Bmak Ws2021 Lectures Chii

Goethe University Frankfurt
Macroeconomics 1 (BMAK)
Wintersemester 2020/21
Prof. Michael Binder, Ph.D.
II. Measuring Macroeconomic Activity
Readings:
- Burda and Wyplosz (2017), Chapter 2
- Jones (2020), Chapter 2
- International Monetary Fund (2009), Balance of Payments and International Investment
Position Manual, Sixth Edition
1
1. Production, Income and Expenditure

In Chapter I, we had seen that comparisons across multiple decades or
longer of levels of "income per capita (per person)" across regions or
countries motivate the study of (long-run) economic growth. We had also
seen that comparisons across a few years of "growth rates of output"
within regions or countries motivate the study of business cycles.
The numbers reported in these tables and figures in Chapter I were based
on the so-called National Income and Product Accounts (NIPA). As
we will learn in the first part of the current chapter, the NIPA provide the
most widely used framework for measuring the state of macroeconomic
activity, and comparing it across time periods and/or countries/regions.
Understanding the key elements of the NIPA is also important so as to
appreciate what precisely is meant by terms such as "income" or "output",
and what interpretations these terms may be given.
2
A first key measure of the state of the economy is gross domestic

product (GDP). GDP may be determined in three different ways:
(i) Product Approach
GDP
= value of all goods and services newly produced, minus the value of all
intermediate goods and services used in the production process
= sum of value added at each stage of the production process.
When measuring economic activity through the level of production, we
need to ensure that the value of the same product is not counted more
than once. For example, a manufacturer of a laptop may use a processor
produced by another manufacturer, and this processor should not be
counted as both a good produced on its own, and as a component of the
laptop. By excluding at each stage of production the cost of intermediate
goods and services, the value added approach ensures that there is no
"double counting".
3
GDP by Value Added Produced: Germany

(Billion Euro and Percent of GDP, 2019)
Agriculture, Forestry and Fishing 24.9 0.7%

Industry Excluding Construction 754.2 21.9%
Construction 166.8 4.8%
Trade, Transport, Accommodation and Food Services 500.8 14.5%
Information and Communication 153.2 4.4%
Financial and Insurance Services 116.9 3.4%
Real Estate Activities 327.2 9.5%
Business Services 361.3 10.5%
Public Services, Education and Health 581.6 16.9%
Other Services 119.2 3.5%
Net Taxes (Taxes Less Subsidies) on Products 342.9 9.9%
Gross Domestic Product 3449.1 100.0%

Source of Data: Destatis (2020)
4
(ii) Income Approach

GDP
= sum of all incomes earned in the production of all new goods and services
that constitute value added.
GDP by Incomes Received: Germany

Compensation of Employees 1845.9 53.5%

Property and Entrepreneurial Income 718.2 20.8%
Net Taxes (Taxes Less Subsidies) on Products and Imports 338.9 9.8%
Other Income (Including Depreciation of Physical Capital and

Income Paid to Nonresidents) 546.0 15.8%
5
(iii) Expenditure Approach

GDP
=
sum of all expenditures by final users of newly produced goods and services:
Y  C  I  G  EX  IM . (1)
      
     
GDP consumption investment government exports
 imports
expenditure
   trade balance (TB)
gross national expenditure (GNE)
 total spending by   total spending by private firms   total spending by   exports imports = trade 
 private households   on newly produced goods and   public sector on   balance: value of newly 
 on newly produced   services (investment in plant   newly produced   produced goods and 
 services and   and equipment as well as in-   goods and services;   services exported minus 
 (durable as well as   ventory investment, with in-   this thus does not   
 imported 
 nondurable) goods,   ventory valued at cost); also   include transfer 
 except new housing   included is spending by private   
   payments 
 households on new housing; 
 all this spending adds to the 
 stock of physical capital 
 
6
GDP by Expenditure Components: Germany

Final Consumption Expenditure 1806.9 52.4%

Gross Fixed Capital Formation 737.7 21.4%
Machinery and Equipment 240.1
Construction 373.7
Other Products 134.2
Changes in Inventories -10.3
Government Final Consumption Expenditure 704.5 20.4%
Trade Balance 199.9 5.8%
Exports 1617.4
Imports 1417.4

Note : Destatis includes public-sector spending on newly produced goods and

services that add to the stock of physical capital in "gross fixed capital formation";
the latter thus encompasses a larger number of components than "investment".
7
Goethe University Frankfurt II. Measuring Macroeconomic Activity
Macroeconomics 1 (BMAK) 1. Production, Income and Expenditure
Wintersemester 2020/21 GDP Recording of a Single Market Transaction
As we have seen in the data, when calculating GDP using the product,
income or expenditure approach, we always obtain the same total value
for GDP. This reflects that for the aggregate economy, production
equals income equals expenditure.
Let us further illustrate this fact and learn about some key rules of NIPA
accounting through considering examples of GDP calculations:
Calculating the Effects of a Single Market Transaction on GDP
On January 20, 2020, a domestic household purchases from a grocery

store two liters of milk, at 1.5 Euro per liter. The grocery store
purchased the milk five days earlier at a wholesale price of 1 Euro per
liter.
How to calculate the effect of this January 20 transaction on the year
2020 GDP of the domestic economy under the product, income and
expenditure approaches?
8
The January 20 transaction contributes to the year 2020 GDP of the

