macroeconomics-Economics homework task
Introduction to Macroeconomics
Lecture Notes
Robert M. Kunst
March 2006
1 Macroeconomics
Macroeconomics (Greek makro = ‘big’) describes and explains economic
processes that concern aggregates. An aggregate is a multitude of economic
subjects that share some common features. By contrast, microeconomics
treats economic processes that concern individuals.
Example: The decision of a firm to purchase a new office chair from com-
pany X is not a macroeconomic problem. The reaction of Austrian house-
holds to an increased rate of capital taxation is a macroeconomic problem.
Why macroeconomics and not only microeconomics? The whole
is more complex than the sum of independent parts. It is not possible to de-
scribe an economy by forming models for all firms and persons and all their
cross-effects. Macroeconomics investigates aggregate behavior by imposing
simplifying assumptions (“assume there are many identical firms that pro-
duce the same good”) but without abstracting from the essential features.
These assumptions are used in order to build macroeconomic models. Typi-
cally, such models have three aspects: the ‘story’, the mathematical model,
and a graphical representation.
Macroeconomics is ‘non-experimental’: like, e.g., history, macro-
economics cannot conduct controlled scientific experiments (people would
complain about such experiments, and with a good reason) and focuses on
pure observation. Because historical episodes allow diverse interpretations,
many conclusions of macroeconomics are not coercive.
Classical motivation of macroeconomics: politicians should be ad-
vised how to control the economy, such that specified targets can be met
optimally.
policy targets: traditionally, the ‘magical pentagon’ of good economic
growth, stable prices, full employment, external equilibrium, just distribution
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of income; according to the EMU criteria, focus on inflation (around 2%),
public debt, and a balanced budget; according to Blanchard, focus on low
unemployment (around 5%), good economic growth, and inflation (0—3%).
In all specifications, aim is meeting several conflicting targets simultaneously.
Examples for further typical questions to macroeconomics: what
causes business cycles (episodes of stronger and weaker economic growth)?
can an increase in the monetary supply by the central bank cause real effects?
what is responsible for long-run economic growth? should the exchange rate
of a currency be kept at a fixed level? can one decrease unemployment, if
one accepts an increase in inflation?
A survey of world economics: three large economic blocks (Eu-
rope, USA+Canada, Japan+Far East) with different problems, the remain-
der mostly developing countries.
- USA: good growth, low inflation, tolerable unemployment rate, per-
sistent external deficit, increasing income inequality.
- EU: moderate growth, low inflation, in some countries high unem-
ployment, inconspicuous external balance (total EU active, in Austria
recently turned active), for some countries large public debt, currently
important unification process, convergence and heterogeneity of indi-
vidual countries. ‘Richest’ EU countries Luxembourg, Denmark, then
‘mid-field’ with Austria, IRL, B, NL, UK, D, F, FIN, I, S; slightly be-
low E, GR, SLO, P. Last come most ‘new’ (2004 accession) countries
(from Malta down to Latvia). Very ‘rich’ non-EU countries Norway,
Iceland, and Switzerland.
- Japan: recently weak growth, large external surplus, deflationary ten-
dencies.
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2 System of National Accounts
Basic idea (not the definition): Summary of all economic activities within
a country’s territory and within a given time range (e.g., a year or quarter)
yields the gross domestic product (GDP). The value of all goods and ser-
vices is determined at market prices (final prices, purchasers’ prices). System
for compilation of data and bookkeeping of all positions is called the System
of National Accounts (SNA). In Europe, compilation of the SNA conforms
to the ESA (European System of Accounts) standard.
Economic activity is mainly measured by transactions. Phrases from
text books: diversification of labor (not complete self-subsistence) causes
transactions, exchange of money for goods or services, exchange of an asset
or liability for a different asset or liability, etc. The transactions take place on
markets. Money makes transactions easier than direct exchange of goods for
goods, which may require ‘double coincidence’ (hungry tailor meets freezing
baker).
Purpose of money: apart from payment and storage of value primarily
unit of measurement (numeraire). In economic text books, usually dollar
($), monetary unit (MU), or euro.
gross: many activities serve to repair or replace worn or damaged ma-
chines and objects (‘depreciation’), therefore it is not the total GDP that
contributes to the accumulation of aggregate wealth. In the SNA, ‘gross’
usually means ‘inclusive of depreciation’, ‘net’ often contains taxes, though
no depreciation.
