NATIONAL INCOME

ACCOUNTING AND THE BALANCE

OF PAYMENTS
 National Income Accounting
• It refers to the calculation of GDP and the
subdivision of GDP into various components.
Included in the various components of GDP
are exports and imports.
 The measurement of GDP
• Gross Domestic Product is the market value of
all final goods and services a country produces
in a year.
• It is a country’s total output measured in the
country’s currency.
 Items excluded from GDP
• First, in our definition of GDP “final goods and
services” means that we count the value of
goods and services sold only to end users.
• Second, the calculation of GDP includes only
reported market transactions. If a good or
service is produced but not sold in the market,
it is excluded from GDP.
 GDP and Changes in Prices
• Although GDP uses current prices as a
measure of market value, current prices can
distort our measure of real output.
• To distinguish increases in the quantity of gods
and services from increases in their prices ,
countries construct a measure of GDP known
as Real GDP.
 Real GDP is a measure of GDP adjusted for
changes in prices.

Nominal GDP is the value of final output

measured in current prices and Real GDP is the
value of final output measured in constant
prices.
 The Components of GDP

GDP is composed of four components. These

are public consumption; Gross private domestic
investment; government on spending goods and
services, and net exports: exports minus
imports.
 GDP in a Closed Economy
• In a closed economy, firms must use any final
good or service that individuals do not
consume or the government does not
purchase to produce new plant and
equipment.
FORMULA: Y= C + I + G
where Y or GDP equals the sum of consumption,
investment, and government spending.
 GDP in an Open Economy
• To make the equation Y= C+I+G work in an
open economy we have to allow for
international trade. Consumers in an open
economy may buy imported goods and
services so we subtract the value of imports
from total domestic spending. The equation
for an open economy is:
Y= C+I +G+ X-M
 Imports, Exports and GDP
• There is another way to look at how the
difference between exports and imports is
related to GDP in an open economy. To
illustrate, we can rearrange the open economy
equation to yield:
X-M=Y-C-I-G
The equation shows that exports minus imports
are equal to GDP minus consumption,
investment and government spending.
 Remember, Y is the total output of final goods
and services in an economy. This total output is
the amount of goods and services that is
available for individuals and the government to
consume or for firms to invest.
• The sum of C, I and G represents the demand
for domestically produced output by the
various sectors in an economy.
• What happens if the domestic demand for
goods and services is larger than the economy
is capable of producing? The economy would
have to import the difference from other
countries and this would produce a trade
deficit.
• Then if the economy were produced more
goods and services than are consumed
domestically exports would exceed imports
and result in a trade surplus.

TABLE 10.1
GDP FOR ALPHA AND BETA IN BILLIONS OF DOLLARS
Countr Y C I G X-M
y
Alpha 10,225 7,057 1,625 1837, -295
Beta 5,134 3,089 1,464 506 75
When real domestic output(Y) is smaller than
the sum of C,I and G, then a country is
consuming more goods and services than it has
produced.

• The trade balance, X-M is a flow variable

which means that it occurs over a period of
time such as one year.
The amount of debt a country has is a stock
variable which means it can be added or
subtracted from. In this case of a trade deficit,
the country is adding to it’s stock of debt to the
rest of the world.
 Trade Balance is a way for a country to
balance it’s production and consumption over
periods of time longer than a year.

Intertemporal Trade is the situation where

countries are trading production for
consumption at different points in time.
 Saving, Investment, The Government
Budget and the Trade Balance
• A country’s GDP measures not only the final
output of goods and services it produces but
also measures a country’s total income.
Money moves in a circular flow from
businesses to the public and back again.
Outflows of income are forms of income that
are withdrawn from the circular form of
income; e.g savings, taxes and imports.
 Not all income flows are immediately spent
on goods and services. Some income is
temporarily withdrawn from the circular flow
and this is called outflows of income.
1. Savings
2. Taxes
3. Imports
 Injections of Income

- Are additions to the circular flow of income

that are not derived from the current income.
1. Investment
2. Government spending
3. Exports
For any economy the sum of the outflows of
income must equal the sum of the injections of
income.
S+T+M=G+I+X
S-Savings G-Government spending
T-Taxes I-Investments
I-Imports X- Exports
 When the outflows are greater than the
injection of spending then the trade balance will
be positive. When the sum of saving and taxes is
less than the sum of government spending and
investment the trade balance will be negative.
 Strategies to Reduce Trade Imbalances

• Trade deficit or surplus has four strategies to

reduce the imbalance.
1. Increasing the level of saving would tend to
reduce the trade deficit.
2. Change the level of business investment.
Increasing the level of investment relative to
saving may worsen the trade deficit but it
may improve economic growth.
3. The third strategy to reduce the trade deficit
would be to increase taxes.

