GLOBAL ECONOMICS: PGP

SHEKHAR TOMAR

Session 1: Introduction &

National Income and Product Accounts

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1.0 MOTIVATION
Impact of a Crude Price Shock

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 Impact of a Crude Price Shock
Consumer Firm
Direct Effect Direct Effect
- Fuel price ↑ - Input cost ↑
Demand wage ↑ - Transport cost ↑
Indirect Effect
- Price of other Indirect Effect
commodities ↑ - Wages ↑
↑ Prices

Action Action
- Substitute car with metro - Substitute input
¯ Consumption
- Eat out less - Cut production
- Demand higher wages - Change prices
Tax cut Increase tax or decrease Pay Higher
on fuel subsidy on non-fuel Government taxes Crowding Out

- Impact on taxes/fiscal deficit - Increase subsidy on fuel/tax cut Credit

Borrowing - Current Account Deficit - Cut Expenditure
RBI

↑ Interest Rate

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Standard Macroeconomics
Question

• Multiple players
• Consumers, Firm, Government, Central Bank (RBI)

• Actions
• Choose consumption, expenditure, inputs, taxes, etc.

• Optimization
• Utility, profit, balance budget, control inflation

• Statistics/Indicators

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The Inter-connected
Economy

• Businesses are influenced by and influence the national and

global economy

• In addition to “idiosyncratic” (micro) factors, “aggregate”

(macroeconomic) factors affect firm performance

• Firm performance and corporate profits in turn affect

aggregate output and growth

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Macroeconomics and the Firm
The role of aggregate market forces on firm’s cash flows

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What is Macro/Global
Economics?

• Study national economy, as a whole

• Macroeconomics = Microeconomics + Aggregation
• Focus is on economy-wide variables:
• Long-run economic growth
• Business cycles
• Unemployment
• Inflation
• Monetary Policy, Fiscal Policy
• The international economy (trade, exchange rates)

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Course Objectives

Learn Analyze Evaluate

Learn concepts - Government policy Critically evaluate

affects economy
and tools used to arguments in the
understand and - “Shocks” affect financial press
economy
analyze the global - Economic news
economy affects interest rates,
asset prices, and
exchange rates

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TOPICS

• National Accounting
• GDP
• GNP

• Real vs. Nominal

• Other Topics
• HDI
• PPP

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 NATIONAL
1.1 ACCOUNTING
National Income and Product
Accounts (NIPA)

• Understand the terminology

• Accounting relationships for the economy

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Three ways of measuring GDP

• The Gross Domestic Product (GDP) is a measure of the total

economic activity in a country in a given year

• It can be measured in three ways:

• Production (Value Added) Approach: Output produced,
excluding output used in intermediate stages. What is
made?

• Expenditure Approach: Amount spent by the ultimate

purchasers of output. What is bought?

• Income Approach: Income received by producers of output.

How or with what is it bought?

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Other Definitions

• Gross National Product (GNP) is value created by factors of

production owned by the country’s citizens, no matter where
the factors are located (country’s income)
GNP = GDP + income from abroad - income sent abroad
GNP = GDP + NFP (Net Factor Payments)

• Alternate terminology:
• Gross National Income (GNI) for GNP
• Net Income earned on Foreign Assets (NIFA) for NFP

• Difference very small for countries like the US. (GDP 18.87 T
$ and GNP 19.11 T $: 2016, nominal.)

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Equivalence of Approaches

• All three approaches to GDP accounting yield the same result

• They attempt to avoid double counting in their own ways

• Fundamental identity of national income accounting:

Production = Expenditure = Income

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Production (Value Added)
Approach

• GDP defined as the market value of final goods and services

newly produced by domestically located capital and labor
during the year

• Value added approach to avoid the problem of double

counting intermediate goods

Value added = Final revenue - cost of intermediate goods

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Production Approach …

• Intermediate goods and services are used up in the same

period that they themselves were produced. Else, they are
final goods.

• A capital good is one that is itself produced and used to

produce other goods, but is not used up in the process
• It is a final good and is therefore included in the GDP

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Expenditure Approach

• Total spending on final goods and services produced in the

country during the year

• The income-expenditure identity:

Y = GDP = C + I + G + NX

• NX = Net Exports = Exports (X) - Imports (M)

• All production consumed or invested by private agents or by

the government or by foreigners
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US National Accounts (2005)
Billion USD

Source: http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Methodo/NIPA%20Guide.pdf

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Expenditure Breakdown

Source: https://fred.stlouisfed.org
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Income Approach

• Account for GDP by how factors of production (labor and

capital) are compensated

• National Income = Compensation + Proprietor’s Income +

Rental Income+ Corporate Profits + Net Interest

• Employee Compensation largest (65 to 70% of national

income typically)

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Income Approach …

• Net National Product (NNP) = National Income + Indirect

Business Taxes

• Indirect business taxes (sales, excise taxes, etc.) are paid by

businesses to the government

• GNP = NNP + Depreciation

• Depreciation is the value of capital that wears out during the

year in which the GNP is measured

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US National Accounts (2005)
Billion USD

Source: http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Methodo/NIPA%20Guide.pdf

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 Example- Production Approach
• Transactions:
• Company A:
• Wages paid to employees $15,000 • The Production approach measures
economic activity by adding value added
• Taxes paid to government $5,000
across sectors
• Revenue - sale of oranges $35,000
• Oranges sold to public $10,000
• Oranges sold to B $25,000 • Value added by Company A=$35,000
• Company B:
• Wages paid to employees $10,000 • Value added by Company B=$15,000
• Taxes paid to government $2,000
• Purchase of oranges from A • GDP=Sum of value added=$50,000
$25,000
• Revenue - sale of orange juice
$40,000