domestic economy as follows:
‐ Product approach: sale of milk on January 20 creates value added

produced in the amount of:
3 Euro (value of milk as sold by the grocery store)
– 2 Euro (value of milk as purchased by the grocery store: intermediate
good)
= 1 Euro.
‐ Income approach: sale of milk on January 20 creates value added

earned in the amount of:
(3 Euro – 2 Euro) = 1 Euro
(income recipients may include staff and owners of the grocery store, as
well as the government, if there was a sales tax involved).
9
‐ Expenditure approach:
purchase of milk on January 20 is consumption expenditure in the
amount of 3 Euro;
at the same time the value of the grocery store's inventory through this
purchase is reduced by 2 Euro (negative inventory investment);
making use of Equation (1), Y = C + I + G + TB, and noting that we have
no government expenditure, no exports and no imports, overall
expenditure is given by:
3 Euro + (– 2 Euro) = 1 Euro.
10
Wintersemester 2020/21 Calculating GDP for a Sample Economy
Calculating GDP for a Sample Economy
Quiet Muffler GmbH has a factory in Landshut valued at a 2,000,000 Euro.

During the year 2020 Quiet Muffler builds ten mufflers. The market value of
each muffler is 800 Euro. Quiet Muffler's costs for the production of each
muffler are: labor, 300 Euro; interest on debt, 250 Euro; imported components
from Malaysia, 100 Euro; and taxes, 50 Euro.
Ecological Engine GmbH, which is located in Ingolstadt, has a factory valued at
4,000,000 Euro. During the year 2020 Ecological Engine builds eleven engines
each having a market value of 5,000 Euro. Ecological Engine's costs to produce
each engine are: labor, 2,000 Euro; imported components from Romania,
1,000 Euro; and taxes, 1,000 Euro.
Ecological Engine sells ten of these engines, but at the end of the year 2020
had not sold the eleventh engine it had produced, which is put into inventory.
Quiet Muffler sells all its ten mufflers and Ecological Engine sells all the ten
engines that it does sell to Future Vehicles AG, which is located in Stuttgart.
11
Using Quiet Muffler's mufflers and Ecological Engine's engines, Future Vehicles
during the year 2020 builds ten cars at a cost of 15,000 Euro each (5,800 Euro
worth of components; 6,200 Euro in labor costs; and 3,000 Euro in taxes per
car). Future Vehicles sells seven of the ten cars it had produced to German
households, for 22,000 Euro each; at the end of the year 2020, it had not sold
the remaining three cars it had produced, which are put into inventory.
How to calculate (under the product, income and expenditure approaches) the
year 2020 GDP of this sample German economy made up of Quiet Muffler,
Ecological Engine, and Future Vehicles?
12
• GDP Based on the Product Approach:

We need to determine the value added adduced by each firm in 2020, and
then sum the values added across all firms in the sample economy (the
following amounts are in Euro):
Quiet Ecological Future Total

Muffler Engine Vehicle
Value of Goods and 10 ∙ 800 10 ∙ 5,000 7 ∙ 22,000 261,000
Services Newly + 1 ∙ 4,000 + 3 ∙ 15,000
Produced
Less Intermediate  10 ∙ 100  11 ∙ 1,000  10 ∙ 5,800  70,000

Goods and Services
Total = Valued Added 7,000 43,000 141,000 191,000

/ GDP Based on
Product Approach
13
• GDP Based on the Income Approach:

We need to add up all (value-added) incomes earned in the sample
economy in 2020. Note that one type of income earned are the firms'
profits. We calculate these in the first step, as profit = revenue − cost :
Profit Quiet Muffler

Revenue 10 ∙ 800 = 8,000
Cost
Labor 10 ∙ 300 = 3,000
Parts (imported) 10 ∙ 100 = 1,000
Interest payments 10 ∙ 250 = 2,500
Tax payments 10 ∙ 50 = 500
Profit = 1,000
14
Profit Ecological Engine

Revenue 10 ∙ 5,000 + 1 ∙ 4,000 = 54,000
Cost
Labor 11 ∙ 2,000 = 22,000
Parts (imported) 11 ∙ 1,000 = 11,000
Tax payments 11 ∙ 1,000 = 11,000
Profit = 10,000
Profit Future Vehicles

Revenue 7 ∙ 22,000 + 3 ∙ 15,000 = 199,000
Cost
Labor 10 ∙ 6,200 = 62,000
Parts (domestic) 10 ∙ 5,800 = 58,000
Tax payments 10 ∙ 3,000 = 30,000
Profit = 49,000
15
Other types of value-added income earned in the sample economy in 2020

include labor income (of the employees), interest income (of the banks) and tax
revenue (of the government). Adding up all valued-added incomes earned in the
sample economy in 2020:
Quiet Ecological Future Total

Muffler Engine Vehicles
Profits 1,000 10,000 49,000 60,000
Labor Income 3,000 22,000 62,000 87,000
Interest Income 2,500 0 0 2,500
Tax Revenue 500 11,000 30,000 41,500
Total = GDP Based 191,000

on Income Approach
16
• GDP Based on the Expenditure Approach:

For the expenditure approach, we can make use of Equation (1),
Y  C  I  G  TB :
Total
Consumption 154,000 154,000
Investment 4,000 + 45,000 49,000
Government Expenditure 0 0
Trade Balance  1,000  11,000  12,000
Total = GDP Based on 191,000

Expenditure Approach
17
GDP vs. GNP/GNI
In addition to GDP, measures of the state of the economy often analyzed

include gross national product (GNP) and gross national disposable
product (GNDP).
GNP is related to GDP as follows:
GDP
+ primary income received by residents from nonresidents = balance on
primary income
− primary income paid by residents to nonresidents
(BPI)
= GNP
Notes:
• Primary income received from nonresidents represents the return received
by residents for providing to nonresidents temporary use of labor, financial
resources or nonproduced nonfinancial assets (the latter include, for
example, licenses and leases).
• Examples include compensation of employees, interest income, dividends
and rents, all as received by residents from nonresidents.
18
GDP vs. GNP/GNI
Thus, GDP captures all incomes received by the producers of new goods and
services operating within the borders of the domestic country (irrespective of
where their permanent residence is), whereas GNP captures all incomes
received by the producers of new goods and services who are permanent
residents of the domestic country (irrespective of where they received these
incomes).
On terminology: GNP is often referred to as GNI (gross national income).

BPI is sometimes referred to as net factor income from abroad (NFIA ).
19
GDP vs. GNP/GNI
GDP vs. GNI: The Case of Ireland
Source: Feenstra and Taylor (2017), International Macroeconomics
20
GNP vs. GNDP/GNDI
GNP in turn is related to GNDP as follows:
GNP
+ secondary income received by residents from nonresidents = balance on
secondary
− secondary income paid by residents to nonresidents income (BSI )
= GNDP
Notes:
• Secondary income received from nonresidents represents income received by
residents without providing to nonresidents a corresponding economic value
in return.
• Examples include personal transfers, social contributions, insurance
premiums and insurance claims, all as received by residents from non-
residents.
On terminology: GNDP is often referred to as GNDI (gross national

disposable income). BSI is sometimes referred to as net unilateral
transfers (NUT).
21
GNP vs. GNDP/GNDI
Major Recipients of Net Unilateral Transfers
22
GDP vs. NDP
Distinction Between Gross and Net Measures
Subtracting technical and physical depreciation of the stock of physical capital,

we move from gross measures to the corresponding net measures. For
example:
GDP
− consumption of fixed capital (depreciation)
= NDP (net domestic product)
Net measures convey how much income is available if the value of the
productive capacities (that is, the stock of physical capital) is to be
maintained.
23
Wintersemester 2020/21 GDP, GNP, GNDP and NDP
Calculating a Firm's Contributions to GDP, GNP, GNDP and NDP
In the year 2020, Berlin-based InVogue develops a new app listing current
sales events in several German cities; the app in the year 2020 is
downloaded globally 500,000 times at a purchase price of 3 Euro. InVogue's
IT equipment at the beginning of the year 2020 is valued at 120,000 Euro.
InVogue pays the following annual wages to its programmers: 550,000 Euro
to programmers who are residents of Germany, and 150,000 Euro to
programmers who are residents of Poland. The annual rate of depreciation
on InVogue's IT equipment is 25%. The programmers who are residents of
Germany in 2020 transfer 5,000 Euro of their earnings to an orphanage in
Cambodia. The programmers who are residents of Poland in 2020 transfer
20,000 Euro of their earnings to relatives in Poland. The profits of InVogue
are paid as dividends to its owners, who are residents of Qatar.
Calculate the year 2020 contributions of InVogue to the GDP, GNP, GNDP and
NDP of the German economy.
24
The year 2020 contributions of InVogue to the German economy are as

follows:
‐ GDP Contribution: Value added in the amount of 3 Euro (sales price of
app) ∙ 500,000 (number of downloads) = 1,500,000 Euro.
‐ GNP Contribution: Both the earnings of the Polish programmers (150,000
Euro) and the dividend payments earned by the Qatari owners (which in
turn are equal to the profits of InVogue: 1,500,000 Euro (revenue) –
700,000 Euro (total cost of labor) = 800,000 Euro) constitute primary
income paid to nonresidents. The GNP contribution is thus equal to
1,500,000 Euro (GDP contribution) – 950,000 Euro (BPI contribution) =
550,000 Euro.
‐ GNDP Contribution: The transfer of the German programmers to the
Cambodian orphanage (5,000 Euro) constitutes secondary income paid to
nonresidents. The GNDP contribution is thus equal to 550,000 Euro (GNP
contribution) – 5,000 Euro (BSI contribution) = 545,000 Euro.
25
‐ NDP Contribution: The year 2020 depreciation is equal to 120,000 Euro

(value of capital stock at the beginning of the year 2020) ∙ 0.25 (rate of
depreciation as a fraction) = 30,000 Euro. The NDP contribution is thus
equal to 1,500,000 Euro (GDP contribution) – 30,000 Euro (depreciation)
= 1,470,000 Euro.
26
Potential Problems with GDP
Potential Problems with GDP (and Related NIPA Measures)
GDP as a measure of an economy's valued added, and even more so as a

measure of a society's standard of living, may suffer from several
drawbacks:
• Measurement issues:
‐ Some goods and services, for example home production, are not
transacted and are thus not captured in GDP.
‐ Some goods and services are not officially transacted, for example
informal or illegal activities, and are thus difficult to capture as
part of GDP.
27
Size of Shadow Economy