Consumption of fixed capital (in economics, depreciation) of SNA is the
estimated wear and tear of produced means of production (this ‘depreciation’
should not be confused with positions in tax declarations or with changes in
the currency exchange rate).
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Capital stock is the stock of fixed capital (machines, buildings, …) in
enterprises and in the general government sector. This must be distinguished
carefully from the informal usage of the word ‘capital’ as ‘money, liquid
wealth’. By definition, capital contains all produced means of production.
The separation of capital such as machinery from intermediate consumption
such as raw materials can be difficult.
economic activities: only market activities can be fully accounted for.
Therefore, private exchange and domestic services pass by unnoticed. By de-
finition, however, legitimacy of a transaction should not play a role. There-
fore, the shadow economy (moonlighting) and illegal drug production are
part of the GDP, but such activities are difficult to measure. A consequence
of this measurement problem is an exaggerated wedge between developing
countries and OECD countries (with the per capita GDP of Angola you can-
not survive in Austria). Interest focuses on transactions–bilateral (requited)
transactions (purchase etc.) and unilateral (unrequited) transactions (trans-
fers)–while value changes of existing objects are not accounted fully.
value added : definition of GDP as the sum of values added in the produc-
tion process (ore → metal → screw → motor part → video recorder) avoids multiple counts. Problems in the valuation of public services.
market prices: in principle, all goods and services are valued at market
prices, that is, inclusive of all taxes. If data is collected at the net value
(without taxes), taxes must be added.
economic agents: Resident ‘institutional units’ are classified with regard
to their distinctive characteristics. Types of institutional units are: pri-
vate households, general government, financial and non-financial corpora-
tions (comprises most so called firms or enterprises), non-profit institutions
serving households. Foreign (non-resident) units are summarized as the ‘rest
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of the world’, provided there are transactions with resident units. The same
person can be part of a private household and of an enterprise (rents out an
apartment, or even only uses his/her own condo but is assumed to rent it
out to him/herself).
resident is an institutional unit that is situated on a country’s territory.
Citizenship is not the criterion for residence. However, foreign students or
short-term foreign workers are not viewed as resident.
private households: produce and invest relatively little, consume, obtain
wage and profit income from corporations and from the government. As
self-employed persons, they obtain ‘mixed income’, though the separation of
households from corporations is occasionally difficult. Small (non-corporate)
firms and farms are counted as private households.
general government (‘public sector’): receives taxes from enterprises and
from private households, provides public goods (‘consumes them by itself’
according to SNA), no intention of profit.
corporations: produce and invest, do not consume, intention of profit.
Corporations, not the government sector, comprise also firms in public prop-
erty, if they cover 50% of their costs from sales. Because depreciation is now
called ‘consumption of fixed capital’, it represents a kind of consumption of
corporations. Corporations are either financial (banks etc.) or non-financial.
non-profit institutions serving households (NPIsH): institutions (such as
schools, churches) that cover less than 50% of their production costs from
sales; idea: no intention of profit. A small sector, for simplification often
added to households.
rest of the world : consumes goods and services produced by residents
(exports) and produces goods and services consumed by residents (imports).
imports of services: includes travels abroad by residents
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exports of services: includes consumption of foreign tourists on the terri-
tory of the economy (imputed based on valuta purchases etc.)
sectors: the activities of individuals of a similar kind are added up (ag-
gregated). The aggregate of all households forms the household sector etc.,
whereby transactions within the sector disappear. This ‘consolidation’ elim-
inates the exchange between households, as it does not increase collective
wealth. Recorded are the production of capital within the firms, the pro-
duction by private households, public consumption, which by definition is
produced and consumed by the general government itself.
ex post : SNA records only after the economic processes have already
occurred, therefore only limited validity for the assessment of future reactions
in the economy. ex ante would be a task for economic theory.
flows and stocks: SNAmainly records flows of goods and services within a
time period (for example, the consumption of Austrian households in the first
half-year of 1996). Sometimes, also stocks are of interest (wealth, number
of unemployed persons, central bank money, capital stock on July 31, 1996)
at a fixed time point. Changes of stocks are flows (bath tub: water level at
time point 1 = water level at time point 0 + inflow — outflow; inflow and
outflow are flows; water level is a stock)
stocks: also short for ‘common stocks’ (shares) and occasionally for ‘in-
ventories’ (beware of the possibility of confusion)
2.1 Matrix of transactions between sectors
The new SNA convention affects this traditional presentation (followingHas-
linger), though it remains instructive and valid in principle. The NPIsH
sector is omitted here, an artificial sector ‘value changes’ completes the trans-
action matrix.
