value of intermediate goods is

reflected in the price of the final good. For example, the price of the loaf of bread bought

from the baker reflects the value of the flour that was used in making the loaf of bread.

Including the value of intermediate goods in a country’s output is not necessary, as the

value of intermediate goods is reflected in the value of the final product. Excluding their

value is necessary, or else we would be double counting intermediate goods.

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GDP and GNP

Gross National Product (GDP) is the market value of all final goods and services

produced within an economy’s borders in a given period.

Gross National Product (GNP) is the market value of all final goods and services

produced with an economy’s resources.

An economy’s resources are its citizens, the land owned by its citizens and the capital

owned by its citizens in the form of structures, machines and equipment.

The key distinction between GDP and GNP is the location of production. With GDP,

location of production is the only thing that matters: ownership of the resources used to

produce the good or service is completely irrelevant. The opposite is the case with GNP.

Here, the country to which a resource belongs, and not the country in which the resource

is located matters. For example, the entire value of the cars produced by the Honda car

manufacturing facility in 2005 located in Ohio is included in US 2005 GDP. However,

In the last 15 years, GDP has become the measure of choice. What is the reason for this?

I.c National Product Accounts and Theory

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The national income and product accounts do not divide output between consumption

goods and investment goods. Instead, NIPA divides output into 4 categories based on the

identity of the purchaser. These four categories are: Consumption, Investment,

Government Expenditures, and Net Exports. For some purposes it is useful to know

what groups in the economy are buying its final product. All of these purchases, in the

end are either in the form of consumption goods or investment goods. For three of the

four expenditure categories (and their subcategories), it is obvious whether the purchases

are consumption goods or investment goods. Table 1 reclassifies the expenditure good

categories in the National accounts as either Consumption Goods (C) or Investment

Goods (X)

Table 1

Expenditure Category Theoretical Classification

Consumption Expenditures

• Non-Durables C
• Services C
• Durables X
Investment Expenditures X

Government Expenditures

• Government Consumption C
• Government Investment X
Net Exports ?

Consumption durable goods are televisions, cars, TVs, stoves to name a few. These

goods are not used up with their use, and hence are by nature investment goods. In

contrast, food, electricity, which are example of non-durable goods, and dental cleaning,

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dry laundry, which are examples of services, are completely used up, and hence are by

nature consumption goods.

Some Government expenditures such as on police, fire, the legal system and public

education, are purchases of services that are enjoyed publically. Hence, these

expenditures, which in the National Accounts, go under the heading of Government

Consumption are in theory Consumption goods. Other government expenditures, such as

roads, bridges, dams and levees, which are not used in the period they are built, but rather

provide services well into the future, go under the heading of Government Investment in

the National Accounts and are in theory Investment Goods.

The one expenditure category that is not easy to classify as either Investment goods or

Consumption goods is Net Exports. Net Exports is the difference between Exports and

Imports. Imports need to be subtracted because the Consumption, or Investment, or

Government Expenditure categories do not distinguish if the final good purchased by the

consumer, business or government agency was domestically produced or foreign

produced. If the bulk of net exports (associated with a trade deficit) consisted of TVs

made in Taiwan, then the bulk of net exports would be in the way of investment goods.

category of final goods, being either consumption goods or investment goods.

1.d Real and Nominal GDP

Often we will be interested in comparing a country’s output across two different years.

For this purpose, the appropriate measure to use is Real GDP.

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Nominal GDP in year t is the value of the final goods and services produced in year t

evaluated in year t prices. Let pnt denote the year t dollar price of the nth final good

produced in the economy and let qnt denote the quantity of the good produced in that

year. Then, if there are N goods, then

Nom GDPt = p1t q1t + p 2t q 2t + ..... + p Nt q Nt . (1)

Real GDP in year t is the value of the final goods and services produced in year t

evaluated in the prices of a base year. Let pBt denote the year B dollar price of the nth

final good produced in the economy. Then

Re al GDPt = p1B q1t + p 2 B q 2t + ..... + p NB q Nt . (2)

Why is real GDP a better measure for comparing the amount of final goods and services

produced by an economy between two periods? As Equation (1) reveals, Nominal GDP

from one year to the next may differ because of differences in prices between years as

well as differences in quantities between years. With Real GDP, the price used to value

the quantities in each year is the same. Hence, Real GDP reflects only quantity changes

between years. Thus, when making comparisons across time, Real GDP is the superior

meausure.