(Estimated Size Relative to GDP, Fraction, 2015)
Source: Burda and Wyplosz (2017)
28
‐ Changes in the quality of goods and services are often ignored,

especially for services, and may be difficult to capture.
• Conceptual issues:
‐ Some components of GDP may be viewed as "regrettables" (not
enhancing the well-being of society).
‐ GDP does not take into account factors other than income that are
important for the well-being of society: for example,
• value of health,
• value of leisure time, and
• value of the environment.
29
Alternative measures of a society's standard of living exist, for example the

"Human Development Index" (HDI), calculated by the United Nations.
HDI takes into account information on health (such as life expectancy at

birth) and education (such as years of schooling), in addition to that on
GDP, in aiming to measure the "quality of life".
Despite the existence of such alternative measures, GDP continues to be

the main measure used in practice for comparing the standard of living
achieved across time periods and countries.
30
2. Balance of Payments
Understanding of the interactions of the domestic economy with

individual other economies and the rest of the world overall requires
knowledge of the so-called Balance of Payments (BoP) accounts.
The BoP is composed of three sub-accounts, the current account, the

capital account and the financial account:
31
Current Account
Current Account
The current account captures the following transactions between residents

of the domestic economy and nonresidents:
(i) exports and imports of goods and services,

(ii) primary income received and paid,
(iii) secondary income received and paid.
The current account balance (CA) is given by:
CA  TB  BPI  BSI . (2)
32
Capital Account
Capital Account
The capital account captures the following transactions between residents of
the domestic economy and nonresidents:
(i) acquisition and disposal of nonproduced nonfinancial assets
(including, for example, land, water, licenses, leases, brand names,
trademarks and domain names),
(ii) capital transfers received and granted
(capital transfers, in contrast to transfers that are part of secondary
income, involve the transfer of ownership of nonproduced nonfinancial
assets or the forgiveness of liabilities by a creditor without receiving a
corresponding value in return; this includes, for example, the donation of
land and debt forgiveness).
The capital account balance (KA) is given by:

KA   net acquisition of nonproduced nonfinancial assets ( NANA)
(3)
 net receipt of capital transfers ( NRCT ) .
33
Financial Account
Financial Account
The financial account captures financial asset and financial liability transactions
between residents of the domestic economy and nonresidents, categorized as
follows:
(i) foreign direct investment
(including, for example, equity, bonds and non-bank loans that entitle to
enterprise voting power of at least 10%),
(ii) portfolio investment
(including, for example, equity, bonds and non-bank loans that entitle to
enterprise voting power of less than 10%, as well as derivatives),
(iii) other investment
(including, for example, currency, bank deposits and bank loans),
(iv) reserves
(including, for example, foreign currency reserves held by the monetary
authorities and foreign currency loans granted by international organiza-
tions to the monetary authorities).
34
Financial Account
The financial account balance (FA) is given by:

FA  net acquisition of foreign financial assets ( NAFA) (4)
 net incurrence of foreign financial liabilities ( NIFL) .
If FA > 0, the domestic economy in net terms supplies funds to the rest of the
world, and is called a net lender: Its sum of acquisition of financial assets
and repayment of financial liabilities exceeds its sum of disposal of financial
assets and incurrence of financial liabilities.
If FA < 0, the domestic economy in net terms borrows funds from the rest of
the world, and is called a net borrower: Its sum of disposal of financial
assets and incurrence of financial liabilities exceeds its sum of acquisition of
financial assets and repayment of financial liabilities.
35
Double-Entry Accounting
In recording transactions in the current, capital and financial accounts, the

BoP invokes the principle of doubly-entry accounting: Each transaction
is recorded in the BoP of the domestic economy as consisting of two
entries of equal value, credit and debit, reflecting the inflow and outflow
elements of each transaction:
Any transaction leading to a payment from nonresidents to residents is first

recorded as a credit entry, and the second recording is then as an off-
setting debit entry.
Any transaction leading to a payment from residents to nonresidents is first

recorded as a debit entry, and the second recording is then as an off-
setting credit entry.
36
Thus, the BoP transactions for which the first entry is a credit entry are:
exports of goods and services, primary and secondary income payments
received, disposal of nonproduced nonfinancial assets, capital transfers
received, disposal of financial assets, as well as incurrences of financial
liabilities.
Also, the BoP transactions for which the first entry is a debit entry thus
are: imports of goods and services, primary and secondary income
payments made, acquisition of nonproduced nonfinancial assets, capital
transfers granted, acquisition of financial assets, as well as repayment of
financial liabilities.
37
Per se separate is the issue of the sign of each entry. The sign of the first
and second entries is in line with the account balances given in Equations
(2), (3) and (4):
Thus, transactions that enter with a plus sign are: exports of goods and
services, primary and secondary income payments received, disposal of
nonproduced nonfinancial assets, capital transfers received, acquisition of
financial assets, as well as repayment of financial liabilities.
Also, transactions that enter with a minus sign are: imports of goods and
services, primary and secondary income payments made, acquisition of
nonproduced nonfinancial assets, capital transfers granted, disposal of
financial assets, as well as incurrences of financial liabilities.
It follows that in the current and capital accounts, the first entries that are
credit entries are recorded with a plus sign, and the first entries that are
debit entries are recorded with a minus sign. However, in the financial
account, the first entries that are credit entries are recorded with a minus
sign, and the first entries that are debit entries are recorded with a plus sign.
38
Let us summarize these BoP accounting principles:

Credits Debits Balance
Current Account
Exports of goods and services (+) Imports of goods and services (−) TB
Primary income received (+) Primary income paid (−) BPI
Secondary income received (+) Secondary income paid (−) BSI
CA
Capital Account
Disposal of nonproduced nonfinancial assets (+) Acquisition of nonproduced nonfinancial assets (−) − NANA
Capital transfers received (+) Capital transfers granted (−) NRCT
KA
Financial Account
Disposal of foreign direct investment assets (−) Acquisition of foreign direct investment assets (+) NAFA (FDI)
Incurrences of foreign direct investment liabilities (−) Repayment of foreign direct investment liabilities (+) − NIFL (FDI)
Disposal of portfolio investment assets (−) Acquisition of portfolio investment assets (+) NAFA (PI)
Incurrences of portfolio investment liabilities (−) Repayment of portfolio investment liabilities (+) − NIFL (PI)
Disposal of other investment assets (−) Acquisition of other investment assets (+) NAFA (OI)
Incurrences of other investment liabilities (−) Repayment of other investment liabilities (+) − NIFL (OI)
Disposal of reserve assets (−) Acquisition of reserve assets (+) NAFA (RA)
Incurrences of reserve liabilities (−) Repayment of reserve liabilities (+) − NIFL (RA)
FA
39
BOP Accounting Identity
Given the double-entry accounting principle and the definitions of the three
sub-account balances, the following BoP accounting identity holds:
CA  KA  FA . (5)
Since the financial account balance measures the net lending/borrowing

position of the domestic economy relative to the rest of the world, Equation
(5) implies that the same must be true for the sum of the current and
capital account balances:
If CA + KA > 0, the domestic economy is a net lender to the rest of the

world. If CA + KA < 0, the domestic economy is a net borrower from the
rest of the world.
40
BoP Recording of Single Market Transactions
Let us further illustrate the BoP by considering examples of BoP calculations:
BoP Recording of Single Market Transactions – First Example
A German car manufacturer sells newly produced cars to a consortium of car

dealers in the U.S., with the sale involving a transfer from the U.S. checking
account of the car dealer consortium to the U.S. checking account of the
German car manufacturer (value of this transaction: 750,000 Euro).
How to record this transaction in the German BoP? Also, if this was the only
transaction entering the German BoP, what would be the balances of the
German current, capital and financial accounts?
41
• Sale of cars leads to a payment from U.S. residents to German residents,

and therefore first recording is a credit entry in German BoP, and second
recording in German BoP must then be an off-setting debit entry.
• First recording in German BoP: credit, current account, export of goods and
services, 750,000 Euro.
• Second recording in German BoP: debit, financial account, other investment,
750,000 Euro (increase in foreign financial asset holdings).
• BoP sub-account balances:
CA = 750,000 Euro
KA = 0
FA = 750,000 Euro.
• BoP accounting identity:
CA + KA = 750,000 Euro = FA .
42
BoP Recording of Single Market Transactions – Second Example
A German resident buys stock of various companies on a U.S. stock

exchange, with a cash payment (value of this transaction: 10,000 Euro).
Again, how to record this transaction in the German BoP? Also, if this was
the only transaction entering the German BoP, what would be the balances
of the German current, capital and financial accounts?
43
• Purchase of stocks leads to a payment from German residents to U.S.

residents, and therefore first recording is a debit entry in German BoP,
and second recording in German BoP must then be an off-setting credit
entry.
• First recording in German BoP: debit, financial account, portfolio
investment, 10,000 Euro (increase in foreign financial asset holdings).
• Second recording in German BoP: credit, financial account, other
investment, − 10,000 Euro (decrease in foreign financial asset
holdings).
CA = 0
KA = 0
FA = 0 (note that the increase of holdings of stocks (+ 10,000 Euro) is
offset by a decrease of holdings of currency (− 10,000 Euro)).
CA + KA = 0 = FA .
44
BoP Recording of Single Market Transactions – Third Example
A German manufacturer of GPS devices buys a patent from a Chinese

company, funded by a loan from a Dutch bank (value of this transaction:
200,000 Euro).
Once more, how to record this transaction in the German BoP? Also, if this
was the only transaction entering the German BoP, what would be the
balances of the German current, capital and financial accounts?
45
• Purchase of patent leads to a payment from German residents to

