Ec 123
Section 2
• THIS SECTION
– National Income Accounting
– Prices
– Examples: The Great Depresssion & Japan
• NEXT
– No class 4/14
– Section 3: The theory of output determination/dynamics
Ec 123 Section 2
1
Discussion
• What should be the goals of macroeconomic
policies?
• How should they be measured?
Ec 123 Section 2
2
National Income Accounting
• Gross Domestic Product (GDP) is the market value of
all final goods and services produced within the
territory of a country for a given time period.
– all goods and services are valued at market prices
– only final goods & services--no double counting
– only goods and services which pass through organized
markets are counted.
• Gross National Product = GDP + [income by
nationals from abroad] - [income by foreign
nationals, produced domestically]
Ec 123 Section 2
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National Income Accounting
GDP is not a measure of welfare (at least not
directly):
– only market activity gets counted.
– places no value on leisure time.
– "bads" as well as "goods" get counted: cost of wars and
cleaning up disasters get counted.
– ecological costs are not counted.
Two ways to breakout GDP:
method and Income method
Ec 123 Section 2
Expenditure
4
Circular Flows in the Economy
Foreign
Countries
Foreign
Borrowing
Foreign
Savings
Imports
(M)
Exports
(X)
Income (Y)
Investment (I)
Firms
Borrowing
Govt.
Spending
(G)
Households
Consumption (C)
Taxes
Taxes
Govt.
(T)
(T) Transfers
(TR)
Government
Savings
(S)
Govt.
Borrowing
Financial
Markets
Ec 123 Section 2
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Expenditure breakout of GDP
GDP = C + I + G + (X-M)
where
• Consumption (C): consumer spending on final goods and services
for current use.
• Investment (I): private expenditures on new plant and capital
(does not include purchase of paper assets).
• Government Spending (G): federal, state and local spending of
new goods and services; does not include transfer payments (ex.,
social security).
• Net Exports (X-M): exports represent an inflow of income, imports
an outflow.
Ec 123 Section 2
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Expenditures on Good & Services
Foreign
Countries
Exports
(X)
Imports
(M)
Investment (I)
Firms
Govt.
Spending
(G)
Households
Consumption (C)
Government
Financial
Markets
Ec 123 Section 2
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Income breakout of GDP
Start with
Y + TR = C + S + T
where
• Aggregate income (Y): total private income.
• Government transfer payments (TR): Social security, food
stamps, farm subsidies, etc.
• Gross private savings (S): income put aside for future
consumption by households and businesses
• Taxes (T): total taxes paid to local, state and federal govt.
Substitute Y = GDP into top equation and rearrange:
GDP = C + S + (T-TR)
Ec 123 Section 2
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Income breakout of GDP
Foreign
Countries
Income (Y)
Firms
Households
Consumption (C)
Taxes
Govt.
(T) Transfers
(TR)
Government
Financial
Markets
Ec 123 Section 2
Savings
(S)
9
A useful manipulation
Substitute the expenditure breakout for GDP to obtain:
C + I + G + (X-M) = C + S + (T-TR)
Implications:
• A fiscal deficit must be financed by lower investment, higher
private savings, or increased foreign borrowing.
• An increase in savings will lead to increased investment, an
increased fiscal deficit or an increase in net exports.
• A decline in net exports is associated with lower domestic
savings, a larger fiscal deficit, or increased investment.
Ec 123 Section 2
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Nominal versus real quantities
• Nominal GDP is measured by the prices of the time under
discussion:
ex., nominal Japan GDP1998 = ¥498,499.3 billion
• Real GDP. To make real comparisons of goods and services across
time, we need to adjust for inflation.
• To convert nominal to real quantities, we adjust for inflation
through use of price indices.
– The index number for 1998 is 103.7 (base year 1990). Interpretation:
Prices in 1998 were 103.7% as high as in 1990.
Ec 123 Section 2
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Traditional Price Deflators
Put another way, the GDP price deflator for 1955
(P1955) is 17.8. Then,
nominal GDP
real GDP 1955 
P1955
1955
 100
8,369.5 billion Yen

 100
17.8
 47,075 billion Yen (base yr
= 1990)
We can construct price deflators for other items of
national
income
accounts
(investment,
 manufacturing, etc.), and use them to compare how
these items change over time.
Ec 123 Section 2
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Japan Background
“First of all, there is the problem of whether or not Japan, regardless of the
political and economic system she eventually chooses, can maintain any
satisfactory standard of living in the future. She cannot grow enough food to
feed all her people…All she has to offer on the the world market is her own
energy--manpower and energy of coal and water. With these she can
transform imported raw materials into goods for re-export. The slim margin
of profit from this re-export trade must be sufficient to pay for all the imports
Japan must have to support her own people. To do this Japan’s export trade
must be huge. But where is she to find the markets in a divided world and in a
Far East disrupted by revolutions and bitterly determined not to trade with her?
Japan’s situation is basically similar to England’s, but infinitely worse. She is far
less richly endowed with the vital resources of coal and iron…She is less
highly industrialized. She has no overseas empire to aid her, but instead a
legacy of distrust and hate. And she has almost twice the population to support
on her meager resources.”
- Edwin O. Reischauer, The United States and Japan, 1950
Ec 123 Section 2
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Japan: The Miracle Years
• What is Japan’s development strategy?
• How does Japan achieve this strategy?
Ec 123 Section 2
14
Summary
• GDP is a measure of economic output that
is often used as a benchmark for economic
policy success.
• Growth in GDP can be achieved through
policies
changes
in
investment,
consumption, and government spending.
• Japan’s ‘miracle’ growth was fueled by
rampant large-scale investment and export
growth.
Ec 123 Section 2
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