NATIONAL INCOME ACCOUNTING COMPONENTS OF GDP

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  CHAPTER III
  
  
  NATIONAL INCOME ACCOUNTING
  COMPONENTS OF GDP
  MEASURING INFLATION
  

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  1. COMPONENTS OF DEMAND
  
  Analysis of demand for output
  Output is split into components of demand
  Total demand for domestic output is made up of following four components:
  Consumption spending of the households (C),
  Investment spending of the businesses (I)
  Government’s purchases of goods and services (G)
  Foreign demand (NX)
  
  The four components of the total output is expressed into following identity:
  
  Y= C+ I+ G+ NX (1)
  
  It (1) is called national income accounting identity
  

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  2. CONSUMPTION
  
  Main component of demand is consumption (Table-1)
  Consumption includes spending on anything (e.g. food to golf lessons)
  It also involves consumption spending on durable goods (e.g. automobiles)
  Such spending normally regarded as investment rather than consumption
  
  Table – 1: Components of demands 2007
  Components of GDP
  
  $ Billions
  
  Percent (%)
  
  Consummations
  
  5 139.00
  
  68.1
  
  Investment (domestic)
  
  1 096.00
  
  14.5
  
  Government Sector
  
  1 409.00
  
  18.7
  
  Net Export
  
  - 119.0
  
  -1.3
  
  Total GDP
  
  7 545.00
  
   100%
  
  

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  Division of GDP in the USA from 2007 shows that:
  
  Consumption made 68.1% of GDP in USA
  Share of Investments is 14.2%
  Share of government sector is 17.7%
  And Share of Foreign Demand is 1.1%
  Share of the components are not constant
  They vary from Year to Year and country to country
  

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  Division of GDP in Japan from 2003 shows that:
  Japan consumes a far smaller share of GDP than USA
  Rising share of consumption in USA in 1980s was important reasons for poor economic performance
  
  Higher consumption means:
  Less investment
  Larger trade deficits
  Lower saving
  

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  3. GOVERNMENT
  
  Government spending includes:
  Salaries of government employees
  Government spending for purchases of goods and services
  Defence expenditures
  Costs of transport and communication
  Government transfer payments as social security and unemployment benefits
  

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  4. INVESTMENT
  
  Investment includes:
  Investment increases ability to produce output
  Building of plants
  Construction of factories and offices
  Including new machineries
  Additions to a firm's inventories
  Expenditure also for education means investment
  Human capital means ability to produce
  Investment in education is regarded as investment in human capital
  However, personal educational expenditures as consumption
  But public educational expenditures is government investment spending
  

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  5. NET EXPORTS
  
  ‘Net exports’ account the difference between domestic spending on foreign goods and foreign spending on domestic goods
  When foreigners purchase our goods, their spending adds to the demand of our domestic goods
  When we purchase foreign goods has, it decreases demand for our domestic goods
  The difference between exports and imports is ‘Net Export’
  US net export is negative since the 1980s (Table-1)
  It means a deficit of trade-balance
  In some years net exports have been close to zero
  

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  7. SOME IMPORTANT IDENTITIES
  
  Let us introduce some notations and conventions
  It will be followed throughout the book
  
  Let us first simplify our analysis making following assumptions:
  
  Let us denote C for consumption and I for investment spending
  Let us output produced equals output sold
  Let us the economy has neither a government nor foreign trade
  
  

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  Hence, we can write: Y= C + I (1)
  Identity (2) shows the allocation of income
  It means the Nation Income could be either consumed or invested
  
  Let us establish a relationship among saving, consumption, and GDP:
  Again the National Income could be either consumed or saved
  Hence, we can write: Y = C + S(2)
  This (3) shows the components of demand
  
  

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  From (1) and (2), we have:
  
  C + I = Y = C + S (3)
  I = S (4)
  It means (4), in a simple economy investment equals saving
  
  Let analysis this conclusion
  More is saved more is invested
  More consumption means less investment
  Less consumption means more investment
  The conclusion is it is better to save more, them more saving means investment & growth
  

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  3. REINTRODUCING GOVERNMENT AND FOREIN TRADE
  
  Let us now introduce government and external
  sector in the model above
  
  Let us:
  Government purchases equals G
  Government taxes equals TA
  Transfers (Social Transfer) to the private sector equals TR
  Net exports (Exports - Imports) is NX
  

