CHAPTER 15 MACROECONOMIC ISSUES AND MEASUREMENT 339 ‘Agriculture, hunting, forestry, ‘and fisheries 10241 08 Mining and quarying 25,458 21 Manufacturing 148,097 mB ect, gas, and water supply 24953 20 Construction 65,923 547 + Wholesale and retail trade 132,113 os f Hotelsand restaurants 33,730 2B © Transport and communications 81,059 66 | Financial intermediation and E | realestate 266,485 28 | Publicadministration and Py defence 54935 45 © Education 62316 a ff © Health and social work 81518 a7 & (ther services 8,807 48 © Gross value added at current F basic prices 1,086,859 lus Adjustment to current basic prices (taxes minus subsicies on products) | GDP at market prices 137856 1,224,715 Figure 15.2 gives a stylized version of how income and expenditure interact with each other in what is called a circular flow diagram. To begin with, consider an eco- nomy that is made up solely of domestic individuals and domestic firms. For a moment we assume that the eco- omy has no imports or exports and no government. The individuals provide labour for the firms and they buy the firms! output. The income that flows to individuals is represented by the black line in the figure running up Table 15.1 gives the gross valu added by major indus- trial sectors for the UK-économy in 2005. You will see from this table that gross value added becomes GDP by the addition of further term (taxes on products minus subsidies) We will explain this step in moving from value auded 16 GDP below.* Oe that we have used ‘gross’ in two different senses "st in comparing the gross and net values of a firm's output, and then in the term ‘gross value added’ The first usage relies on the common meanings of ‘gross’ and ‘net’ The gross value of the firm's output s the total out- put before making any deductions, while the net value deducts inputs made by other firms. In ‘gross valueadded! the usage is different. Value added is already defined as firms’ net output; the word ‘gross is added because of its, specific meaning jrNational Accounts statistics. Gross’ in xints aggrogates refer to the fact that we are ently produced outputs or incomes with- into account the wearing out, or depreciation, died isthe value added of the economy as a whole before any allowance for depreciation, and gross domestic prod- ucts the nation’s output before allowing for depreciation. ‘This latter meaning will be used in many measures con- sidered below such as gross domestic product and gross national income. the left-hand side of the diagram, and their spending. con the final output of firms is represented by the black line running down the right-hand side. National output {or national income) can be measured either from the ‘Gross value added at basic pricesissimilar to what usedtobe called ‘GDP at factor cost, butte latter term fll out ofthe National Aecounts in 1998,340 Parts MACROECONOMICS: ISSUES AND FRAMEWORK Domestic households Financial system ‘Abroad Government & aartaxincme pid or Domestic producers x Figure 15.2 An economy is made up of income and ‘spending flows between firms and households. spending side in terms of spending on final goods pro- duced, or on the income side. These incomes of resource ‘owners can be measured either as the sum of values added in the economy or as the sum of individual incomes. In practice, final spending is not made up simply of individuals’ consumption spending, so when we approach the explanation of GDP from the spending side we neeg to add in investment spending, government consump. tion, and exports (the green lines) ‘We will refer backtto this diagram several times in future chapters. When we do so we will point out that, for the level of income and output to be constant (rather than rising or falling), the injections of spending from outside the circular flow must just equal the withdrawals (or leak. ages) from the circular flow. In the model to be developed in subsequent chapters, we call the injections exogenous or ‘autonomous spending, These are investment, government consumption, and exports, and are shown in the diagram in green, The leakages or withdrawals are taxes, saving, and imports, shown in blue. The circular flow diagram shows how incomes give rise to spending which gives rise to output which gives rise toincomes. Withdrawals, or leakages, arise from income that is not passed on in the circular flow through spending; while injec- tions are spending that does not arise out of incomes but is exogeneous. ‘The measures of national income and national product, that are used in Britain derive from an accounting system that has recently been standardized by international agreement and is thus common to most major countries. It is known as the System of National Accounts. A more detailed specification of this accounting system applies to all EU member states under the European System of Accounts 1995 (which was applied in all EU countries by April 1999 and was introduced into UK accounts in 1998). These accounts have a logical strugture, based on the simple yet important idea that all output must be owned. by someone. So whenever national output is produced, it must generate an equivalent amount of claims to that output in the form of national income. Corresponding to the two sides of the circular flow in Figure 15.2 are two ways of measuring national income: by determining the value of what is produced and the ‘value of the income claims generated by production. Both measutes yield the same total, which is called gross domestic product (GDP). When it iscalculated by adding, up the total spending for each of the main components of final output, the results called GDP spending-based. When, itis calculated by adding up all the incomes generated by the act of production, itis called GDP income-based All value produced in the form of output mustalso gener- atea claim to the income generated in the process of creat- ing that value. For example, any spending you make when you buy a TV set must also be received by the supplier of that set. The value of what you spend is the spending; the value ofthe product sold to you's the output. Thus, the two values calculated on income and spending bases are ident- ical conceptually, and they differin practice only because of errors of measurement. Any discrepancy arising from such errors is then reconciled so that one common total {sgivenas the measure of GDP. Both calculations are ofinter- est, however, because each givesa different and useful break down, Also, having two independent ways of measuring the same quantity provides a useful check on statistical procedures and on unavoidable errors in measurement. GDP‘spending-based FP spending-bas6d for a given yar is up the spending going topurch: lated bya d tne final output