Homework's Mathematical Methods

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Session6-chapter5-Summer2020.pptx

National and International Accounts: Income, Wealth, and the Balance of Payments

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Measuring Macroeconomic Activity: An Overview

Income, Product, and Expenditure

The Balance of Payments

External Wealth

Conclusions

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In this chapter, we study economic transactions between countries, how they are undertaken, and what impact they have on the macroeconomy.

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Introduction

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1 Measuring Macroeconomic Activity: An Overview

At various points in the circular flow of payments, economic activity is measured and recorded in the national income and product accounts.

In an open economy, however, such measurements are more complicated because we have to account for cross-border flows.

These additional flows are recorded in a nation’s balance of payments accounts.

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Gross national expenditure (GNE) is the total expenditure on final goods and services by home entities in any given period.

GNE is made up of three parts: personal consumption C, investment I, and government spending G.

GNE= (C + I + G)

A country’s gross domestic product (GDP) is the value of all (intermediate and final) goods and services produced as output by firms, minus the value of all goods and services purchased as inputs by firms (value added).

The Flow of Payments in a Closed Economy:

Introducing the National Income and Product Accounts

1 Measuring Macroeconomic Activity: An Overview

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GDP is a product measure, in contrast to GNE, which is an expenditure measure.

In a closed economy, income is paid to domestic entities. It thus equals the total income resources of the economy, also known as gross national income (GNI).

The Flow of Payments in a Closed Economy:

Introducing the National Income and Product Accounts

1 Measuring Macroeconomic Activity: An Overview

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FIGURE 5-1

The Closed Economy Measurements of national expenditure, product, and income are recorded in the national income and product accounts, with the major categories shown. The purple line shows the circular flow of all transactions in a closed economy.

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1 Measuring Macroeconomic Activity: An Overview

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The difference between payments made for imports and payments received for exports is called the trade balance (TB), it equals net payments to domestic firms due to trade.

GNE plus TB equals GDP, the total value of production in the home economy.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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The value of factor service exports minus factor service imports is known as net factor income from abroad (NFIA), and thus GDP plus NFIA equal GNI, the total income earned by domestic entities from all sources, domestic and foreign.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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Gifts may take the form of income transfers or “in kind” transfers of goods and services.

They are considered nonmarket transactions, and are referred to as unilateral transfers.

Net unilateral transfers (NUT) equals the value of unilateral transfers the country receives from the rest of the world minus those it gives to the rest of the world.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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These net transfers have to be added to GNI to calculate gross national disposable income (GNDI).

Thus, GNI plus NUT equals GNDI, which represents the total income resources available to the home country.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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The current account (CA) is a tally of all international transactions in goods, services, and income (occurring through market transactions or transfers).

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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The value of asset exports minus asset imports is called the financial account (FA).

These net asset exports are added to home GNDI when calculating the total resources available for expenditure in the home country.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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A country may not only buy and sell assets but also transfer assets as gifts.

Such asset transfers are measured by the capital account (KA), which is the value of capital transfers from the rest of the world minus those to the rest of the world.

The Flow of Payments in an Open Economy: Incorporating the Balance of Payments Accounts

1 Measuring Macroeconomic Activity: An Overview

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FIGURE 5-2

The Open Economy Measurements of national expenditure, product, and income are recorded in the national income and product accounts, with the major categories shown on the left.

Measurements of international transactions are recorded in the balance of payments accounts, with the major categories shown on the right.

The purple line shows the flow of transactions within the home economy.

The green lines show all cross-border transactions.

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1 Measuring Macroeconomic Activity: An Overview

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2 Income, Product, and Expenditure

The expenditure approach looks at the demand for goods: it examines how much is spent on demand for final goods and services. The key measure is GNE.

The product approach looks at the supply of goods: it measures the value of all goods and services produced as output minus the value of goods used as inputs in production. The key measure is GDP.

The income approach focuses on payments to owners of factors: it tracks the amount of income they receive. The key measures are gross national income (GNI) and gross national disposable income (GNDI) (which includes net transfers).

Three Approaches to Measuring Economic Activity

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Personal consumption expenditures (usually called “consumption”) equal total spending by private households on final goods and services, including nondurable goods such as food, durable goods, and services.

Gross private domestic investment (usually called “investment”) equals total spending by firms or households on final goods and services to make additions to the stock of capital. Investment includes construction of a new house or a new factory, the purchase of new equipment, and net increases in inventories of goods held by firms (i.e., unsold output).

