Global Economics: PGP: Session 1: Introduction & National Income and Product Accounts

Global Economics: PGP
Session 1: Introduction &

National Income and Product Accounts
Shekhar Tomar
Make global economics great again!
Source: https://www.businessinsider.in/Trumps-trade-war-is-getting-serious-heres-why-it-started-what-it-means-for-the-US-economy-and-how-
it-could-hit-you/articleshow/65092628.cms
June 4, 2019 GLEC: Session 1 2

Impact of a crude price shock
• What gets impacted, who are the Players and what are their Actions?

How much money is riding on the table?
• Take a one year zero coupon bond with discount rate 10% for a year
100
𝑃1 = 1 = 90.90
(1 + 0.1)
• RBI cuts the interest rate by 25 basis points
100
𝑃2 = 1
= 91.11
(1 + 0.0975)
• What happens to your portfolio if you hold 10 billion such bonds?

Motivation
• Businesses are influenced by and influence the national and global

economy
• In addition to “idiosyncratic” (micro) factors, “aggregate”

(macroeconomic) factors affect firm performance
• Firm performance and corporate profits in turn affect aggregate

output and growth

Course Objectives
• Learn concepts and tools used to understand and analyze the global
economy
• In particular, analyze how:

• Government policy affects economy
• “Shocks” (disturbances) affect economy
• Economic news affects interest rates, asset prices, and exchange
rates
• Economies are interconnected
• Learn to critically evaluate arguments in the financial press.

Topics we will study
• Long run productivity & economic growth
• Effects of globalization on a nation’s economy
• Short run fluctuations (recessions and booms)
• Increasing general price level (inflation)
• Effects of government policies on economy

• Positive analysis (what does policy do?)
• Normative analysis (what is a good policy?)

What is Macro/global economics?
• Study national economy, as a whole. Study interconnected

economies
• Macroeconomics = Microeconomics + Aggregation
• Focus is on economy-wide variables:
• Long-run economic growth
• Business cycles
• Unemployment
• Inflation
• The international economy (trade, exchange rates)
• Macroeconomic policy

What Macroeconomists do?
• Macroeconomic Forecasting
• Macroeconomic Analysis
• Theoretical analysis
• Mathematical models
• Economic variables are determined simultaneously
• Empirical analysis
• Study patterns in data
• Controlled experimentation is very difficult at the macro
level

Macroeconomics and the Firm
The role of aggregate market forces on firm’s cash flows

No Free Lunch for the Global Firm
• The globally operating firm faces great opportunities as well as
great dangers
• Opportunities: New markets, low cost labor, specialization in
sectors of “comparative advantage”
• Dangers: Financial crises and contagion, risk of expropriation,
exchange rate fluctuations

The Financial Crisis in Asia (late 90s)

U.S. Real GDP Growth

The Diverse Global Economy
• In an increasingly globalized world, economic performance of other

countries affect firms
• The world is very diverse economically:

• Some countries grow fast, others slow
• Some countries are rich, others poor

Countries grow at very different rates

GDP growth: some examples
Source: World Bank Development Indicators
• No free lunch when it comes to growth

Unemployment rate
US
India

Inflation
US
India
GLEC: Session 1 18
World Current Account Balance

The Stock Market Connection
• Financial variables such as stock and bond prices depend on the interest
rate, output, and other macro variables.
• Since macro outcomes and policies fluctuate, so do asset prices.

The Classical-Keynesian Debate
• The Classical view:

• Prices and wages adjust rapidly and economy achieves
equilibrium
• All unemployment is “frictional” and voluntary
• The Keynesian view:

• Prices and wages are “sticky”; downward adjustment rarely
occurs
• Unemployment is a result of disequilibrium

Key concepts
• Firms are affected by micro and macro factors
• Aggregation of micro decisions leads to macroeconomic

outcomes; macro conditions affect micro decisions
• Keynesians believe markets often fail and government

intervention needed; Classical economists believe markets by and
large work on their own

National Income and Product Accounts (NIPA)
• Understand the terminology

• Accounting relationships for the economy

Three ways of measuring GDP
• The Gross Domestic Product (GDP) is a measure of the total
economic activity in a country in a given year
• It can be measured in three ways:

• Production (Value Added) Approach: Output produced,
excluding output used in intermediate stages. What is made?
• Expenditure Approach: Amount spent by the ultimate
purchasers of output. What is bought?
• Income Approach: Income received by producers of output.
How or with what is it bought?

Equivalence of Approaches
• All three approaches to GDP accounting yield the same result
• They attempt to avoid “double counting” in their own ways
• Fundamental identity of national income accounting:

Production = Expenditure = Income

Production (Value Added) Approach
• GDP defined as the market value of final goods and services

newly produced by domestically located capital and labor during
the year
• Value added approach to avoid the problem of double counting

intermediate goods.
• Value added = Final revenue - cost of intermediate goods

Production Approach (contd.)
• Intermediate goods and services are used up in the same period

that they themselves were produced. Else, they are final goods.
• A capital good is one that is itself produced and used to produce

other goods, but is not used up in the process
• It is a final good and is therefore included in the GDP

Production Approach (contd.)
• GNP is value created by factors of production owned by the
country’s citizens, no matter where the factors are located
(country’s income)
• GNP (income) = GDP (product) + income from abroad - income
sent abroad = GDP + NFP
• Alternate terminology:
• Gross National Income (GNI) for GNP
• Net Income earned on Foreign Assets (NIFA) for NFP
• Difference very small for countries like the US. (GDP 18.87 T $
and GNP 19.11 T $: 2016, nominal.)