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Diagram of monetary flows (payments) from the row sectors to the column
sectors, grossly simplified, goods flows partly in the opposite direction:
→ firms government households non- residents
value
changes
firms Tdir,F + Tind WF +Πd Im Πund,net
government subv + IP CP WP + trH SP
households C Tdir,H SH
non-residents X Im−X value changes IF,net IP,net names (notation as used in economics, not necessarily in SNA):
C . . . (private) consumption of households
CP . . .public consumption
IF . . . investment of corporations (enterprises, firms)
IP . . . investment of general government (public investment)
(‘investment’ always concerns means of production, not purchases of as-
sets)
Inet . . . investment without depreciation (wear and tear of the capital
stock)
WF . . .wage payments of firms to households
WP . . .wage payments in the public sector
trH . . . transfers to households (pensions, benefits, superscript indicates
direction ‘to households’; ‘transfers’=unilateral transactions without coun-
terpart)
SH , SP . . . saving (public sector often negative)
subv. . . . subsidies to enterprises
T . . . taxes etc.
Tind . . . indirect taxes are deductions before the calculation of income
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(mainly value added tax) including customs, officially production taxes.
Tdir . . .direct taxes are deductions from earned income (wage tax, income
tax etc.), including contributions to social security
Πund . . .undistributed profits
Πd . . .distributed profits (dividends etc.)
X . . . exports
Im . . . imports
Economic circuit: row sums = column sums (inflow=outflow), nothing
is lost, often graphical presentation with arrows. (metaphorical analogy wa-
ter: sector Atmosphere with input evaporation and output rain, sector Conti-
nents with input rain and output evaporation from inland water and outflow
at estuaries, sector Oceans with input at estuaries and output evaporation
from seas; earth is a closed circuit, amount of water is globally preserved)
open and closed circuit: without value changes, the economic circuit
is open, for example at X > Im more payments would flow to Austria than
from Austria to non-residents. The hypothetical value changes sector (global
bank?) loses X − Im and closes the circuit.
2.2 Accounts of the SNA
The new SNA consists of a sequence of several accounts, in which many
single positions are recorded, while others result as balancing items (bold
type in the accounts). These accounts are calculated for all sectors (financial
and non-financial corporations, public households, private households and
NPIsH, rest of the world) and for the total economy.
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2.2.1 Sectorial accounting
The accounts that are decomposed according to sectors (financial and non-
financial corporations, public households, private households and NPIsH) are
primarily income accounts, which focus on the contributions of individual
sectors to national income. Point of departure is the production account.
Gross output (all production at basic prices, i.e. without value added tax and
customs) is booked on the credit side of this account. To this correspond,
as uses, the intermediate consumption and the depreciation (consumption of
fixed capital). The balancing item is net value added. The columns ‘resources’
and ‘uses’ correspond to the bookkeeping terms ‘credit’ and ‘debit’.
Uses Resources
intermediate consumption gross output
depreciation
net value added
In the generation of income account, the balancing item of the production
account is transferred to the Resources. From the net value added, salaries
and wages (workers’ compensation) and some (so called ‘other’) production
taxes (e.g. payroll tax) are paid. The position ‘other subsidies received’
represents negative taxes, only the difference is of concern. The balancing
item of this account is called ‘operating surplus and mixed income’, where the
households and NPIsH earn mixed income, while the firms and government
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receive an operating surplus:
Uses Resources
wages paid net value added
other taxes on production paid
— other subsidies received
operating surplus, net
mixed income, net
In the account of primary income allocation, the generation of income is
turned on its head. It yields, as a balancing item, the income of the sector.
