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National Income Accounts

Posted by mjmedlock on July 7, 2011 in international economics |

The national income accounts are called GNP and GDP. They both measure the value of the economy in a year, yet they are slightly different.

GDP, gross domestic product, is the total value of all the final* goods and services produced by domestic factors of production and sold in the domestic market in the year (or specific time period).

GNP, gross national product, differs from GDP in that it includes net receipts of income from the rest of the world.

Most countries now use GDP as a measure of national income rather than GNP. Why do think that is?

*Only final good and services are counted to avoid double counting.

Components of GDP

 

National Income Identity: Closed economy

In a closed economy GDP is comprised of:

Consumption

Investment

Government purchases

The equation for national income identity can be expressed as follows:

Let Y= output, C=consumption, I=investment, G=government purchases

Y= C +I+G

 

Savings: closed economy

 

Savings (S) is all the national income not given to consumption or government purchases.

S=Y-C-G

In the previous equation we can see that also that Y= C +I+G. We can rearrange the equation to show:

I=Y-C-G

Therefore

S=I

Therefore, in a closed economy savings (S) is equal to investment(I) and so if a closed economy wants grow national income it can only do so by saving more and reducing consumption and government purchases.

What about in an open economy?

The current account

In an open economy there will be trade with other nations. This will be in the form of exports (EX) and imports (IM). The balance of imports and exports is called the current account (CA).

CA=EX-IM

If a country has a more exports than imports it has a current account surplus. If it has more imports than exports it has a current account deficit.

The current account has important implications for domestic output. A prolonged current account deficit implies that there will be a fall in output. The current account also indicates the amount and direction of international borrowing and lending. If a country is running a deficit it must have a way to finance it. How? It can do this either by running down previously acquired foreign wealth or by international borrowing.  Likewise a country can continue to have a surplus with the countries it trades with by lending them the money to buy its products.

Saving and the current account

An open economy has the ability to save either by building up capital stock or by acquiring foreign wealth. A closed economy can only save by building up its capital stock.

An open economy can raise investment without having to increase saving. It can do this by borrowing money from abroad. In essence it is importing present consumption and then later exporting future consumption in the form of paying back the loan.

S=I+CA

For example: The UK wants to buy German machinery to build up its capital stock and therefore increase national output. However, it doesn’t want to reduce current consumption. To get the required investment the UK borrows money from German investors. The machinery increases the UK’s capital stock (I). It also increases the UK’s current account deficit by the amount equal to the increase in investment.

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