The Following Are Components Of National Product And N

Page21the Following Are Components Of National Product And National In

The following are components of national product and national income for a country: Items Billions of Dollars Consumption of goods and services 500 Corporate Income taxes 30 Corporate retained earnings 30 Depreciation allowances 90 Exports 210 Government expenditures on goods and services 200 Government Net Income transfers to Households 70 Gross Fixed Investment 150 Imports 210 Indirect taxes net of subsidies 100 Interest on government debt 15 Interest paid by producers in the production and service sectors 20 Net income from abroad 10 Non-cash Labour income 20 Personal income taxes 90 Rent of building and equipment 30 Total corporate profit 75 Total earned Labour income (including self employed wages, supplementary labour income, and farmers' income) 530 Total non-Corporate Profit (income from nonfarm unincorporated business) 25 Variation in the stock of inventories 10 Using the figures given in the previous table, answer the following questions. Justify your answers.

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a) (i) Calculate total government expenditures; (ii) Calculate total government revenues; (iii) Is the government running a surplus, deficit, or balanced budget?

To analyze the fiscal stance of the government, we first need to calculate its total expenditures and revenues. Total government expenditures encompass all government spending on goods and services, along with transfers and interest payments. In this dataset, government expenditures on goods and services are directly provided as 200 billion dollars. Additionally, government net income transfers to households amount to 70 billion dollars, as these are financial transfers that constitute government spending in the broader fiscal policy context. Interest payments on government debt are given as 15 billion dollars, which should also be included as part of government expenditures. Summing these components gives total government expenditures as 200 + 70 + 15 = 285 billion dollars.

Government revenues primarily come from taxes, which include corporate income taxes (30 billion dollars), personal income taxes (90 billion dollars), and indirect taxes net of subsidies (100 billion dollars). Therefore, total government revenues equal 30 + 90 + 100 = 220 billion dollars.

Comparing the total expenditures and revenues, the government's fiscal balance is calculated as revenues minus expenditures: 220 - 285 = –65 billion dollars. Since this value is negative, the government is running a budget deficit of 65 billion dollars.

b) (i) Calculate GDP via the expenditures approach; (ii) Calculate National Income

The expenditures approach to GDP sums all final spending on goods and services produced within a country during a given period. Using the provided data, the components include consumption (500), gross fixed investment (150), government expenditures (200), and net exports (exports minus imports). Given exports are 210 billion dollars and imports are 210 billion dollars, net exports are zero. The variation in inventories (10 billion) also influences GDP calculations. Therefore, GDP can be calculated as:

GDP = Consumption + Investment + Government Spending + Net Exports + Change in Inventories

GDP = 500 + 150 + 200 + 0 + 10 = 860 billion dollars.

However, note that gross fixed investment (150), change in inventories (10), and government spending are directly provided, and net exports (exports minus imports) are zero, simplifying the calculation.

Next, to find the national income, we subtract depreciation (90), indirect taxes net of subsidies (100), and interest on government debt (15) from GDP, then add net income from abroad (10). Formally:

National Income = GDP - Depreciation - Indirect taxes + Net income from abroad

National Income = 860 - 90 - 100 + 10 = 680 billion dollars.

c) Calculate National Income via the income approach. Does this match with your answer to question (b) (ii)?

The income approach calculates national income by summing all income earned by the factors of production within the country, including total earned labour income, total non-corporate profit, corporate profit, and non-cash labour income. From the data:

• Total earned Labour income (including self-employed wages, supplementary labour income, and farmers' income): 530 billion dollars
• Total non-corporate profit: 25 billion dollars
• Total corporate profit: 75 billion dollars
• Non-cash labour income: 20 billion dollars
• Rent of buildings and equipment: 30 billion dollars
• Interest paid by producers: 20 billion dollars
• Interest on government debt: 15 billion dollars
• Net income from abroad: 10 billion dollars

Adding these components:

National Income = Labour income + Corporate profit + Non-corporate profit + Non-cash labour income + Rent + Interest paid + Net income from abroad

National Income = 530 + 75 + 25 + 20 + 30 + 20 + 10 = 730 billion dollars.

This figure differs from the GDP calculated via the expenditure approach (860 billion), indicating potential discrepancies due to hidden factors, statistical differences, or measurement errors. Nonetheless, in theory, the income approach should match the expenditure approach, and such differences highlight measurement challenges.

d) Explain why your answers to questions (c) and (b)(ii) should match each other.