For the total economy, the net value is slightly modified relative to the sum
of single sectors, as primary income may also cross borders and also because
of the hypothetical position ‘financial services indirectly measured’ (FISIM).
The relative contributions by the positions differ widely across sectors. Thus,
only the general government receives production taxes, while only households
receive wages. The meaning of a primary income is that it is generated
completely in the production process. By contrast, the secondary income is
income after its redistribution through unilateral transfers. Correspondingly,
production taxes (indirect taxes) show up in the primary account, but not
the ‘direct’ taxes.
Uses Resources
property income paid operating surplus, net
mixed income, net
wages received
production taxes received
— subsidies paid
property income received
primary income, net FISIM
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In the account of secondary income distribution, fiscal authorities show their
power. Neither corporations nor private households receive direct taxes,
while other transfers re-distribute income flows among all sectors. As a bal-
ancing item, this account yields the so called disposable income, i.e. the
amount of income that is actually disposable for the sector’s expenditures
(or to the economy’s expenditures for the aggregate account)
Uses Resources
current taxes on income and wealth
paid primary income, net
social contributions paid current taxes on income and wealth
received
monetary social benefits paid social contributions received
other current transfers paid monetary social benefits received
disposable income, net other current transfers received
In the use of income account, all sectors except the corporations consume
out of their disposable income. The balancing item is the saving of the
sector, with a small correction because of contributions to pension funds,
which we would like to ignore. The quotient of saving and disposable income
in the household sector is called the household saving rate and represents an
important economic quantity. In Austria, this saving rate has dropped in
recent years from double-digit percentages to around 8%. Occasionally, also
the total saving rate is reported, which rather is a balancing item against the
non-resident sector.
Uses Resources
consumer expenditures disposable income, net
saving, net
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In the capital account, saving serves as a resource for investment. After
deduction of a few lesser items, the net position of lending and borrowing
evolves as a balancing item. Gross fixed investment is called ‘gross’, as it
comprises depreciation. It is called fixed investment to distinguish it from
inventory investment, which is also seen as an investment. Fixed investment
can be broken up into residential construction, other construction investment
(buildings and structures, i.e. factories, streets, tunnels, …), and equipment
investment (machines, vehicles, …). Gross fixed investment minus deprecia-
tion is called net fixed investment.
Uses Resources
gross fixed investment net saving
— depreciation capital transfers received, net
changes in inventories
net acquisition of valuables
net acquisition of non-produced
assets
net position of lending and borrowing
2.2.2 SNA for the total economy
Parallel to sectorial SNA, there is an accounting for the total economy, in
which the main emphasis is on production accounts rather than on income.
In these total accounts, we find the primary target variable of SNA, the
gross domestic product (GDP). The GDP is distinct from the income items,
as it relates to the production by resident units rather than to the income
of residents. For production, all activities count that are performed on the
territory of an economy. For income, we are rather interested in activities
that are exercised by residents with permanent residence on this territory,
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whether these activities take place at home or abroad. For disposable income,
one is more interested in the persons who earn the income. For the GDP,
it is more important, where production occurs. Even for disposable income,
however, residents are not defined by their citizenship. Longer-term guest
workers in Austria are counted as Austrians, while some border workers,
foreign students etc. are not counted as residents.
Again there is a production account, which departs from gross output,
which is recorded without goods taxes. Goods taxes are those indirect taxes
that depend on the quantity of production, i.e. primarily value added tax
(VAT) and customs. GDP should however also include these, thus they are
added, before intermediate consumption is subtracted. The balancing item is
GDP. Net of depreciation, this variable is called net domestic product (NDP).
GDP and NDP should correspond to the row sums across the values added
of all sectors.
Uses Resources
intermediate consumption gross output
gross domestic product goods taxes — goods subsidies
depreciation
net domestic product
In the sequence of accounts, the balancing item of exports and imports ac-
cording to SNA is recorded in a separate account as external balance of goods
and services. Otherwise, the generation of income account follows, whose
balancing item is again the operating surplus and mixed income. Note that
the previously added goods taxes are subtracted here just like other taxes,
such that the sectorial income accounts are comparable to the total. All
subsidies are minus positions (minus items), what really matters is the net
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position of taxes minus subsidies.