Breakdown of GDP (source: CIA Factbook)
• Percentage of GDP by sector (2016):
US India China
Agriculture 1.1% 16.5% 8.6%
Industry 19.4% 29.8% 40.7%
Services 79.5% 45.4% 50.7%

Income Approach
• Account for GDP by how factors of production (labor and

capital) are compensated
• National Income = Compensation + Proprietor’s Income +

Rental Income+ Corporate Profits + Net Interest
• Employee Compensation largest (65 to 70% of national income

typically)

Income Approach (contd.)
• Net National Product (NNP) = National Income + Indirect
Business Taxes
• Indirect business taxes (sales, excise taxes, etc.) are paid by

businesses to the government
• GNP = NNP + Depreciation
• Depreciation is the value of capital that wears out during the year
in which the GNP is measured

Expenditure Approach
• Total spending on final goods and services produced in the
country during the year
• The income-expenditure identity: Y = GDP = C + I + G + NX
• NX = Net Exports = Exports (X) - Imports (M)
• All production consumed or invested by private agents or by the

government or by foreigners

Expenditure Breakdown
• Percentage of GDP by sector (2016):
US India China
Cons. (C) 68.6% 60.8% 38.7%
Inv. (I) 16.4% 30.6% 43.8%
Gov. (G) 17.7% 11.4% 14.2%
NetExp(NX) -2.7% -2.8% 3.3%

Example: Production Approach
• Transactions:
• Company A:
• Wages paid to employees $15,000 • The Product approach measures economic
• Taxes paid to government $5,000 activity by adding value added across sectors
• Revenue - sale of oranges $35,000
• Oranges sold to public $10,000
• Oranges sold to B $25,000 • Value added by Company A=$35,000
• Company B:
• Wages paid to employees $10,000
• Value added by Company B=$15,000
• Taxes paid to government $2,000
• Purchase of oranges from A $25,000
• Revenue - sale of orange juice $40,000 • GDP=Sum of value added=$50,000

Example: Income Approach
• Transactions:
• Company A:
• The income approach measures economic
• Taxes paid to government $5,000 activity by adding income across the producers,
• Revenue - sale of oranges $35,000 employees and the government.
• Oranges sold to public $10,000
• Oranges sold to B $25,000
• Employee income =
• Company B: $15,000 + $10,000 =
$25,000
• Government income =
• Purchase of oranges from A $25,000 $5,000 + $2,000 = $7,000
• Revenue - sale of orange juice $40,000 • Corporate profits =
$15,000 + $3,000 =
$18,000
• National income is $50,000

Example: Expenditure Approach
• Transactions:
• Company A: • The expenditure approach measures
• Wages paid to employees $15,000 economic activity by adding the market
• Taxes paid to government $5,000 value of final goods in the economy.
• Revenue - sale of oranges $35,000
• Oranges sold to public $10,000 • Ultimate users in this example are
• Oranges sold to B $25,000 consumers.
• Company B: • They spent $10,000 on oranges and
• Wages paid to employees $10,000 $40,000 on orange juice.
• Purchase of oranges from A $25,000 • The GDP of this example economy is
• Revenue - sale of orange juice $40,000 equal to $50,000.

International Comparisons
• To compare per capita GDP across countries, can use:
• Market Exchange Rates: Unreliable for comparing living

standards; does not reflect relative purchasing power of two
currencies (due to non-traded goods, taxes, tariffs, and
transport costs).
• Purchasing Power Parity (PPP) Exchange Rates: A better

measure for comparisons. What does a $ really buy in each
country?

Disparity in Per Capita Income
(Real values at PPP exchange rates)

Limitations of GDP
• What is left out?

• Some underground and informal activity
• Depletion of natural resources, environmental degradation
• Homemakers’ contribution
• Human capital formation
• UN attempts at reforms (HDI: Human Development Index)

Price Indices
“Apple Economy”:
• In 2015, 10 lbs of apples produced; sell @ $5/lb. GDP=$50.
• In 2016, 10 lbs of apples produced; sell @ $10/lb. GDP=$100
• What is the GDP growth in the economy?

Real versus Nominal GDP
Y = Py, where
• Y: nominal GDP, P: GDP deflator or general price level; y: real

GDP (quantity)
• Nominal GDP values output at current prices.
• Real GDP values output at a base year prices. Picks up only the
increase in GDP coming from higher quantities of goods and
services, rather than higher prices.