Chinese (via Dutch) residents, and therefore first recording is a debit
entry in German BoP, and second recording in German BoP must
then be an off-setting credit entry.
• First recording in German BoP: debit, capital account, nonproduced
nonfinancial assets, − 200,000 Euro (increase in foreign non-
produced nonfinancial asset holdings).
• Second recording in German BoP: credit, financial account, other
investment, − 200,000 Euro (increase in foreign financial liability hol-
dings).
CA = 0
KA = − 200,000 Euro
FA = − 200,000 Euro.
CA + KA = − 200,000 Euro = FA . 46
Macroeconomics 1 (BMAK) 2. Balance of Payments
Wintersemester 2020/21 Cross-Country Data
Let us complete our discussion of the BoP by considering some empirical

data on major components of the current, capital and financial accounts:
47
Main Components of the Current and Capital Accounts:

Germany, Euro Area, United States and China
(Million U.S. Dollars, 2019)
Germany Euro Area United States China
Current account (excludes reserves and related items) 273,137.0 353,900.9 -480,228.0 141,335.5
Goods, credit (exports) 1,464,375.5 2,691,990.7 1,652,437.0 2,399,017.8
Goods, debit (imports) 1,216,920.1 2,329,963.1 2,516,769.0 1,973,746.8
Balance on goods 247,457.6 362,029.8 -864,332.0 425,271.0
Services, credit (exports) 346,551.9 1,111,101.0 875,830.0 244,359.2
Services, debit (imports) 370,759.0 1,033,707.8 588,363.0 505,508.2
Balance on goods and services 223,248.3 439,420.9 -576,865.0 164,122.0
Primary income, credit 258,499.9 895,637.2 1,135,691.0 235,810.0
Primary income, debit 155,259.8 811,984.7 899,347.0 268,846.5
Balance on goods, services, and primary income 326,488.4 523,073.4 -340,521.0 131,085.4
Secondary income, credit 82,961.5 126,483.0 141,984.0 25,907.4
Secondary income, debit 136,312.9 295,655.6 281,691.0 15,657.4
Capital account (excludes reserves and related items) -339.2 -22,319.0 -6,244.0 -327.3
Capital account, credit 52,923.7 52,462.6 66.0 218.0
Capital account, debit 53,262.9 74,780.5 6,312.0 545.3
Balance on current and capital account 272,797.8 331,581.9 -486,472.0 141,008.2
Source of Data: IMF (2020)
48
Main Components of the Financial Account and BoP Balance:

Germany, Euro Area, United States and China
(Million U.S. Dollars, 2019)
Germany Euro Area United States China
Financial account (excludes reserves and related items) 230,165.9 300,488.5 -400,205.0 -37,754.7
Direct investment, assets 134,940.6 144,559.6 188,470.0 97,703.4
Equity and investment fund shares 118,742.9 142,538.0 173,538.0 84,928.0
Debt instruments 16,198.9 2,019.4 14,932.0 12,775.5
Direct investment, liabilities 72,211.2 126,000.0 351,631.0 155,815.3
Equity and investment fund shares 44,911.0 174,875.3 290,311.0 131,250.7
Debt instruments 27,300.2 -48,875.3 61,320.0 24,564.6
Portfolio investment, assets 138,675.9 455,460.8 46,571.0 89,418.8
Equity and investment fund shares 75,043.0 72,556.1 -191,306.0 29,332.2
Portfolio investment, liabilities 33,328.4 525,704.5 179,976.0 147,366.5
Equity and investment fund shares -12,820.2 321,819.3 -244,072.0 44,906.0
Financial derivatives (other than reserves) and employee stock options 25,166.8 41,475.2 -38,340.0 2,355.0
Fin. derivatives and employee stock options, assets 25,166.8 ... ... -1,392.7
Fin. derivatives and employee stock options, liabilities ... ... ... -3,747.6
Other investment, assets -56,316.2 225,361.6 201,051.0 32,291.2
Other equity 16,623.4 4,917.3 1,367.0 1,491.0
Debt instruments -72,939.5 220,444.2 199,684.0 30,800.2
Other investment, liabilities -93,237.3 -85,337.4 266,350.0 -43,658.7
Other equity 262.5 296.1 ... 0.0
Debt instruments -93,499.9 -85,633.5 266,350.0 -43,658.7
Balance on current, capital, and financial account 42,631.8 31,093.3 -86,267.0 178,762.9
Net errors and omissions -43,225.0 -18,912.0 90,927.1 -198,050.9
Reserves and related items -594.2 12,184.7 4,660.1 -19,288.1
Reserve assets -594.2 7,345.6 4,660.1 -19,288.1
Net credit and loans from the IMF (excluding reserve position) 0.0 -4,839.1 0.0 0.0
Exceptional financing ... ... 0.0 ...
(...) Indicates a lack of statistical data that can be reported or calculated from underlying observations
Source of Data: IMF (2020)

49
3. Saving and Wealth
As for individual households and firms, the economic well-being of an

economy beyond income also depends on its wealth. A firm, for
example, is routinely assessed both on the basis of its income
statement and its balance sheet (the latter listing assets and liabilities).
This is as measuring changes in wealth permits monitoring the
sustainability of economic development.
How to measure the national wealth of an economy, and how does

national saving contribute to the accumulation of national wealth?
50
Private Saving
Private Saving
Saving of the private sector:
S pvt  Y  BPI  BSI  T  GT  C , (6)