Uses Resources
wages paid net domestic product
goods taxes paid
other production taxes paid
goods subsidies received
other subsidies received
operating surplus and
mixed income, net
In analogy to the sectorial account, an account of primary income alloca-
tion follows here, which yields the so-called net national income (NNI) as
a balancing item. The NNI should correspond to the sum of primary in-
comes net across all resident sectors. In the sequence of corrections in the
last two accounts (generation of income and primary distribution), the differ-
ence between resident production and resident income disappears, such that
the resulting NNI again expresses the income of residents, which is indicated
by the word ‘national’. Before all, the net position of border-crossing prop-
erty income can be sizeable, while the net position of border-crossing wages
and subsidies is comparatively small. In order to calculate ‘gross national
income’ (GNI), one must add depreciation to net national income. GNI ap-
proximately corresponds to the historical ‘gross national product’ (GNP).
The name ‘income’ for this item is better than ‘product’, as it describes the
income of residential population and not their production.
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Uses Resources
property income paid operating surplus and
mixed income, net
wages received
production taxes received
— subsidies paid
net national income property income received
By way of the account of secondary income distribution, we obtain the dispos-
able income of the total economy. The positions in this account are relatively
small, as only few direct taxes and social contributions cross borders and their
net position is even smaller:
Uses Resources
income and property taxes paid net national income
social contributions paid income and property taxes received
monetary social benefits paid social contributions received
other current transfers paid monetary social benefits received
disposable income net other current transfers received
Like households, also the total economy consumes out of its disposable in-
come. Mainly, the household and the government sectors contribute to this
consumption. After an above mentioned small correction due to the change
in pension funds, the saving of the economy results as a balancing item. In a
parallel account for the non-resident sector, this use of income account also
shows the external position ‘external balance of current transactions’. This
is important insofar, as this ‘SNA current balance’ is available to an open
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economy to finance its investment, apart from its saving.
Uses Resources
consumption expenditure disposable income net
saving net
The capital account has again the form that was described above. Finally,
the net position of lending and borrowing should correspond to the current
external balance. Due to measurement errors, there is no exact correspon-
dence. Therefore, there is the possibility of a ‘statistical difference’ on the
debit side. In total, however, the net position of lending and borrowing for
the total economy should be the negative value of the external balance.
Uses Resources
gross fixed investment net saving
— depreciation capital transfers net
inventory changes
net acquisition of valuables
net acquisition of non-produced assets
net lending/borrowing
2.3 Variants of GDP
Once more the most important current and historical (partly still used) def-
initions
• Gross national income (GNI, formerly ‘gross national product’): GDP plus primary income of residents from the rest of the world minus
primary income of non-residents from the economy; a GDP according
to the concept of residency of income earners instead of residency of
production units. International mobility (work abroad) confuses the
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concept (extreme examples Luxemburg, Kuwait). Persons with per-
manent residence in Austria are always counted as residents!
• Gross social product: obsolete expression for gross national income (GNI).
• Net domestic product: GDP minus depreciation.
• Net domestic product at factor costs: Net domestic product with- out all production taxes (minus Tind plus subv).
• Net national income (formerly ‘net national product’): gross na- tional income minus depreciation.
• Net disposable income of the economy: net national income (at market prices, i.e. including all production taxes) plus balancing item
of border-crossing transfers. Should be a future main indicator of the
economy.
• GDP (etc.) at basic prices: Intermediate stage between the calcu- lation at market prices (i.e. including all production taxes) and the
calculation at producer prices (i.e. excluding all production taxes).
Here, only goods taxes (comprises as its most important parts the value
added tax and customs) minus goods subsidies are subtracted. Only
after the further subtraction of ‘other production taxes minus other
subsidies’ (e.g., payroll tax), the value at producer prices is obtained.
According to convention, the original gross output is compiled at ‘basic
prices’, GDP and NNI are then shown at market prices.
Factor costs: the compensation paid to the production factors capital
(machinery and buildings) and labor, by profits and wages, without taxes
(net minus subsidies).
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Primary income: defined as income earned by direct participation in
the production process. Labor and property income. Formerly ‘factor in-
come’.