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 Example: Expenditure
Approach
• Transactions: • The expenditure approach measures
• Company A: economic activity by adding the
• Wages paid to employees $15,000 market value of final goods in the
economy.
• Taxes paid to government $5,000
• Revenue - sale of oranges $35,000
• Ultimate users in this example are
• Oranges sold to public $10,000 consumers.
• Oranges sold to B $25,000
• Company B: • They spent $10,000 on oranges and
• Wages paid to employees $10,000 $40,000 on orange juice.
• Taxes paid to government $2,000
• Purchase of oranges from A • The GDP of this example economy
$25,000 is equal to $50,000.
• Revenue - sale of orange juice
$40,000

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 Example: Income Approach
• Transactions:
• Company A:
• Wages paid to employees $15,000
• Taxes paid to government $5,000
• Revenue - sale of oranges $35,000
• Oranges sold to public $10,000
• Oranges sold to B $25,000
• Company B:
• Wages paid to employees $10,000
• Taxes paid to government $2,000
• Purchase of oranges from A
$25,000
• Revenue - sale of orange juice
$40,000
• The income approach measures
economic activity by adding income
across the producers, employees and
the government.
• Employee income =
$15,000 + $10,000 =
$25,000
• Government income =
$5,000 + $2,000 = $7,000
• Corporate profits =
$15,000 + $3,000 =
$18,000
• National income is $50,000
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Summary

Source:https://www.bea.gov/sites/default/files/methodologies/nipa-handbook-all-chapters.pdf
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 Sectoral Breakdown of GDP

Percentage of GDP by sector (2016):

US India China
Agriculture 1.1% 16.5% 8.6%
Industry 19.4% 29.8% 40.7%
Services 79.5% 45.4% 50.7%

(source: CIA Factbook)

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 REAL VS.
1.2 NOMINAL
 What’s the GDP growth?

Apple Economy

• In 2015, 10 kg of apples produced; sell @ USD 5/kg. GDP=USD 50

• In 2016, 10 kg of apples produced; sell @ USD 10/kg. GDP=USD 100

• What is the GDP growth in the economy?

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Real vs. Nominal GDP

YN = Py

• YN : nominal GDP, P: GDP deflator or general price level; y:

real GDP (quantity)

• Nominal GDP values output at current prices

• Real GDP values output at a base year prices. Picks up only

the increase in GDP coming from higher quantities of goods
and services, rather than higher prices

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Production and Price Data

Source: ABC

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Base Year Matters

Source: ABC

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Inflation

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Inflation

π = 100(Pt+1 - Pt) / Pt

• Inflation: Year-on-Year Growth Rate in the price level

• GDP deflator = Nominal GDP/Real GDP

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Example- Real vs. Nominal

• In the Apple economy, if 2015 used as base year:

• Nominal GDP, 2016: 10x10=$100
• Real GDP, 2016: 10x5=$50
• GDP deflator = Nominal/Real = 2

• Inflation in Apple Economy:

π = 100(Pt+1 - Pt) / Pt = 100*(10-5)/5 = 100%

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Interest Rates

• The (short-term) interest rate is the risk-free rate of return that

can be earned in the market

• i: Dollar (nominal) interest rate

• Invest USD 1 today at the rate i. Receive USD(1+i) in one year.

How much would you pay to receive USD 1 in one year?

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Real Interest Rate

• Suppose you lend USD 100 at 10% (nominal) interest. Price of

apples is USD 10/kg. Get back USD 110. If price of apples
then is USD 11/kg, as a lender, what is your return?

• Real interest rate, r, is rate of return in units of goods: r = i – π

• In above example, i = 10%, π = 10%, r = 10 – 10 = 0%

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 OTHER
1.3 MEASUREMENTS
International Comparisons

• To compare per capita GDP across countries, can use:

• Market Exchange Rates: Unreliable for comparing living

standards; does not reflect relative purchasing power of two
currencies (due to non-traded goods, taxes, tariffs, and transport
costs).

• Purchasing Power Parity (PPP) Exchange Rates: A better

measure for comparisons. What does a $ really buy in each
country?

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PPP vs. Nominal GDP

Source: http://statisticstimes.com/economy/gdp-nominal-vs-gdp-ppp.php

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PPP vs. Nominal GDP

Source: http://statisticstimes.com/economy/gdp-nominal-vs-gdp-ppp.php

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How good is GDP per capita?

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Limitations of GDP

• What is left out?

• Some underground and informal activity
• Depletion of natural resources, environmental degradation
• Homemakers’ contribution
• Human capital formation
• UN attempts at reforms (HDI: Human Development Index)

• Correlation of GDP per capita with other variables like education

(http://hdr.undp.org/en/content/human-development-index-hdi)

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 Key Concepts
• GDP is all value added in the country irrespective of who owns assets;
GNP is country’s income no matter where assets are located

• Production, income, and expenditure approach are different ways of

looking at the same economy

• Real GDP increase nets out increase coming from prices to see only
increase in quantity

• Inflation is the rate of change of (aggregate) price index

• The real interest rate is nominal interest rate minus inflation

• Need to use PPP adjustment to compare GDP across countries

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Glossary

GDP Gross Domestic Product (also Y)

NFP Net Factor Payments (also NIFA)
GNP Gross National Product = GDP + NFP (also GNI)
C National Consumption
I National Investment
G Government Expenditure
X Exports
M Imports
NX Net exports = X - M
T Total taxes
π Inflation
Pt General price level at time t
i Nominal interest rate
r Real interest rate

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