GNI
 GNDI

private GNDI
where
T = taxes levied by government on private sector;
GT = net transfers from government to private sector.
Government Saving
Saving of the government sector:
S govt  T  GT  G. (7)
 
net government income
51
National Saving
National Saving
Adding up private saving and government saving, we obtain
S  S pvt  S govt
 Y  BPI  BSI  T  GT  C   T  GT  G 
(8)
 Y  BPI  BSI  C  G.
Substituting the expenditure approach-based definition of GDP from Equation
(1), Y = C + I + G + TB, into Equation (8), we obtain:
S  I  TB  BPI  BSI . (9)


CA
National saving can thus be allocated to two uses:

(i) funding (through I) the domestic accumulation of physical capital;
(ii) funding the current account balance, that is (see our discussion of the BoP),
being a net lender to the rest of the world (if CA > 0, and under KA = 0).
52
Saving, Investment and Current Account
Saving, Investment and Current Account
53
National Wealth
National Wealth
National wealth is the overall wealth of the residents of an economy. How to
measure it? Consider first the net asset position of an individual. His/her end of
period t net asset position is given by:
net asset position at end of period t

 net asset position at beginning of period t
 acquisitions of assets during period t
 disposals of assets during period t
 valuation changes of net assets during period t .
In general, end-of-period wealth is thus a function of
• beginning-of-period wealth,
• saving (net asset acquisitions minus net asset disposals), and
• valuation changes.
54
National Wealth
Tracing saving sufficiently far back into the past, the components of saving
(including their subsequent valuation changes) thus inform us about the
components of wealth.
From Equation (9), we know that national saving can be allocated either
towards investing in physical capital in the domestic economy or towards
lending to the rest of the world, that is, towards accumulation of wealth abroad.
Note that the domestic economy's stock of physical capital (K) is related to
investment in physical capital as follows:
K end of  K beginning of    K beginning of  It . (10)

period t period t  period t

rate of investment
depreciation during period t
of physical
capital during
period t
55
National Wealth
National wealth therefore is composed of:

(i) the domestic economy's capital stock (K), and
(ii) the domestic economy's wealth abroad (net international investment
position (NIIP), equal to foreign nonfinancial and financial assets (FOA)
minus foreign nonfinancial and financial liabilities (FOL)):
national wealth  K  FOA  FOL . (11)


 
domestic wealth wealth abroad  NIIP 
Notes:
• Domestic financial assets held by domestic residents are not part of
national wealth.
(The value of domestic financial assets for their holders is offset by them
being a liability of the same amount for the domestic issuers of these
assets.)
56
National Wealth
• Equating the stock of physical capital at the end of period t with the
stock of physical capital at the beginning of period t + 1, the capital
accumulation equation, (10), may also be written as
K t 1  K t    K t  I t
 1     K t  I t . (12)
Equation (12) will feature in our short-, medium- and long-run models
of the macroeconomy.
Let us further illustrate national wealth accounting by considering the

calculation of national saving and national wealth for two sample
economies:
57
Macroeconomics 1 (BMAK) 3. Saving and Wealth
Wintersemester 2020/21 Calculating National Saving and Wealth for Sample Economies
Calculating National Saving and National Wealth for Sample Economies

Green Engine GmbH is located in the economy East, and at the beginning of
the year 2020 had a capital stock worth 70,000 Euro. During 2020, Green
Engine builds 200 electric engines and its capital stock depreciates by 4,000
Euro. The market value of each engine is 300 Euro. Green Engine's costs for
the production of each engine are: cost of labor from workers who are
residents of East, 20 Euro; cost of labor from workers who are residents of the
economy West, 75 Euro; taxes, 10 Euro. Green Engine sells all 200 of the
engines produced in 2020 to Quiet Vehicles AG (which is located in West). Also
during 2020, the owners of Green Engine purchase 3,000 shares of the stock
of Quiet Vehicles AG, at a price of 10 Euro per share. Finally during 2020, the
owners of Green Engine earn 5,000 Euro in interest payments on a savings
account held with a bank in West (the balance on this account at the beginning
of the year 2020 had been 75,000 Euro, and the only transaction in this
account that occurs during 2020 is the crediting of the 5,000 Euro interest
payment).
58
Quiet Vehicles entered the year 2020 with a capital stock worth 250,000
Euro. During 2020, Quiet Vehicles builds 200 motorcycles and its capital stock
depreciates by 20,000 Euro. The costs for the production of each motorcycle
are: 300 Euro worth of components from Green Engine; 500 Euro cost of
labor from workers who are residents of West. Quiet Vehicles sells 5 of the
motorcycles produced for 2,000 Euro to private households in East; it sells
105 of the motorcycles produced to private households in West (also at 2,000
Euro per motorcycle). At the end of the year 2020, Quiet Vehicles puts all
remaining 90 motorcycles produced but not sold in 2020 into its inventory.
How to calculate the year 2020 national saving as well as the national wealth
at the end of the year 2020 of the economies East and West?
59
National Saving:
East West
Investment 0 90 ∙ 800
(addition to inventory)
Trade Balance 200 ∙ 300 − 200 ∙ 300
(exports of engines) (imports of engines)
− 5 ∙ 2,000 5 ∙ 2,000
(imports of motorcycles) (exports of motorcycles)
Balance on Primary − 200 ∙ 75 200 ∙ 75

