Output is split into components of aggregate demand. Analysing domestically produced goods and services.

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NATIONAL INCOME ACCOUNTING
COMPONENTS OF GDP -
MEASURING INFLATION
MD Siyam HossainMD Siyam Hossain
Bangladesh Institute of Business & Technology.Bangladesh Institute of Business & Technology.
Narayangonj,DhakaNarayangonj,Dhaka
Dhaka,BangladeshDhaka,Bangladesh
www.facebook.com/mdsiyamhossain

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1. COMPONENTS OF DEMAND
Analysis of demand for output
 Output is split into components of aggregate demand
 Analysing domestically produced goods and services
 Total demand for domestic output is made up of following
four components:
 Consumption spending by households (C),
 Investment spending by businesses and households (I)
 Government’s (federal, state, and local) purchases of
goods and services (G)
 Foreign demand (NX)
The four components and the total output is expressed into
following identity:
 Y= C+ I+ G+ NX (1)
 It (1) is called national income accounting identity

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2. CONSUMPTION
 Main component of demand is consumption spending by
household (Table-1)
 Consumption includes spending on anything (e.g. food to golf
lessons)
 It also involves consumption spending on durable goods (e.g.
automobiles)
 Such spending normally regarded as investment rather than
consumption
Table – 1: Components of demands 2003
Components of GDP $ Billions Percent (%)
Consummations 5 139.00 68.1
Investment (domestic) 1 096.00 14.5
Government Sector 1 409.00 18.7
Net Export - 119.0 -1.3
Total GDP 7 545.00 100%

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Division of GDP in the USA from 2003 shows that:
 Consumption made 68.1% of GDP in USA in 2003
 Share of Investments is 14.2%
 Share of government sector is 17.7%
 And Share of Foreign Demand is 1.1%
 Share of the components are not constant
 They vary from period to period and country to
country

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Division of GDP in Japan from 2003 shows that:
 Japan consumes a far smaller share of GDP
than USA
 Rising share of consumption in USA in 1980s
was important reasons for poor economic
performance
Higher consumption means:
 Less investment
 Larger trade deficits
 Lower saving

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3. GOVERNMENT
Government spending includes:
 National defence expenditures
 Costs of road expansion by state and local
governments
 Salaries of government employees
 Government spending is referred as purchases of
goods and services
 Government makes also transfer payments
 Transfer payments are social security benefits and
unemployment benefits
 These are payments made to people without any
service in exchange

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4. INVESTMENT
 Investment means additions to the physical stock of capital
 Investment does not include buying bond or stock of a firm
Investment includes:
 Building of machinery
 Construction of factories and offices
 Additions to a firm's inventories
 Investment increases ability to produce output in future
 Human capital embodied knowledge and ability to produce
 Investment in education is regarded as investment in human
capital
 However, personal educational expenditures as consumption
 But public educational expenditures as government investment
spending

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Classification consumption or investment
spending:
 In national income accounts:
Individual's purchase is consumption expenditure
Purchase of store is inventory investment
 Investment is indicated as ‘gross’ because from
investment depreciation is not deducted
 Net investment is gross investment minus depreciation
 Actually, investment includes investment in human
capital
 Official national income accounting counts only
additions to physical capital stock as investment

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5. NET EXPORTS
 ‘Net exports’ account for domestic spending on
foreign goods and foreign spending on domestic
goods
 When foreigners purchase our goods, their spending
adds to the demand of our domestic goods
 When we purchase foreign goods has, it decreases
demand for our domestic goods
 So, difference between exports and imports is a
component of total demand for our goods
 [Difference between exports and imports is ‘Net
Export’]
 US net export is negative since the 1980s
 It means a deficit of balance-trade (Table-1)
 In some years net exports have been close to zero

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7. SOME IMPORTANT IDENTITIES
Let us introduce some notations and
conventions
It will be followed throughout the book
We simplify our analysis making following assumptions:
Disposable income equals GDP (Yd = Y)
No difference between gross investment and net
investment
It has neither a government nor foreign trade
Let us denote C for consumption and I for
investment spending
Let output produced equals output sold