From GNE to GDP: Accounting for Trade in Goods and Services

2 Income, Product, and Expenditure

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Government consumption expenditures and gross investment (often called “government consumption”) equal spending by the public sector on final goods and services, including spending on public works, national defense, the police, and the civil service. It does not include any transfer payments or income redistributions, such as Social Security or unemployment insurance payments—these are not purchases of goods or services, just rearrangements of private spending power.

From GNE to GDP: Accounting for Trade in Goods and Services

2 Income, Product, and Expenditure

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This formula says gross domestic product is equal to gross national expenditure (GNE) plus the trade balance (TB).

The trade balance (TB), also referred to as net exports, may be positive or negative.

If TB > 0, exports are greater than imports and we say a country has a trade surplus.

If TB < 0, imports are greater than exports and we say a country has a trade deficit.

From GNE to GDP: Accounting for Trade in Goods and Services

(5-1)

2 Income, Product, and Expenditure

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Gross national income equals gross domestic product (GDP) plus net factor income from abroad (NFIA).

From GDP to GNI: Accounting for Trade in Factor Services

(5-2)

2 Income, Product, and Expenditure

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If a country receives transfers worth UTIN and gives transfers worth UTOUT, then its net unilateral transfers (NUT), are

NUT = UTIN − UTOUT .

Adding net unilateral transfers to gross national income, gives a full measure of national income in an open economy, known as gross national disposable income (GNDI), henceforth Y:

From GNI to GNDI: Accounting for Transfers of Income

(5-3)

2 Income, Product, and Expenditure

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From GNI to GNDI: Accounting for Transfers of Income

FIGURE 5-4

Major Transfer Recipients The chart shows average figures for 2000 to 2010 for all countries in which net unilateral transfers exceeded 15% of GNI. Many of the countries shown were heavily reliant on foreign aid, including some of the poorest countries in the world, such as Liberia, Eritrea, Malawi, and Nepal. Some countries with higher incomes also have large transfers because of substantial migrant remittances

from a large number of emigrant workers overseas (e.g., Tonga, El Salvador, Honduras, and Cape Verde).

2 Income, Product, and Expenditure

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On the left is our full income measure, GNDI.

The first term on the right is GNE, which measures payments by home entities.

The remaining terms measure net payments to the home country from all international transactions in goods, services, and income. We group the three cross-border terms into an umbrella term that is called the current account (CA).

What the National Economic Aggregates Tell Us

(5-4)

2 Income, Product, and Expenditure

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Understanding the Data for the National Economic Aggregates

TABLE 5-1

U.S. Economic Aggregates in 2015 The table shows the computation of GDP, GNI, and GNDI in 2015 in billions of dollars using the components of gross national expenditure, the trade balance, international income payments, and unilateral transfers.

2 Income, Product, and Expenditure

Line Category Symbol $ billions
1 Consumption (personal consumption expenditures) C 12,272
2 1 Investment (gross private domestic investment) I 3,021
3 1 Government consumption (government expenditures) G 3,183
4 5 Gross national expenditure GNE 18,476
5 1 Trade balance TB 2529
6 5 Gross domestic product GDP 17,947
7 1 Net factor income from abroad NFIA 214
8 5 Gross national income GNI 18,161
9 1 Net unilateral transfers NUT 2134
10 5 Gross national disposable income GNDI 18,027

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Some Recent Trends

FIGURE 5-5

U.S. Gross National Expenditure and Its Components, 1990-2015 The figure shows consumption (C), investment (I), and government purchases (G) in billions of dollars.

2 Income, Product, and Expenditure

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This equation is the open-economy national income identity. It tells us that the current account represents the difference between national income Y (or GNDI) and gross national expenditure GNE (or C + I + G). Hence:

GNDI is greater than GNE if and only if CA is positive, or in surplus.

GNDI is less than GNE if and only if CA is negative, or in deficit.

What the Current Account Tells Us

(5-5)

2 Income, Product, and Expenditure

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The current account is also the difference between national saving (S = Y − C − G) and investment:

This equation, often written as CA = S – I , is called the current account identity even though it is just a rearrangement of the national income identity. Thus,

S is greater than I if and only if CA is positive, or in surplus.

S is less than I if and only if CA is negative, or in deficit.

What the Current Account Tells Us

(5-6)

2 Income, Product, and Expenditure

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Global Imbalances

FIGURE 5-7 (1 of 2)

The charts show saving, investment, and the current account as a percent of each subregion’s GDP for four groups of advanced countries. The United States has seen both saving and investment fall since 1980, but saving has fallen further than investment, opening up a large current account deficit approaching 6% of GDP in recent years.

