Understanding GDP, National Income, and Fiscal Policy
National Accounting: Measuring Economic Activity
National accounting measures the activity of an economy over a period, usually one year, recording the transactions between the different actors. GDP (Gross Domestic Product) represents the total monetary value of final goods and services produced for the market within a country’s borders in a year.
GDP by Expenditure Approach
The expenditure approach to measuring GDP adds the value of goods and services acquired by each type of end-user (families, businesses, the public sector, and the foreign sector). The formula is:
GDP = C + I + G + NX
- C (Consumption): The share of GDP acquired by families as end-users.
- I (Investment): Private investment is the sum of:
- Plant and services purchased by businesses.
- The construction of new homes for residential use.
- Changes in stocks.
Stock: Goods that have been produced but not yet sold. GDP includes stock changes.
Net Investment (NI): Equal to gross investment (IB) less depreciation (D). NI = IB – D
- G (Public Expenditure): Spending conducted by the public sector on goods and services. Includes all public sector expenditures to pay employees and the cost of goods (roads, railways, etc.) and services (health, financial, etc.) purchased from the private sector. This public spending for consumption and investment equals the public sector’s contribution to GDP.
- NX (Net Exports): The difference between exports and imports of goods and services. Imports are considered a negative sum in the calculation of GDP.
National Income
The sum of wages paid to domestic factors of production (wages, salaries, rents, interest, and profits) for a period of time.
Unemployment
Unemployment affects those in the active population who are of age, have the physical and mental ability to perform paid work, are job seekers, and cannot find it.
Keynesian Perspective on Unemployment
Keynesians, referencing the work of J.M. Keynes, address the existence of unemployment. They generally favor using an expansionary demand policy. From a Keynesian perspective, unemployment beyond frictional unemployment is involuntary because the level of aggregate demand is insufficient.
Business Cycles
Business cycles are fluctuations in GDP and employment around a trend, showing phases of expansion and recession. During expansions, employment tends to increase (the unemployment rate declines), while during economic downturns, employment tends to decrease (the unemployment rate increases).
Economic Cycle Phases:
- Expansion: Rapid growth where production increases, indicating no crisis.
- Peak and Trough: Pivot points in the cycle.
- Recession: A downturn where production and jobs are reduced.
- Depression: A major recession characterized by its magnitude and duration.
Cyclical fluctuations usually start with a fluctuation in spending, initially affecting one or more sectors and then spreading to others.
Transfers and Taxes
Transfers: Payments for which the recipients do not provide any good or service in return.
Taxes: Imposed by the public sector on individuals, households, and businesses, requiring them to pay a certain amount of money in relation to specific economic events, such as consumption or profit generation.
Fiscal Policy
Expansionary Fiscal Policy
Governments, through expansionary fiscal policy, increase public spending or cut taxes to increase production and employment. This can also generate a price increase. However, if price increases are passed on to wages, the beneficial effects of an expansionary policy may disappear.
Restrictive Fiscal Policy
Restrictive fiscal policy can be used to contract aggregate demand. When the economy is near the peak of the cycle, a restrictive fiscal policy might be considered. This involves reducing public spending and/or increasing taxes.
Budget
The public sector’s budget describes its planned expenditures and the income needed to finance them.
Public Revenue
Funds available to the public sector to meet objectives and cover expenses.
Public Debt
Consists of debt securities issued by the state to the public. Public debt is the total value of bonds or debt securities issued by the state held by the public.