National Income

CHAPTER 12 Accounting and

the Balance
of Payments
PREVIEW

National income accounts

 measures of national income
 measures of value of production
 measures of value of expenditure

National saving, investment and the current

account
Balance of payments accounts

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RESERVED.
NATIONAL INCOME
ACCOUNTS
Records the value of national income that results
from production and expenditure.

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NATIONAL INCOME
ACCOUNTS: GNP
Gross national product (GNP) is the value of all
final goods and services produced by a nation’s
factors of production in a given
time period.
 What are factors of production? workers (labor),
physical capital (like factories and equipment), natural
resources and other factors that are used to produce
goods and services.

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NATIONAL INCOME
ACCOUNTS
GNP is one measure of national income, but a
more precise measure of national income is
GNP adjusted for following:
1. Depreciation of capital results in a loss of income
to capital owners, so the amount of depreciation is
subtracted from GNP.
2. Indirect business taxes reduce income to
businesses, so the amount of these taxes is
subtracted from GNP.

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NATIONAL INCOME
ACCOUNTS (CONT.)
Another approximate measure of national income
is gross domestic product (GDP):
Gross domestic product measures the
final value of all goods and services that are
produced within a country in a given
time period.
GDP = GNP – factor payments from
foreign countries + factor payments to
foreign countries
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RESERVED.
 GNP = EXPENDITURE ON A
COUNTRY’S GOODS AND
SERVICES
National expenditure
income = Y = C + I + G + EX
d d d
on production
value of
production
= (C-Cf) + (I-If) + (G-Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
= C + I + G + EX – IM
= C + I + G + CA

Domestic Net expenditure

expenditure by foreigners

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EXPENDITURE AND PRODUCTION
IN AN OPEN ECONOMY

CA = EX – IM = Y – (C + I + G )
When production > domestic expenditure, exports >
imports: current account > 0, trade balance > 0
 when a country exports more than it imports, it earns more income
from exports than it spends on imports
 net foreign wealth is increasing

When production < domestic expenditure, exports <

imports: current account < 0, trade balance < 0
 when a country exports less than it imports, it earns less income
from exports than it spends on imports
 net foreign wealth is decreasing

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SAVING AND THE
CURRENT ACCOUNT
National saving (S) = national income (Y) that is
not spent on consumption (C) or government
purchases (G).

Y–C–G
(Y – C – T) + (T – G)
Sp + Sg = S

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RESERVED.
HOW IS THE CURRENT ACCOUNT
RELATED TO NATIONAL SAVING?

CA = Y – (C + I + G )
implies
CA = (Y – C – G ) – I
= S – I
current account = national saving – investment
current account = net foreign investment

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RESERVED.
HOW IS THE CURRENT ACCOUNT
RELATED TO NATIONAL SAVING?
(CONT.)
CA = S – I or I = S – CA

Countries can finance investment either by saving

or by acquiring foreign funds equal to the current
account deficit.
 a current account deficit implies a financial capital
inflow or negative net foreign investment.

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HOW IS THE CURRENT ACCOUNT
RELATED TO NATIONAL SAVING?
(CONT.)
CA = Sp + Sg – I
= Sp – government deficit – I

Government deficit is negative government

saving
 equal to G – T

A high government deficit causes a negative

current account balance, all other things equal.

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RESERVED.
BALANCE OF PAYMENTS
ACCOUNTS
A country’s balance of payments accounts
accounts for its payments to and its receipts from
foreigners.
Each international transaction enters the accounts
twice: once as a credit (+) and once as a debit (-).

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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

The balance of payment accounts are separated

into 3 broad accounts:
 current account: accounts for flows of goods and
services (imports and exports).
 financial account: accounts for flows of financial
assets (financial capital).
 capital account: flows of special categories of assets
(capital), typically non-market, non-produced, or
intangible assets like debt forgiveness, copyrights and
trademarks.
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RESERVED.
HOW DO THE BALANCE OF
PAYMENTS ACCOUNTS BALANCE?

Due to the double entry of each transaction, the

balance of payments accounts will balance by the
following equation:
current account +
financial account +
capital account = 0

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BALANCE OF PAYMENTS
ACCOUNTS
Each of the 3 broad accounts are more finely
divided:
Current account: imports and exports
1. merchandise (goods like DVDs)
2. services (payments for legal services, shipping
services, tourist meals,…)
3. income receipts (interest and dividend payments,
earnings of firms and workers operating in foreign
countries)
Current account: net unilateral transfers
 gifts (transfers) across countries that do not
purchase a good or service nor serve as income
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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

Capital account: records special asset transfers,

but this is a minor account for most countries.

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RESERVED.
BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

Financial account: the difference between sales of

domestic assets to foreigners and purchases of foreign
assets by domestic citizens.
Financial (capital) inflow
 Foreigners loan to domestic citizens by acquiring domestic assets.
 Foreign owned (sold) assets in the domestic economy are a credit
(+)

Financial (capital) outflow

 Domestic citizens loan to foreigners by acquiring foreign assets.
 Domestically owned (purchased) assets in foreign economies are a
debit (-)
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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

Financial account has at least

3 categories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy

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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

Statistical discrepancy
 Data from a transaction may come from different
sources that differ in coverage, accuracy, and timing.
 The statistical discrepancy is the account added to or
subtracted from the financial account to make it balance
with the current account and capital account.

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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)

Official (international) reserve assets: foreign

assets held by central banks to cushion against
instability in international markets.
 Assets include government bonds, currency, gold and
accounts at the International Monetary Fund.
 Official reserve assets owned by (sold to) foreign
central banks are a credit (+).
 Official reserve assets owned by (purchased by) the
domestic central bank are a debit (-).
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BALANCE OF PAYMENTS
ACCOUNTS (CONT.)
The negative value of the official reserve assets is called the
official settlements balance or “balance of payments”.
 It is the sum of the current account, the capital account, the non-reserve
portion of the financial account, and the statistical discrepancy.
 A negative official settlements balance may indicate that a country is
depleting its official international reserve assets or may be incurring
debts to foreign central banks.
 selling foreign currency by the domestic central bank and buying
domestic assets by foreign central banks are credits for official
international reserve assets, and therefore reduce the official
settlements balance.

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