1.e Growth Rate Calculations

For year to year comparisons, the growth rate of GDP can be calculated as the percentage

change of the variable. For some purposes, particularly the purpose of growth we will

take an average growth rate over some period of time. To compute this growth rate, we

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typically assume that the GDP increases geometrically over time. More specifically, we

assume that

Yt +1 = (1 + γ )Yt (3)

where γ is the growth rate. It follows that

Yt = (1 + γ ) t Y0 . (4)

Typically, we shall want to calculate the value of γ associated with a period of time say

from 1950 to 2000. In that case,

Y2000 = (1 + γ ) 50 Y1950 . (5)

To compute γ, we take the logarithm of both sides. Exploiting the properties of the

natural log, this is

log(Y2000 ) = 50 log(1 + γ ) + log(Y1950 ) , (6)

or

[log(Y2000 ) − log(Y1950 )] / 50 = log(1 + γ ) . (7)

The left hand side is a number that you can compute with the calculator provided on your

computer. Call this number z. Once this number is determined, there is one final step to

actually solve for γ. Given,

log(1 + γ ) = z , (8)

we can solve for γ by applying the inverse function of the natural logarithm, the

exponential function, e. As this is the inverse function, we arrive at

(1 + γ ) = e z . (9)

1.f Logarithm of Output and plotting

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If we applied the logarithm function to equation (4) we obtain a linear equation for the

logarithm of Yt as a function of time, t. This is

log(Yt ) = t log(1 + γ ) + log(Y0 ) . (10)

The slope of this equation is the log(1+γ) which is approximately equal to γ, and the

vertical axis-intercept is log(Y0). Thus, if we plot the log of output the slope of the line

represents the average annual geometric growth rate, γ.

II. National Income Account

II. a Claims on Value Added and National Income

Definition. Value Added by a business (firm) is the value of production minus the value

of intermediate goods used up.

For example, if a bakery has the following input costs incurred to produce loaves of bread

that sell for $2.00/loaf, the value added is

Inputs:
Flour 5 lbs x $1.00/pound
Yeast 3 cups at $1.00 cup
Labor: 1 hour at $10.00/hour

Output: 10 loafs at $2.00/loaf

Value Added= $20.00 - $5.00 - $3.00 = $12.00

The intermediate goods are flour and yeast. Labor is not a good.

The sum of value added over firms in the economy is equal to its national product. Thus

we can alternatively calculate an economy’s GDP or GNP by using value added data of

firms in the economy.

Definition: Aggregate Income is the sum of claims against the value added by businesses.

Since Value Added equals aggregate output, aggregate income equals aggregate

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output. The reason for this as we shall see is that every business has a residual claimant.

The claim of the residual claimant is the value added of the business less the claims by all

other claimants. For a corporation, the residual claim is called corporate profits; for an

unincorporated business, the residual is called proprietor’s income; for the government, it

is called profits of government enterprises less subsidies. For owner occupied housing,

the owner is treated as a business that rents the dwelling to the owner. The residual in

this case is called rental income.

The major categories of claims against product listed in the National Income Accounts

are:

• Indirect business taxes (property, sales, and excise taxes)

• Business transfers (bad debt between businesses)

• Wages, Salaries and Other compensation

• Profit of Government Enterprises less subsidies

• Net Interest Payment (Business Net Interest Payments plus Home Mortgage

Interest Payments)

• Capital Consumption allowance (Depreciation)

• Proprietor’s Income

• Rental Income

• Corporate Profits

Only net interest paid by businesses and home mortgage interest payments are included.

As we shall show later on, the net interest paid by businesses and home mortgage interest

proxies for the return to capital equipment and structures. Most businesses own their own

capital so there is no explicit payment made by businesses for capital inputs. Theory as

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we shall see later on in the book shows that the rental price of capital is equal to the

interest rate and the depreciation rate- the fraction of capital that wears out with use. This

also explains why depreciation is a claim on value added.

Residuals

We can now define residuals.

Corporate profits = Value Added – Depreciation – Indirect Business Taxes – wages,

Salaries and Other Compensation – Business Transfers

Proprietor’s Income is identically defined. Similarly, Profits of Government Enterprises

Less subsidies is the residual of government owned and operated enterprises, such as the

Department of Justice, Federal Reserve Banks, Federal Trade Commission, Food and

Drug Administration. Etc.

Rental Income

The value added of houses that are occupied by the owner is equal to Rents (imputed and

entered as part of Consumption services in the expenditure categories) less maintenance.

Rental Income = Value added – Depreciation – Mortgage Interest Payments – Property

Taxes – Wages, Salaries, and Other Compensation (if any)

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III. Other Macro variables
There are other important macro variables that are typically covered in textbooks on the

macro economy. The price level and unemployment rate are two such variables. For

reasons of space and time, we shall not discuss these variables at this point. Indeed, in

the majority of models we shall study, there will be no money or nominal prices. The

model economies for this reason are called real economies. Money and nominal prices

are not essential to trades in these worlds. There are still prices, but they are real or

relative prices. Namely, the price of one good (say labor) can be expressed in terms of an

other good (say apples).

You might not know it, but you deal with relative prices all the time. The money

prices of any two goods tell us their relative price. For instance, suppose you go into a

grocery store and see that an orange costs $.50 and an apple costs $1.00. Then you know

that with a dollar you could buy either 1 apple or two oranges. So one apple costs 2

oranges. What you have just calculated is the relative or real price of an apple in terms of

oranges. These are the types of prices that will be in our models. .

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