Income (wages paid to workers from West) (wages of workers earned in East)
5,000 − 5,000
(interest income earned in West) (interest income paid to East)
Balance on Secondary 0 0
Income
Total = National Saving 40,000 32,000
60
National Wealth:
East West
Capital Stock 70,000 250,000

(initial capital stock) (initial capital stock)
− 4,000 − 20,000
(depreciation) (depreciation)
90 ∙ 800
(addition to inventory)
Foreign Nonfinancial 3,000 ∙ 10 0
and Financial Assets (stocks held in West)
75,000 + 5,000
(savings account held in West)
Foreign Nonfinancial 0 3,000 ∙ 10
and Financial Liabilities (stocks held by East)
75,000 + 5,000
(savings account held by East)
Total = National Wealth 176,000 192,000
61
Potential Problems with Wealth Measure
Potential Problems with this Measure of National Wealth
As a measure of an economy's comprehensive wealth, the wealth measure we

have considered appears to omit relevant factors, including
• "human capital" (the education and skills of the economy's people), and
• "natural capital" (including the economy's land, forests, minerals and

energy).
Alternative measures of an economy's wealth do exist, for example the World

Bank's "total wealth" that combines physical, human and natural capital as
well as net foreign assets, but data coverage is still relatively limited.
62
Wealth: Cross-Country Data
Total Wealth and Its Components
High-
Lower- Upper- High-
Low- Income
Middle- Middle- Income
World Income Non- Germany
Income Income OECD
Countries OECD
Countries Countries Countries
Countries
2014 Total Wealth per Capita

168,580 13,629 25,948 112,798 264,998 708,839 729,064
(U.S. Dollars at Market Exchange Rates)
of which (in percent)
Produced Capital 27 14 25 25 23 28 33
Natural Capital 9 47 27 17 30 3 1
Human Capital 64 41 51 58 42 70 64
Net Foreign Assets 0 -2 -3 0 5 1 2
Source of Data: World Bank DataBank (2020)
63

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Goethe University Frankfurt

II. Measuring Macroeconomic Activity

II. Measuring Macroeconomic Activity

A first key measure of the state of the economy is gross domestic

GDP by Value Added Produced: Germany

Agriculture, Forestry and Fishing 24.9 0.7%

Net Taxes (Taxes Less Subsidies) on Products 342.9 9.9%

Gross Domestic Product 3449.1 100.0%

(ii) Income Approach

GDP by Incomes Received: Germany

Compensation of Employees 1845.9 53.5%

Other Income (Including Depreciation of Physical Capital and

Gross Domestic Product 3449.1 100.0%

Source of Data: Destatis (2020)

(iii) Expenditure Approach

GDP by Expenditure Components: Germany

Final Consumption Expenditure 1806.9 52.4%

Gross Domestic Product 3449.1 100.0%

Note : Destatis includes public-sector spending on newly produced goods and

Calculating the Effects of a Single Market Transaction on GDP

On January 20, 2020, a domestic household purchases from a grocery

The January 20 transaction contributes to the year 2020 GDP of the

‐ Product approach: sale of milk on January 20 creates value added

‐ Income approach: sale of milk on January 20 creates value added

Calculating GDP for a Sample Economy

Quiet Muffler GmbH has a factory in Landshut valued at a 2,000,000 Euro.

• GDP Based on the Product Approach:

Quiet Ecological Future Total

Less Intermediate  10 ∙ 100  11 ∙ 1,000  10 ∙ 5,800  70,000

Total = Valued Added 7,000 43,000 141,000 191,000

• GDP Based on the Income Approach:

Profit Quiet Muffler

Profit Ecological Engine

Profit Future Vehicles

Other types of value-added income earned in the sample economy in 2020

Quiet Ecological Future Total

Profits 1,000 10,000 49,000 60,000

Labor Income 3,000 22,000 62,000 87,000

Interest Income 2,500 0 0 2,500

Tax Revenue 500 11,000 30,000 41,500

Total = GDP Based 191,000

• GDP Based on the Expenditure Approach:

Consumption 154,000 154,000

Investment 4,000 + 45,000 49,000

Trade Balance  1,000  11,000  12,000

Total = GDP Based on 191,000

In addition to GDP, measures of the state of the economy often analyzed

On terminology: GNP is often referred to as GNI (gross national income).

GDP vs. GNI: The Case of Ireland

Source: Feenstra and Taylor (2017), International Macroeconomics

GNP in turn is related to GNDP as follows:

On terminology: GNDP is often referred to as GNDI (gross national

Major Recipients of Net Unilateral Transfers

Source: Feenstra and Taylor (2017), International Macroeconomics

Distinction Between Gross and Net Measures

Subtracting technical and physical depreciation of the stock of physical capital,

Calculating a Firm's Contributions to GDP, GNP, GNDP and NDP

The year 2020 contributions of InVogue to the German economy are as

‐ NDP Contribution: The year 2020 depreciation is equal to 120,000 Euro

Potential Problems with GDP (and Related NIPA Measures)

GDP as a measure of an economy's valued added, and even more so as a

Size of Shadow Economy

Source: Burda and Wyplosz (2017)