In national accounting, the expenditure approach and the income approach should theoretically produce identical estimates of a country's Gross Domestic Product (GDP). This equivalence stems from the fundamental economic identity that the total value of goods and services produced (GDP) equals the total income generated by producing those goods and services. The expenditure approach sums consumption, investment, government spending, and net exports, reflecting total demand within the economy. Conversely, the income approach aggregates income earned by the factors of production—wages, profits, rents, and interest—that are paid as compensation for supplying resources. Both approaches are two sides of the same coin; one measures output through expenditure, the other through income. Practical discrepancies often occur due to statistical measurement issues, timing differences, or classification errors, but overall, these two methods are designed to converge on a consistent estimate of GDP.

e) What is the usefulness for economic policy of estimating GDP using the expenditure approach?

Estimating GDP via the expenditure approach provides policymakers with crucial insights into the overall demand in the economy. It helps identify the components driving economic activity—such as consumer spending, investment levels, government expenditure, and net exports—and thus guides fiscal and monetary policy decisions. For instance, high consumer spending might signal economic strength, prompting policymakers to focus on inflation control, while declining investment could signal a slowdown, encouraging stimulus measures. Additionally, expenditure-based GDP helps monitor cyclical fluctuations, evaluate the impact of policy interventions, and compare economic performance over time or across countries. It also offers a comprehensive picture of economic health, allowing policymakers to formulate targeted strategies to foster growth, control inflation, or reduce unemployment.

f) (i) Calculate personal income; (ii) Calculate disposable income; (iii) Calculate personal savings

Personal income encompasses all income received by households before taxes. Starting from national income, personal income subtracts corporate profits retained by firms, paid taxes, and adds transfer payments. Given the data, personal income can be approximated as:

Personal Income = National Income - Corporate retained earnings - Corporate taxes + Transfer payments

Here, corporate retained earnings are 30 billion dollars, corporate taxes are 30 billion, and government transfer payments are 70 billion, leading to:

Personal Income = 730 - 30 - 30 + 70 = 740 billion dollars.

Disposable income is personal income minus personal taxes. Personal taxes are 90 billion dollars, so:

Disposable Income = 740 - 90 = 650 billion dollars.

Finally, personal savings equal disposable income minus consumption expenditures. Consumption is 500 billion dollars, thus:

Personal Savings = 650 - 500 = 150 billion dollars.

2. True, false, or uncertain? Justify your answer using data and concepts of chapter 16 of the lecture notes

a) A negative inflation rate is good because lower prices are good for consumers and most economists and policy makers agree that we should have a low inflation rate.

False. While falling prices (deflation) might seem beneficial for consumers through lower costs, it can have adverse effects on economic stability, investment, and employment. Persistent negative inflation signals declining demand, which may lead to reduced production, layoffs, and a downward spiral of economic activity. Moreover, deflation increases the real burden of debt, discouraging borrowing and investment, potentially leading to recession. Most economists favor a low, positive inflation rate around 2%, which encourages spending and investment without eroding purchasing power rapidly. Therefore, negative inflation is generally viewed as harmful rather than beneficial.

b) What is the Phillips curve?

The Phillips curve illustrates the inverse relationship between inflation and unemployment in the short run. It suggests that lower unemployment rates are associated with higher inflation, and vice versa. This trade-off arises because, during periods of low unemployment, labor markets are tight, leading to wage increases and higher prices, contributing to inflation. Conversely, higher unemployment typically suppresses wage growth and inflation. However, in the long run, the Phillips curve is considered vertical, indicating no trade-off between inflation and unemployment, as expectations and structural factors influence the relationship.

c) Based on the Canadian evidence, is it true that a higher inflation rate is associated with a higher growth rate of real GDP?

Empirical evidence from Canada indicates that the relationship between inflation and real GDP growth is complex and not strictly causal. Some periods with moderate inflation have been associated with healthy economic growth, but high inflation often correlates with economic instability and reduced growth. Studies suggest that excessive inflation can distort price signals, reduce investment, and diminish productivity. Therefore, while moderate inflation might coexist with growth, a higher inflation rate does not necessarily cause higher real GDP growth. The relationship depends on various factors, including inflation expectations, policy credibility, and macroeconomic stability.

d) Should the US increase the inflation rate to reduce unemployment to its “natural” level of 4%?

Raising inflation to reduce unemployment, based on the Phillips curve trade-off, is a contentious policy. Historically, in the short term, expansionary policies that increase inflation can lower unemployment temporarily. However, relying on inflation to achieve employment goals risks long-term inflationary spirals, loss of credibility for monetary policy, and potential stagflation. Evidence from Canada and other economies suggests that while some inflation may be tolerated within a stable macroeconomic environment, attempting to foster higher inflation solely to reduce unemployment without addressing structural issues is problematic. The natural rate of unemployment should be achieved through structural reforms rather than inflationary measures, which may erode purchasing power and distort economic signals over time.

References

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3. Friedman, M. (1968). The Role of Monetary Policy. American Economic Review, 58(1), 1-17.
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