2.4 SNA=3 national accounts
In many countries, GDP was formerly calculated three times
• from production
• from its final uses
• from income
Particularly in the UK, three slightly different GDP variants were com-
puted. According to SNA convention today, the first of the three defines
the proper GDP. As already described, GDP is computed by adding ‘goods
taxes minus goods subsidies’ to gross output and subtracting intermediate
consumption. There is also a break-down according to different production
sectors (mining, agriculture, manufacturing etc.), which is not of central in-
terest in macroeconomics. An important component of this break-down is
industrial production, which is computed on a monthly basis and serves as a
fast business indicator.
Of fundamental interest in macroeconomics is the break-down of GDP
according to final uses
GDP = C + CP + I +X − Im . (1)
which is collected in a separate SNA account (Account 0, in economics
GDP is denoted by the letter Y and government consumption by the letter
G). Note that, from the outlined sequence of accounts you obtain C from
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the consumer expenditure of households (including NPIsH), Cp from the
consumer expenditure of general government, I from the capital account,
X− Im from the external account as an external balance. In order to obtain an exact match of the left side (from production) and the right side (from
uses), one should observe:
• the changes in inventories (conceptually seen as investment: inventory investment)
• the change in the stock of valuables (purchases of objects of art etc.) and similar small positions
• a statistical difference (formerly often added to the smaller aggregates as ‘inventory changes and statistical difference’)
Sometimes, the private consumption C is broken down in:
• consumption of durable goods (cars, video recorders, …)
• consumption of non-durable goods (clothing, food, books and journals, …): proximity of purchase and utilization
• consumption of services (dining out, fitness studio, …): not storable
Public consumption CP is broken down into:
• Collective consumption: indivisible utilization (e.g., street lighting)
• Individual consumption: can be allocated to individual persons (e.g., free education)
According to the concept of the new SNA, individual public consump-
tion and private consumption are summarized in the aggregate ‘individual
consumption’. The economic meaning of this convention is questionable.
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Gross fixed investment I (‘gross’=includes depreciation, ‘fixed’=no
inventory investment; also comprises public investment; in SNA: gross fixed
capital formation) is broken down into:
• investment in equipment (machinery, vehicles, …)
• investment in construction (buildings and structures, includes residen- tial construction)
The meaning of the distribution of income account for the determination
of disposable income etc.was already explained. By contrast to many
other parts of the SNA accounts, which exist in real terms (adjusted for in-
flation, at constant prices, in the public sector difficult!) and also in nominal
terms (at current prices), the income distribution is calculated in nominal
terms only. An important derived quantity of the distribution accounts is
the wage quota, i.e. the share of compensation for labor in national income.
The disposable income of households YD serves as the basis for the cal-
culation of the household saving rate
qSH = YD − C YD
.
In Austria, this quotient currently is around 8-9%.
2.5 Other statistics that are related to SNA
Wealth is a stock variable and notoriously difficult to compile (human cap-
ital, unknown value of assets etc.). Household wealth can be estimated from
consumer expenditures on durables and assumptions about the depreciation
of these durable goods. Data on monetary wealth is provided by banks
(checking accounts, saving accounts, bonds, shares). The capital stock
(stock of produced means of production) results from depreciation rates for
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Figure 1: Main components of the SNA (from Dudley Jackson, The New
National Accounts).
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types of capital goods and from gross fixed investment. The stock of in-
ventories results from inventory changes etc.
Input-output (IO) tables are large matrix tables that report the flows
of goods and services among subsectors of an economy, admit detailed in-
formation about intermediary consumption, which is necessary for final pro-
duction in a certain sub-sector.
The balance of payments registers all transactions of goods, services,
payments across borders. Because of different concepts, it does not match
the SNA balances exactly:
- goods balance (only goods, in Austria approximately neutral net posi-
tion)
- services balance (primarily tourism, in Austria positive net position,
and also other services)
- external balance of primary income (compensation of border workers,
primarily border-crossing property income, in Austria passive)
- external balance of transfers (transactions without counterpart, in Aus-
tria passive)
Positions 1—2 together are the so-called ‘trade balance’, Position 1—4 yield
the current accounts balance. The current accounts balance should match,
with inverted sign, the balance of capital flows (capital accounts balance,
short- and long-run capital flows; note the usage of the word ‘capital’ that
does not denote produced means of production here). A difference of the two
positions may stem from the change in reserves of currency and gold in the
central bank, and from diverse statistical discrepancies. All balances together
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are called the balance of payments. Therefore, there cannot be a deficit in
the balance of payments, while there may be a current account deficit.