Japan’s experience is the opposite: investment fell further than saving, opening up a large current account surplus of about 3% to 5% of GDP.

APPLICATION

Saving, Investment, and Current Account Trends: Industrial Countries

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Global Imbalances

FIGURE 5-7 (2 of 2)

The Euro area has also seen saving and investment fall but has been closer to balance overall.

Other advanced countries (e.g., non-Euro area EU countries, Canada, Australia, etc.) have tended to run large current account deficits.

APPLICATION

Saving, Investment, and Current Account Trends: Industrial Countries (continued)

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We define private saving (Sp) as that part of after-tax private sector disposable income Y that is not devoted to private consumption C.

We define government saving (Sg) as the difference between tax revenue T received by the government and government purchases G.

Private saving plus government saving equals total national saving, S

However, in an open economy:

(5-7)

(5-8)

(5-9)

APPLICATION

(5-10)

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3 The Balance of Payments

The financial account (FA) records transactions between residents and nonresidents that involve financial assets. This definition covers all types of assets:

real assets such as land or structures,

and financial assets such as debt (bonds, loans) or equity, issued by any entity.

Subtracting asset imports from asset exports yields the home country’s net overall balance on asset transactions, which is known as the financial account, where FA = EXA − IMA.

The financial account therefore measures how the country accumulates or decumulates assets through international transactions.

Accounting for Asset Transactions: The Financial Account

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The capital account (KA) covers two remaining areas of asset movement of minor quantitative significance.

the acquisition and disposal of nonfinancial, nonproduced assets (e.g., patents, copyrights, trademarks, etc.)

capital transfers (i.e., gifts of assets), an example of which is the forgiveness of debts

We denote capital transfers received by the home country as KAIN and capital transfers given by the home country as KAOUT. The capital account, KA = KAIN − KAOUT, denotes net capital transfers received.

Accounting for Asset Transactions: The Capital Account

3 The Balance of Payments

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From the home perspective, a foreign asset is a claim on a foreign country.

When a home entity holds such an asset, it is called an external asset of the home country.

When a foreign entity holds such an asset, it is called an external liability of the home country because it represents an obligation owed by the home country to the rest of the world.

Accounting for Home and Foreign Assets

3 The Balance of Payments

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The value of the total resources available to the home country for expenditures is equal to the total value of home expenditure on final goods and services, GNE:

Cancelling GNE from both sides we obtain the result known as the balance of payments identity or BOP identity:

How the Balance of Payments Accounts Work:

A Macroeconomic View

(5-12)

3 The Balance of Payments

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The components of the BOP identity allow us to see the details behind why the accounts must balance.

If an item has a plus sign, it is called a balance of payments credit or BOP credit.

If an item has a minus sign, it is called a balance of payments debit or BOP debit.

How the Balance of Payments Accounts Work:

A Microeconomic View

(5-13)

3 The Balance of Payments

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Understanding the Data for the Balance of Payments Account

A country that has a current account surplus is called a (net) lender. By the BOP identity, it must have a deficit in its asset accounts.

Any lender, on net, buys assets (acquiring IOUs from borrowers). For example, China is a large net lender.

A country that has a current account deficit is called a (net) borrower. By the BOP identity, it must have a surplus in its asset accounts.

Any borrower, on net, sells assets (issuing IOUs to lenders). As we can see, the United States is a large net borrower.

3 The Balance of Payments

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4 External Wealth

Just as a household is better off with higher wealth, all else equal, so is a country.

“Net worth” or external wealth with respect to the rest of the world (ROW) can be calculated by adding up all of the home assets owned by ROW and then subtracting all of the ROW assets owned by the home country.

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The level of a country’s external wealth (W) equals

A country’s level of external wealth is also called its net international investment position or net foreign assets. It is a stock measure, not a flow measure.

If W > 0, home is a net creditor country: external assets exceed external liabilities.

If W < 0, home is a net debtor country: external liabilities exceed external assets.

The Level of External Wealth

(5-14)

4 External Wealth

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There are two reasons a country’s level of external wealth changes over time.

Financial flows: As a result of asset trades, the country can increase or decrease its external assets and liabilities. Net exports of home assets cause an equal increase in the level of external liabilities and hence a corresponding decrease in external wealth.

Valuation effects: The value of existing external assets and liabilities may change over time because of capital gains or losses. In the case of external wealth, this change in value could be due to price effects or exchange rate effects.

Changes in External Wealth

4 External Wealth

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