Income Approach (Y = Income

I

Households

Firms

FINANCIALMARKET

Goods & ServicesMARKET

C

S

Income Approach (Y = Income)

Factors M.(Capital Labor)

GovernmentG

BudgetDeficitT

Rest of world

Ex

Im

BOPDeficit

Rent InterestProfit

Wages

Compensation of Employees 10,005Payment for labor services.Net wages and salaries plus fringe benefits paid by

employers such health care insurance, social security contributions, and pension fund contributions.

Net Interest 485The interest households receive on loans they make minus the interest households pay on their own borrowing.

Rental Income of Persons 702Rental income of persons is the payment for the use of land and other rented inputs.

Corporate Profits 2,009A combination of interest on capital and profit for entrepreneurship. Paid out as dividends and undistributed profits are all counted as income.

Proprietors’ Income 1,411Proprietors are people who run their own businesses. A mixture of the previous four items.

___________________________________________Net national product at factor cost 14,612

[ Government expenditures are about 45-50% of this. ]

GDP is the sum of the incomes in the economy during a given period.

The expenditure approach values goods and services at market prices,the income approach values them at factor cost.

+ Indirect taxes (They make market prices exceed factor cost.)– Subsidies (They make factor cost exceed market prices.)

___________________________________________________________

National Income 15,957

National income includes NET profit.

Gross profit is a firm’s profit beforesubtracting the depreciation of capital.

Net profit is a firm’s profit aftersubtracting the depreciation of capital.

Depreciation = The decrease in the value of capital that results from its use and from obsolescence—alsocalled capital consumption.

Because GDP includes GROSS investment,we must add depreciation to total income.

Because GDP is not national but domestic product, we need to add domestic income of foreigners and deduct foreign income of citizens

GDP Y 18,436 100%Compensation of employees 10,556 57%Net Interest, Rents, Profits 2,252 12%Proprietors Income 1,411 8%Indirect taxes - Subsidies 1,345 7%Depreciation 2,676 15%Net US income of foreigners 196 1.06 %

Income Approach

GDP Y 18,436 100%Consumption C 12,695 69%Investment I 2,974 16%Government Purchases G 3,263 18%Net Exports Ex-Im -495 - 3%

Expenditure Approach II.2016

Environment Quality (no costs here)• We do not count the deteriorating planet’s resources as a

negative part of GDP.

• Pollution is not subtracted from GDP; Cleaning adds to it.

Household Production (out of market)

• Real GDP omits household production, it underestimates the value of the production of many people, most of them women.

Underground Production (out of legal market)

• Hidden from government to avoid taxes and regulations or illegal.

• Because underground economic activity is unreported, it is omitted from GDP.

Government Production (valued at costs)

Building a failed solar panels factory adds o GDP as much as any other production

Real GDP per capita : Not all ProductionNot a ConsumptionNot a Standard of Living

Leisure Time (unmeasured consumption)

• Our working time is valued as part of GDP, but our leisuretime is not.

Other Influences on the Standard of LivingFreedom of thoughtFreedom of expressionFreedom of giving

Social mobility, MeritocracyEquity of (after tax monetary) income…

Depreciation (consumed by nature)

GDP Y 18,436 100%Compensation of employees 10,556 57%Net Interest, Rents, Profits 2,252 12%Proprietors Income 1,411 8%Indirect taxes - Subsidies 1,345 7%Depreciation 2,676 15%Net US income of foreigners 196 1.06%

Income Approach

GDP Y 18,436 100%Consumption C 12,695 69%Investment I 2,974 16%Government Purchases G 3,263 18%Net Exports Ex-Im -495 - 3%

Expenditure Approach II.2016

• IS-LM model• IS Curve• LM Curve• IS-LM Examples• Fiscal and Monetary policies• Keynesians vs. Monetarists

IS-LM modelModels short run changes in the GDP

Short run = changes in prices not known

Short-run Production Equilibria (IS curve)Production = Total demand (expenditures)

Short-run Asset Allocation Equilibria (LM curve)Money demanded = Money supplied

Y

Real i LM

IS

Short Run Equilibrium

IS

Y

Real i

IS

Excess demand for goods

Excess supply of goods

Short-run Asset Allocation Equilibria (LM curve)Money demanded = Money supplied

Y

Real i LMExcess supply of money

Excess demand for money

Short-run Production Equilibria (IS curve) Production = Total demand (expenditures)

LM

IS-LM model

YReal GDP

i

RealInterest

Rate

LM

IS

Short Run Equilibrium

• IS-LM model• IS Curve• LM Curve• IS-LM Examples• Fiscal and Monetary policies• Keynesians vs. Monetarists

IS Curve

Y

Real i

IS

Excess demand for goods

Excess supply of goods

Short-run Production Equilibria (IS curve) Production = Total demand (expenditures)

A. When Income (Y) increases both Consumption (C) and Private Savings (S) increase.

B. When real interest rate (i) increases companies’ investments (I) decrease.

C. In equilibrium: Total Demand (ZZ) = Production (Y) = Income (Y)

We will derive IS curve based on these three facts:

I. IS curve FigureII. IS curve Equation

I

Households

Firms

Wages

FINANCIALMARKET

Goods & ServicesMARKET

Rent InterestProfit C

S

Factors M.(Capital Labor)

GovernmentG

BudgetDeficitT

Rest of world

I Ex

Im

BOPDeficit

IS Curve FigureC. In equilibrium: Total Demand (ZZ) = Production(Y) = Income (Y)

Households

Firms

FINANCIALMARKET

Goods & ServicesMARKET

GovernmentG

BudgetDeficitT

IS Curve Figure

Budget Deficit = G – T

FINANCIALMARKET

Goods & ServicesMARKET

Rest of world

Ex

Im

BOPDeficit

IS Curve Figure

BOP Deficit = Im – Ex +/- foreign wages, profits,…

Budget Deficit = G – T

I

HouseholdsFINANCIALMARKET

Goods & ServicesMARKET

S

TWIN DEFICITS:(G – T) = S – I + (Im – Ex)Budget deficit BOP def.

Government

BudgetDeficit

Rest of world

BOPDeficit

IS Curve Figure

S = I + (G – T) + (Ex – Im)

S = I + G – T + NX

BOP Deficit = Im – Ex +/- foreign wages, profits,…

Budget Deficit = G – T

S = I + G – T + NXIn case of (1) closed economy: NX = 0

(2) balanced budget: T = G S = I

Private Saving = InvestmentNote that if G-T or NX changes then so do S and I

Investment I and Real Interest Rate i (exp.)B. When real interest rate (i) increases

companies’ investments (I) decrease.

Private Saving S and Income YA. When Income (Y) increases both

Consumption (C) and Private Savings (S) increase.

I

S

I

(Real) i

Y

S

IS Curve Figure

S = I + G – T + NXIn case of (1) closed economy: NX = 0

(2) balanced budget: T = G S = I

Private Saving = InvestmentNote that if G-T or NX changes then so do S and I

Investment I and Real Interest Rate i (exp.)B. When real interest rate (i) increases

companies’ investments (I) decrease.

Private Saving S and Income YA. When Income (Y) increases both

Consumption (C) and Private Savings (S) increase.

I

S

I

(Real) i

Y

S

IS Curve Figure

G increases, T decreases(fiscal expansion)

X increases, Im decreases(depreciation=weakening of currency)

Expected Profitability of I increases(less regulation, smaller corp. taxes, …)

Willingness to save increases(consumers scarred,…)

S

I

Real i

Y

LY

Li

Real i

Y

LM curve

Ms = Li +LY

IS curveI

S

I

(Real) i

Y

S

IS Curve Figure