4. Changing government spending is the fourth

strategy.
 TABLE 10.2
METHOD AVAILABLE TO REDUCE TRADE IMBALANCES
Country Has A Trade
Deficit Surplus
Increase Private Savings Decrease Private Savings
Or Or
Increase Government taxes Decrease Government Taxes
Or Or
Decrease Business Increase Business Investment
Investment
Or Or
Decrease Government Increase Government Spending
Spending
 TABLE 10.3
RELATIONSHIP BETWEEN SAVINGS, INVESTMENT, THE GOVERNMENT BALANCE, & TRADE BALANCE
(ALL FIGURES ARE PERCENTAGES OF GDP)

Country Time S I (X-M)

Period (G-T)
U.S 1978-1980 17.6 17.1 0.4 -0.1
  1986-1988 15.8 16.1 2.7 -3.0
  1996- 1998 13.8 16.1 -0.4 -1.5
Japan 1978-1980 36.5 31.7 4. 9 -0.1
  1986-1988 32.6 29.5 -0.4 3.5
  1996-1998 30.5 23.4 4.5 2.6
EU 1978-1980 26.6 22.1 4.2 0.3
1978-1980 20.8 16.1 4.0 0.7
1996-1998 19.2 16. 9 2.7 0.4

           
 The Balance of Payments

Balance of Payments is the record of all

economic transactions derived from the
exchange of goods and services, income and
assets between residents of one country and the
rest of the world.
• It is made up of the balance on the current
account and the balance on capital account.

-Balance on current account is an accounting of

international transactions that includes goods,
services, investment, income and unilateral
transfers.
-Balance on capital account is recording of
changes in the holdings of foreign assets by
foreign residents.
 The Balance on Current Account
Merchandise trade balance is the difference
between exports and imports of goods.

The balance on services is the difference

between exports and imports of services.
 TABE 10.5
SUMMARY 0F U.S TRANSACTI0NS 1964-2000, IN BILLI0NS 0F D0LLARS

Year Trade Service Goods and Investment Unilateral Current

Balance Balance Service Income Transfers Account
Balance Balance Balance Balance
1964 6.8 -0.8 6.0 5.0 -4.2 6.8
1966 3.8 -0. 2. 9 5.0 -5.0 3.0
1968 .6 -0.4 0.3 6.0 -5.6 0.6
1970 2.6 -0.3 2.5 6.2 -6.2 2.3
1972 -6.4 1.0 -5.4 8.2 -8.5 -5.8
1974 -5.5 1.2 -4.3 15.5 -9.2 2.0
1976 -9.5 3.4 -6.1 16.1 -5.7 4.3
1978 -33. 9 4.2 -29.8 20.4 -5.8 -15.1
1980 -25.5 6.1 -19.4 30.1 -8.3 2.3
1982 -36.5 12.3 -24.2 35.2 -16.3 -5.5
1984 -112.5 3.4 -109.1 35.1 -20.3 -94.3
1986 -145.1 6.6 -138.5 15.3 -24.1 -147.2
1988 -127.0 12.4 -114.6 18.7 -25.3 -121.2
1990 -111.0 30.1 -80. 9 28.6 -26.7 -79.0
1992 -6. 60.4 -36.5 23.0 -35.0 -48.5
1994 -165.8 69.1 -96.7 16.7 -38.3 -118.2
1996 -191.0 89.2 -101.8 21.0 -40.0 -120. 9
1998 -246.7 79. 9 -166.8 -6.2 -44.4 -217.5
2000 -452.2 76.5 -373.7 -14.3 -34.1 -444.7
 The balance on goods and services is the
difference between exports and imports of both
goods and services.

The balance on investment income is the

difference between income earned on foreign
assets and payments to foreign residents on their
assets.
 The balance on goods, services and income is the
summation of the merchandise trade balance, the
balance on services and the balance on investment
income.

Unilateral transfers are grants or gifts extended to

or received from other countries.

The balance on current account is an accounting of

international transactions that includes goods
,services, investment income and unilateral transfers.
 The Balance on Capital Account
Changes in assets abroad is the change in the
total amount of foreign assets that domestic
residents own.

Official reserve assets are government

holdings of gold or foreign currency used to
acquire foreign assets.
 Special Drawing Rights(SDRs) is a form of
international money created by the
International Monetary Fund.

The International Monetary Fund(IMF) is a

multilateral agency created in 1946 to promote
international monetary stability and
cooperation.
 Change in foreign assets is the change in the
amount of assets in a country that foreign
residents own.
The Current Account and The Capital Account

• The rule that total inflows and outflows need

to be equal leads to an interesting bit of logic.
• If the current account balance is negative then
the capital account balance must be positive.
A country running a deficit on trade in goods
and services must somehow finance this
deficit by borrowing from foreigners.
 Balance of Payment Stages
The popular misconception of a country’s
international trade position is that deficits are
bad and surpluses are good. Overtime, the
foreign direct investment may lead to an
increase in export which creates a trade
surplus. The point is that in many cases
deficits are typical for economies at different
stages of development.
 Group 9
Almarez, Lay Ann
Aguila, Keycee
Gomez, Hazel Jane
Murla, Mark Jake
Masilungan,
Ericson