Price indexes (deflators) must be calculated for the GDP and for all of
its demand-side components (durable consumption, total private consump-
tion, construction investment etc.)
Traditionally, deflators followed the concept of the Paasche index
pt+1t =
P j pj,t+1xj,t+1P j pj,txj,t+1
(2)
(what would the goods now demanded have cost one year ago?). After select-
ing a special base year, in which real (‘at constant prices’) and nominal (‘at
current prices’) variables (e.g., GDP) coincide, a current price index evolves
from
Pt = p t t−1p
t−1 t−2 . . . p
t0+1 t0 Pt0 ,
where Pt is 1 (or 100) in the base year t0.
Alternatively, basket indexes are calculated according to the concept of
the Laspeyres index
pt+1t =
P j pj,t+1xj,0P j pj,txj,0
(3)
(by how much did the price of a fixed basket of goods and services increase
over the last year?). The basket is modified partly continuously, partly in
base years, as goods are continuously replaced by other comparable goods.
It is common to standardize the Laspeyres index in the base year at 100,
though this standardization plays no role. The most important Laspeyres-
type index is the consumer price index (CPI), which, e.g., determines the
increases of rents and wages.
Since 2004, SNA deflators are no more calculated as Paasche indexes but
rather as geometric averages of Paasche and Laspeyres indexes (chaining).
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A consequence is that identities–such as the important Account 0 identity–
do not hold exactly for real quantities any more.
What distinguishes de facto the consumption deflator and the consumer
price index? With the Laspeyres index, the households stand no chance
to substitute goods that have become more expensive by relatively cheaper
ones (e.g., books by computer software), therefore the CPI usually increases
faster.
hedonic prices: technical products (cars, computers) develop fast. Some
experts argue that these should not be valued at the market price, but at the
price of their inner characteristics (fuel consumption, speed of calculation).
This concept often yields a general decrease in the price of such goods by
increase in quality, though the problem remains whether the customers are
forced to consume an additional and relatively cheap ‘quality’ of such goods
(tinted car windows, automatically installed software). The concept is partly
used by statistical agencies for the calculation of all indexes.
The rate of inflation is the percentage change of a price index Pt, i.e.
100 Pt − Pt−1 Pt−1
where Pt, e.g., may denote the consumer price index. As long as price infla-
tion remains ‘normal’, the logarithmic rate 100(logPt − logPt−1) is a conve- nient approximation and is often preferred for technical reasons.
Labor market statistics provide the important unemployment rate
on a monthly basis. According to the traditional (‘Austrian’) definition
unemployment rate = registered unemployed
employed + registered unemployed (4)
where the denominator is called the (dependent) labor force. Here, self-
employed persons do not count as employed. In contrast, the official un-
employment rate (‘international definition’, ESA rate) relies on census mea-
24
surement, as registering at employment agencies is not a good indicator for
unemployment (no registration, when there is no chance of obtaining benefits
or if search is hopeless; fake registration of persons working in the shadow
economy) in many countries. According to this convention, self-employed
persons are included. In Austria, the ‘international’ concept leads to a lower
rate; in Spain, it leads to a higher rate.
2.6 Critique of National Accounts
- SNA measures incorrectly
(a) Measurement and numbers are bad: Critique of reducing the real
world to data (atypical for a quantitative science, such as eco-
nomics)
(b) SNA does not measure welfare⇒ social indicators, questionnaires etc. (borderline to sociology)
(c) SNA measures flows, whereas true wealth is expressed by stocks
of property and possessions.