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  Output produced is either consumed, invested (saved), or used by government
  
  Hence:
  Y = C + I + G + NX(5)
  
  Let us introduce concept of output and disposable income
  We know that output equals disposable income (YD)
  
  It means:
  Y= YD (6)
  
  Disposable income could be used either for consumption or investment
  YD = C + S (7)
  

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  Disposable income (YD) is equal to income plus transfers
  less taxes (TA)
  
  YD = Y + TR – TA(8)
  Combination of the identities (7) and (8), we have:
  C + S = Y + TR- TA (9)
  C + S = Y + TR  TA (10)
  
  From equation (5) and equation (10), we have:
  C + S = Y + TR  TA
  C + S = C + I + G + NX + TR  TA
  [Y = C + I + G + NX]
  S  I = (G + TR TA) + NX (12)
  

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  Case-I
  
  If saving equals investment, then maximum
  possible investment is achieved:
  In this case, government spending and net export is zero
  It means, there is no government spending
  And either there is no foreign trade or trade is balanced
  Net export could be zero, if there is no foreign trade or trade-balance is zero
  However, government spending could never be zero
  

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  Case-II
  
  By unchanged government spending, investment could be increased by increasing imports
  Apparently, it means that if more is imported more could be invested
  This is correct, but more and more capital goods (and not luxury) have to be imported
  However, only more and more export enables import of more and more capital goods that ensure growth
  Hence, export must be enhanced, but by import in place of luxury goods import of capital goods must be ensured
  

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  Conclusion
  
  Investment and hence growth could be
  enhanced:
  Minimizing government spending
  Promoting export and import of more and more capital goods
  Cutting tax
  Increasing consumption cutting tax
  Supporting income through social and other supports
  All of these support consumption and saving that foster growth
  

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  4. BUDGET, TRADE, SAVING AND INVESTMENT
  
  Let us explain impact of government spending and net export on investment with an example (Table-2)
  Case-1
  In case-1 saving is $1000 and there is no BD and TBD
  Saving $1000 was fully invested
  If there is no BD and TBD, saving is fully invested
  Table – 2: Budget, Trade, Saving and Investment (Billions Dollars)
  Y = C + I + [G + TR  TA] + NX
  Y = C + I + [BD] + NX
  

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  Case-2
  In case-2 there was no TBD, but Budget of $150
  So, savings $150 was eaten up by BD
  Hence, investment decreased to the amount of $150
  If there is Budget deficit a part of saving is eaten up by BD
  For growth it is better not to have any Budget deficit
  
  Cae-3
  In case-3 trade balance was 0, but there was budget surplus of $150
  So, the saving and investment increased to the amount of $150.
  The Investment was $1150
  That means, savings were increased by the amount of trade balance surplus
  So, growth is fostered by trade balance surplus
  

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  Case-4
  In case 4 there was no Budget deficit, but a trade balance surplus of $150
  So, the saving and Investment increased to the amount of $150. The investment was $1150.
  If there is a trade balance surplus, but no budget deficit, the investment increases to amount of trade balance surplus
  
  
  Case-5
  In cae-5 there was no budget deficit, but a trade balance deficit of $150
  So, savings was decreased by trade balance deficit of $150
  So, investment was only $850 ($1000-$250)
  If there is no budget deficit, but a trade balance deficit, the investment is reduced to amount trade balance deficit
  

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  Case-6
  
  There is budget surplus of $150 and trade balance deficit of $ 100
  So, savings and investment was increased by $50
  The investment was $1050 ($1000+$50)
  If there is budget surplus but a trade balance deficit, the saving and investment increases to the amount of budget surplus decreases to the amount of trade balance deficit
  

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  Case-7
  
  There is budget deficit of $150 and trade balance surplus of $ 100
  So, savings and investment decreases to the amount of $50
  The investment was $950 ($1000-$50)
  If there is budget deficit but a trade balance surplus, the saving and investment decreases to the amount of budget deficit decreases to the amount of trade balance deficit
  

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  Questions
  Describe the different components of GDP and explain the relationship among the components saving, investment and government sector.
  Explain the relation between savings and investment using the national income accounting identities.
  Explain the impact of national budget, trade balance on savings and investment using an example.
  

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  End of the Chapter
  
  Thank You Very Much
  
  For Patient Listening