PS#1 all the question I. National Income Accounts Suppose an economy’s national accounts are GNP = 100, C = 70, I = 40, G = 20 and EX = 20 where GNP is gross national product, C is consumption, I is i

ECON 171 , Ch.13 1 Ch. 13 National Income and Balance of Payments I. The National Income Accounts 1. What is national income account? • Measures national income that results from production and expenditure . • The amount of expenditure by buyers = the amount of income for sellers = the value of production • Thus, at the national level, income = output . ECON 171 , Ch.13 2 2 . Measures of national income: GNP vs. GDP • Gross N ational P roduct ( GNP ) : the value of all final goods and services produced by a nation ’ s factors of production (such as workers, physical capital , natural resources, etc.) in a g iven time period • Can we say “National income is the income earned by a nation’s factors of p roduction”? • Another widely used economic statistic GDP (Gross D omestic Product) measures the final value of all goods and services produced within a country in a given time period. • GNP excludes economic activity that occurs in the U.S. but is owned by foreigners and includes American economic activity that occurs in other countries. ECON 171 , Ch.13 3 3. Compositions of GNP • Since GNP measures national income which is equal to aggregate expenditure on final goods and services, Y = C + I + G + (EX – IM) where Y = GNP C = consumption G = government purchases EX = exports IM = imports ( EX – IM ) = current account balance ( CA ) or net exports ECON 171 , Ch.13 4 Fig.1: U.S. GNP and its Components ECON 171 , Ch.13 5 • To precisely measure national income using GNP, we would need to make the following adjustments: National Income = GNP – Depreciation + Net Unilateral Transfers 4 . National Income Identity for an Open Economy • In an open economy, Y = C + I + G + CA where C + I + G measures “ expenditure by domestic individuals and institutions ” and CA (= EX – IM ) measures “ net expenditure by foreign individuals and institutions ” ECON 171 , Ch.13 6 • Rearranging the above identity gives CA = (EX – IM) = Y – (C + I + G) Interpretation: W hen production > domestic expenditure, exports > imports → N et foreign wealth is increasing ! Example 1 : An open economy producing wheat (100 bushels) only ECON 171 , Ch.13 7 • Saving and the Current Account National saving ( S ) is defined as the portion of national income ( Y ) that is not spent on consumption ( C ) or government spending ( G ): S = Y – C – G Note that S = I in a closed economy. I n an open economy , S = I + CA . ( Why?) In other words, an open economy can save by building up its capital stock or by acquiring foreign wealth. Private saving ( S p ) is defined as the part of disposable income (Y – T) that is not consumed: S p = Y – T – C ECON 171 , Ch.13 8 Government saving ( S g ) is net tax revenue (T) minus government spending (G): S g = T – G Thus, national saving S = Y – C – G = ( Y – T – C ) + ( T – G ) = S p + S g • Because S = S p + S g = I + CA, S p = I + CA + ( G – T ) Interpretation: P rivate saving can be used to finance i) domestic capital investment (I), ii) purchases of wealth from foreigners (CA), and iii) government budget deficit ( G – T ) . ECON 171 , Ch.13 9 I I. Balance of Payments (BoP) Accounts 5 . What is BoP? • Records a country ’ s payments to and its receipts from foreigners • Any transaction resulting in a receipt from foreigners is entered as a credit (+) and in a payment to foreigners is entered as a debit ( – ) in BoP. • BoP accounts are separated into: i) C urrent A ccount : exports or imports of goods and services (plus, income receipts such as interest and dividend payments, earnings of firms and workers operating abroad, and net unilateral transfers) ECON 171 , Ch.13 10 ii) Fi nancial A ccount : international purchases or sales of financial assets (e.g., stocks) , including official international reserve s which are foreign assets held by the central bank in the form of g overnment bonds, currency, gold, and accounts at the IMF Note : O fficial reserve assets sold to foreign central banks are a credit because the Federal Reserve can spend more money to cushion against instability . iii) C apital Ac count : special transfers of assets, typically non - market activities (e.g., debt forgiveness) or acquisition or disposal of non - produced and intangible assets such as copyrights and trademarks ECON 171 , Ch.13 11 • Double - entry bookkeeping : Every international transaction automatically enters the BoP twice, once as a credit and once as a debit . Example 2 • You import a fax machine from Italian company Olivetti . Olivetti deposits your check in a U.S. bank. Credit Debit Fax machine purchase ( current account, U.S. good import) $1,000 Sale of U.S. bank deposit (financial account, U.S. asset sale) $1,000 ECON 171 , Ch.13 12 • You buy lunch in France and pay $200 by credit card. French restaurant receives payment from your credit card company. Credit Debit Meal purchase ( ) ( ) Sale of credit card claim ( ) ( ) • You buy a share of British Petroleum (BP) stock at $90 . BP deposits the money in a U.S. bank. Credit Debit BP stock purchase ( ) ( ) BP ’ s deposit ( ) ( ) ECON 171 , Ch.13 13 • You receive $ 100 in interest from German bonds you own. The $ 100 is deposited in a German bank. Credit Debit Interest income ( ) ( ) Purchase of German deposit ( ) ( ) • U.S. banks forgive a $ 5 million debt owed by the government of Argentina . U.S. banks who hold the debt thereby reduce the debt by crediting Argentina ’ s bank accounts. Credit Debit D ebt forgiveness ( ) ( ) Reduction in banks ’ claims ( ) ( ) ECON 171 , Ch.13 14 • Fundamental balance of payments identity : Current Account + capital account = Financial Account ECON 171 , Ch.13 15 Table 1: U.S. BoP Account for 2012 (billions of dollars) ECON 171 , Ch.13 16 • The U.S. has the most negative net foreign wealth in the world, and so is the worl d’ s largest debtor nation. Its foreign debt continues to grow because its current account continues to be negative. Fig. 2 : U.S. Gross Foreign Assets and Liabilities, 1976 - 2012