- SNA measures too much
(a) regrettable necessities should not be measured, such as road acci-
dents, criminal activity, expenditures for longer commute to work,
as these do not increase welfare: definition of boundaries is diffi-
cult, strong consequences for international and intertemporal com-
parisons unlikely (military goods even now only contribute, if they
can also be used for civilian purposes)
(b) damage to health and the environment should be subtracted. Throw-
away goods should not increase wealth ⇒ slower growth if such
25
concepts are considered tentatively (Nordhaus/Tobin: measure
of economic welfare MEW instead of GDP)
- SNA measures too little
(a) economic activities, which do not touch official markets (house-
hold work, so-called shadow economy), are not compiled accu-
rately (household work is deliberately excluded, as: (1) it is dif-
ficult to measure, (2) externalizing of services in principle even
now an indicator of welfare, (3) household services as component
of GDP would destroy the differentiation between unemployment
and employment; shadow economy is included in official GDP, al-
though its assessment is concededly difficult; illegal production is
by definition a part of GDP!)
(b) quality of life, leisure, creation of national parks, cleaning of air
and water are not valued sufficiently, as these are not market goods
and do not have market prices (task for environmental economics)
26
3 The goods market
Wherever necessary, it is assumed that households and firms are identical
and produce and consume only one good. This good serves as a consump-
tion good as well as an investment good. Demand is assumed to be satisfied
immediately by supply at a given and fixed price. The decomposition (Ac-
count 0) of national income Y (or GDP, these are assumed as equal in what
follows) according to uses
Y = C + I +G+X − Im (5)
(consumption C, investment I, government expenditure G loosely corre-
sponds to the CP from SNA, exports X, imports Im) simplifies to
Y = C + I +G (6)
in a closed economy, which does not communicate with the rest of the
world by means of imports or exports (as opposed to an open economy). At
first, it will be assumed that the economy is closed.
Consumption C: households consume out of their disposable income,
we write
C = C(YD)
+
This is a (for the moment, not exactly specified) consumption function.
The sign ‘+’ indicates that consumption rises with increasing income and
falls with decreasing income, i.e. it reacts ‘positively’. A simple functional
form is the linear specification
C = c0 + c1YD (7)
27
with c1 > 0 and typically also c0 > 0. This so-called Keynes consumption
function contains two parameters c0, c1, i.e. not directly observable, fixed
constants. As a behavioral equation, it describes the action of households
as depending on their income. By contrast, the simplifying relation
YD = Y − T (8)
with taxes T is not a behavioral equation, but rather a definitional equa-
tion (identity). In more detail, the variable T may be identified with ‘in-
come taxes minus transfers from government to households’ and may even
be thought to comprise social contributions and benefits.
‘Lump sum’: except for some exercise examples, taxes T are assumed
to be independent of income. Each identical household pays a fixed amount
to the government, a ‘lump sum’.
The parameter c0 is the autonomous consumption of the economy.
Because the households are all alike, c0 is the sum of all expenditures of all
households that is necessary for their survival, if these do not receive any
income.
The parameter c1 is the marginal propensity to consume and de-
scribes, by how much consumption rises, if households receive an increase in
their income by, e.g., one euro. In this case, they increase consumption by
c1 euro. It makes sense to require c1 < 1, i.e. c1 ∈ (0, 1). One also writes
c1 = ∂C
∂YD (9)
Unlike c1, the average propensity to consume
C
YD = c0 YD
is not a constant, but falls with increasing income. C/YD answers the ques-
tion, how much out of the total income is consumed, not out of a ‘marginal’
28
additional income. Falling average, but constant marginal propensity to con-
sume was one of the famous Keynes axioms.
Investment I, government expenditure G, taxes T : are kept fixed
and are, as ‘exogenous’ variables, not determined in the model; no relation-
ship between G and T ; exogenous (determined outside the model) variables
act like parameters, though, unlike those, they are observed directly. For-
mally, one writes:
I = Ī (11)
G = Ḡ (12)
T = T̄ (13)
The behavioral equation (7), the definitional equation (8), and the three iden-
tities that express exogeneity (11), (12), (13) describe the aggregate demand
in the simple closed economy.
The supply results from the quantity of the produced good Y .
Equilibrium on the goods market, i.e. a cleared goods market, in which
there are no increasing inventories and no unsatisfied and hungry consumers,
means that Y and aggregate demand Z = C + I +G are equal, i.e. Y = Z,
or
Y = c0 + c1YD + Ī + Ḡ
= c0 + c1(Y − T̄ ) + Ī + Ḡ
and thus
Y = 1
1− c1 (c0 + Ī + Ḡ− c1T̄ )
Thought experiments
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