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 Hence, we can write: Y= C + I (2)
 Identity (2) shows the allocation of income
Let us establish a relationship among saving,
consumption, and GDP:
 Let output produced is either consumed or saved
 Hence, we can write: Y = C + S (3)
 This (3) shows the components of demand
From (2) and (3), we have:
 C + I = Y = C + S (4)
 I = S (5)
 It means (5), in a simple economy investment equals saving
 Let analysis this conclusion
 More is saved more is invested
 More consumption means less investment
 Less consumption means more investment

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3. REINTRODUCING GOVERNMENT AND FOREIN TRADE
Let us now introduce government and external sector in model
above consideration. Let us denote:
 Government purchases G and taxes by TA
 Transfers to the private sector (including interest) by TR
 Net exports (Exports - Imports) by NX
 So, output produced is either consumed, invested, used by govt or
saved
 Y = C + I + G + NX (6)
 Let us introduce the concept of output and disposable income
 We know that output equals disposable income
 Disposable income could be used either for consumption or
investment
 YD = C + S (7)
 Disposable income (YD) is equal to income plus transfers less
taxes (TA)

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That is disposable income is increased by transfers and
reduced by taxes, hence:
 YD = Y + TR – TA (8)
 Disposable income is allocated for consumption and saving
 That is combining identities (7) and (8), we have
 C + S = YD = Y + TR- TA (9)
 C + S = Y + TR − TA (10)
 C = Y + TR − TA − S (11)
 Consumption is equal to income plus transfers less tax and
saving
From equation (6) and equation (10), we have:
 C + S = Y + TR − TA
 C + S = C + I + G + NX + TR − TA [Y = C + I + G + NX]
 S − I = (G + TR −TA) + NX (12)

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Case-I:
 If saving equals investment, then maximum possible investment
is achieved
In this case, government spending and net export is zero
It means, there is no government spending
And either there is no foreign trade or trade is balanced
Net export could be zero, if there is no foreign trade or trade-
balance is zero
 However, government spending could never be zero
Case-II
 By unchanged government spending, investment could be
increased by increasing export
 In this case, more and more export enables import of more and
more capital goods that ensure growth

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Conclusion
Investment could be increased by:
 Minimizing government spending
 Promoting Export that enables more and more
import of capital goods
 Cutting more and more tax
 Increasing consumption cutting tax
 Supporting income through social and other
supports
 All of these steps supports consumption and saving
that foster growth

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4. BUDGET, TRADE, SAVING AND INVESTMENT
 Let us explain impact of government spending and net export on
investment with a fictive example (Table-2)
Row-2
 In 2001 saving was $1000 and there is no BD and TBD
 Saving $1000 was fully invested
 If there is no BD and TBD, saving is fully invested
Table – 2: Budget, Trade, Saving and Investment (Billions Dollars)
Year NI Consumption Saving Investment BD NX
2001 4000 2000 1000 1000 0 0
2002 4000 2000 1000 850 150 0
2003 4000 2000 1000 900 0 - 100
2004 4000 2000 1000 750 150 - 100
2005 4000 2000 1000 950 150 100
2006 4000 2000 1000 1050 50 100

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Row-3
 In 2002 there was no TBD, but BD from $100
 So, a part of savings was eaten up by BD
 Hence, investment decreased to the amount of BD, $100
 If there is BD but no TBD, a part of saving is eaten up by
BD
Row-4
 In 2003 there was no TBD, but a BD from $100 (-$100)
 That means, a part of savings was used for import
 Hence, investment decreased to the amount of TBD, $100
 If there is BD but no TBD, a part of saving is eaten up by
BD

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Row-4
 In 2004 there was BD from $150 and TBD from $ 100
 So, a part of savings was used for BD and TBD
 Investment was reduced by BD and TBD $250 ($150+$100)
 If there is BD and a TBD, investment is reduced to amount BD
and TBD
Row-6
 In 2005 there was BD from $150 and TBS from $ 100
 So, savings was increased by TBS of $100
 But the increased savings/income ($1100) that could be
invested was reduced by BD of $150
 So, investment was only $950 ($1100+$150)
 If there is BD but a TBS, investment is reduced to amount BD
but increased by the TBS

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Row-7
In 2005 there was BD from $50 and TBS from
$ 100
So, savings was increased by TBS of $100
But the increased savings/income ($1100) that
could be invested was reduced by BD of $50
So, investment was only $1050 ($1100+$50)
If there is BD but a TBS, investment is
reduced to amount BD but increased by the
TBS