Real vs Nominal example
• In the Apple economy, if 2015 used as base year:

• Nominal GDP, 2016: 10x10=$100; Real GDP, 2016: 10x5=$50;
GDP deflator = Nominal/Real = 2
• Inflation: Rate of growth of price level: pt+1 = 100(Pt+1 - Pt) / Pt.
• In Apple example, p = 100*(10-5)/5 = 100%

Production and Price Data
Source: ABC

Base Year Matters
Source: ABC
Interest Rates
• The (short-term) interest rate is the risk-free rate of return that can
be earned in the market
• i: Dollar (nominal) interest rate
• Invest $1 today at the rate i. Receive $(1+i) in one year. How much
would you pay to receive $1 in one year?
• Price of bond that pays $1 in one year is $ 1/(1+i). Bond price and
interest rate move in opposite directions

Real interest rate
• Suppose you lend $100 at 10% (nominal) interest. Price of apples
is $10/lb. Get back $110. If price of apples then is $11/lb, as a
lender, what is your return?
• Real interest rate, r, is rate of return in units of goods: r = i – p
• In above example, i = 10%, p = 10%, r = 10 – 10 = 0%

Inflation and Nominal Interest Rate in the
United States

Expected inflation
• At the time transaction is made, inflation is unknown. People

form forecasts to get expected inflation
• Use this to get expected real interest rate: re = i – pe
• Can nominal interest rates be negative? Real interest rates?

Key concepts
• GDP is all valued added in the country irrespective of who

owns assets; GNP is country’s income no matter where assets
are located
• Production, income, and expenditure approach are different
ways of looking at the same economy
• Need to use PPP adjustment to compare GDP across countries
• Real GDP increase nets out increase coming from prices to see
only increase in quantity
• Inflation is the rate of change of (aggregate) price index
• The real interest rate is nominal interest rate net of inflation

Glossary of Terms
GDP Gross Domestic Product (also Y)
NFP Net Factor Payments
(also NIFA)
GNP Gross National Product = GDP + NFP
(also GNI)
C National Consumption
I National Investment
G Government Expenditure
X Exports
M Imports
NX Net exports = X - M
S National Saving = Spvt + Sgovt
T Total taxes
TR Transfer payments
INT Interest payments
p Inflation
Pt General price level at time t
i Nominal interest rate
r Real interest rate

Global Economics: PGP: Session 1: Introduction & National Income and Product Accounts

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Global Economics: PGP: Session 1: Introduction & National Income and Product Accounts

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Global Economics: PGP

Session 1: Introduction &

June 4, 2019 GLEC: Session 1 2

June 4, 2019 GLEC: Session 1 3

June 4, 2019 GLEC: Session 1 4

• Businesses are influenced by and influence the national and global

• In addition to “idiosyncratic” (micro) factors, “aggregate”

• Firm performance and corporate profits in turn affect aggregate

June 4, 2019 GLEC: Session 1 5

• In particular, analyze how:

• Learn to critically evaluate arguments in the financial press.

June 4, 2019 GLEC: Session 1 6

• Long run productivity & economic growth

• Effects of globalization on a nation’s economy

• Short run fluctuations (recessions and booms)

• Increasing general price level (inflation)

• Effects of government policies on economy

June 4, 2019 GLEC: Session 1 7

• Study national economy, as a whole. Study interconnected

June 4, 2019 GLEC: Session 1 8

June 4, 2019 GLEC: Session 1 9

June 4, 2019 GLEC: Session 1 10

June 4, 2019 GLEC: Session 1 11

June 4, 2019 GLEC: Session 1 12

June 4, 2019 GLEC: Session 1 13

• In an increasingly globalized world, economic performance of other

• The world is very diverse economically:

June 4, 2019 GLEC: Session 1 14

June 4, 2019 GLEC: Session 1 15

Source: World Bank Development Indicators

• No free lunch when it comes to growth

June 4, 2019 GLEC: Session 1 17

June 4, 2019 GLEC: Session 1 19

June 4, 2019 GLEC: Session 1 20

• The Classical view:

• The Keynesian view:

June 4, 2019 GLEC: Session 1 21

• Firms are affected by micro and macro factors

• Aggregation of micro decisions leads to macroeconomic

• Keynesians believe markets often fail and government

June 4, 2019 GLEC: Session 1 22

• Understand the terminology

June 4, 2019 GLEC: Session 1 23

• It can be measured in three ways:

June 4, 2019 GLEC: Session 1 24

• All three approaches to GDP accounting yield the same result

• They attempt to avoid “double counting” in their own ways

• Fundamental identity of national income accounting:

June 4, 2019 GLEC: Session 1 25

• GDP defined as the market value of final goods and services

• Value added approach to avoid the problem of double counting

• Value added = Final revenue - cost of intermediate goods

June 4, 2019 GLEC: Session 1 26

• Intermediate goods and services are used up in the same period

• A capital good is one that is itself produced and used to produce

June 4, 2019 GLEC: Session 1 27

June 4, 2019 GLEC: Session 1 28

• Percentage of GDP by sector (2016):

June 4, 2019 GLEC: Session 1 29

• Account for GDP by how factors of production (labor and

• National Income = Compensation + Proprietor’s Income +

• Employee Compensation largest (65 to 70% of national income

June 4, 2019 GLEC: Session 1 30