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Plenary lecture notes International Economics
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Plenary lecture notes International Economics including some extra explanation from the professor.
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Hoorcollege 103-09-2018
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?
Factors that are used to produce goods and services:
- Workers (labor services),
- Pysical capital (like buildings and equipment),
- Land (estate, farmland), natural resources (rare earths, minerals) and others.
• The value of final goods and services produced by home-owned factors of production are counted as
home country’s GNP
National Income Accounts: GDP
Another approximate measure of national income:
• Gross domestic product (GDP) measures the
final value of all goods and services that are produced within a country in a given time period.
• GDP = GNP [produced by a country’s factors of prod.]
– payments (from foreign countries) for home factors of
production, but produced abroad (e.g. domestic capital invested abroad)
+ payments (to foreign countries) for foreign factors of
production, but produced at home (e.g. foreign capital invested in the NL)
GNP is calculated by adding the value of expenditure on final goods and services produced. There are 4 types of
expenditure:
1. Consumption: expenditure by domestic consumers
2. Investment: expenditure by firms on buildings & equipment
3. Government purchases: expenditure by governments on goods and services (usually also referred to
as government consumption, but it also includes government investment, e.g. infrastructural
investment)
4. Current account balance (“exports” minus “imports”): net expenditure by foreigners on domestic
goods and services including factor payments (incl. interest payments)
Where produced?
Who ones factor of At home Abroad
production? Home owned -
Foreign owned +
GNP (home owned (yellow)) to GDP (home produced (blue)): - abroad produced + foreign owned
National Income: GNP = Expenditure on a Country’s Goods and Services
Expenditure
National on domestic
income = Y = Cdom + Idom + Gdom + EX production
value of
domestic
= (C-Cfor) + (I-Ifor) + (G-Gfor) + EX
production
= C +I +G + EX – (Cfor + Ifor +Gfor)
= C +I +G + EX – IM
= C +I +G + CA
Expenditure by domestic Net expenditure by foreign
individuals and institutions individuals and institutions
(domestic expenditure)
,National income: two interpretations
Ex post national income identity:
• national income = Y = C + I + G + CA = expenditure on domestic production
• Final products not purchased by households or gov. are counted as inventory investment by firms.
Equilibrium condition in a demand driven model: (not mentioned in book)
• Keynesian Cross
• Supply = dom. Production = Y = AD (aggregate demand)
= C + I + G + CA (meaning Cdem + Idem + Gdem + EXdem - IMdem)
National Income: other issues
Alternative representation of the national income identity:
• National inc./prod + imports = expenditures at home + abroad (goods/services available in home
country)
• Y + IM = C + I + G + EX
EX-IM has two meanings: (confusing in the book)
• In CA (here): Net expenditure by foreign individuals and institutions
- This includes, for instance, interest payments for debt / foreign capital
• In trade balance:
- It means exports and imports of goods and services
A nation’s net foreign assets:
CA = EX – IM = Y – (C + I + G )
• When production > domestic expenditure (= domestic absorption = expenditures by dom. indiv./inst.),
• Then “exports” > “imports”: current account > 0 (CA surplus)
• (and probably trade balance > 0):
• When a country “exports” more than it “imports”, it earns more income from “exports” than it spends
on “imports” → Net foreign assets increase.
• CA surplus “produces” net foreign wealth (investment)
When production < domestic expenditure, then “exports” < “imports”: current account < 0 (CA deficit) → Net
foreign assets decrease.
Savings and the Current Account
• National saving (S) : = national income (Y) that is not spent on consumption (C) or gov. purchases (G):
S:=Y–C–G
= (Y – C – T) + (T – G)
= Sp + Sg [Sg is also the gov. budget]
• We already know: CA = EX – IM = Y – (C + I + G )
= (Y – C – G ) – I
= S–I
• Current account = national saving - investment
• Current account = change in net foreign assets
= net foreign investment
• “IM > EX” (CA < 0) S < I
• 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 asset inflow (= negative net foreign investment).
• CA = Sp + Sg – I
= Sp + government budget – I
= (Sp – I) + (T – G)
• Twin deficit:
- (<0) (=0) (<0)
- A deficit in the budget corresponds to/implies a current account deficit, if the private sector
does not increase savings.
,Summary:
• (Sp – I) + (T – G) = (X – M)
• private public external
• savings + (gov. budget) = (current account)
• surplus surplus surplus
Note: this is an ex post identity → there is no direct causality:
• e.g. for solving the twin deficit problem: (T – G) < 0 and (X – M) < 0: it does not necessarily work to
reduce imports in order to solve the budget problem
Balance of payments: The Shortest Ever Summary
• Definition: flow of all payments for transactions conducted between home country and the rest of the
world
• (CA + KA = ERR) [before 2000]
CA (+ capital acc.) + financial acc. = ERR [new IMF standard]
• BoP balanced by definition, but ERR (which should be 0)
Each international transaction enters the accounts twice: once as a credit item (+) and once as a debit
item (-)
• But loosely speaking:
- “BoP deficit” ≡ deficit official settlements balance (= surplus in reserve portion of FA)
= losing international reserves
- “Imports > exports” = current account deficit
[ = “BoP deficit” if private investment in financial accounts more or less balanced]
Balance of payments versus a balance sheet
A firm’s balance sheet:
• Provides information on the firm’s assets, liabilities and thus its net worth at a particular point in time.
• The balance sheets of two subsequent years provide information on the changes in value of the firm’s
assets, liabilities & net worth.
• Profit and loss account reports profits and losses from the firm’s activities / changes in net worth
resulting from changes in assets, liabilities.
A country’s balance of payments:
• Provides information on a country’s profit and loss account (current account) and the resulting change
in a country’s net worth (i.e. private net foreign wealth and public reserves).
The Balance of Payments
Money flows in (+) Money flows out (-)
Credit Debit
Exports Imports
Decrease private net or foreign wealth (assets) Increase private net foreign wealth (assets)
Decrease in reserves Increase in reserves
Balance of payments account
• A country’s balance of payments accounts for its payments to and its receipts from foreigners during a
certain period.
• An international transaction involves two parties, and each transaction enters the accounts twice:
once as a credit (+) and once as a debit (-).
• 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
, Balance of payments: 3 main accounts
• Current account: with the following sub accounts:
- Merchandise: exports vs. imports (goods like DVDs)
- Services: exports vs. imports (payments for legal services, shipping services, tourist meals, …)
- Factor Income: receipts vs. payments (interest & dividend payments, earnings of firms &
workers operating in foreign countries)
- Unilateral transfers: receipts vs. payments (gifts; transfers across countries that do not
purchase a good or service nor serve as income for goods and services produced, e.g. foreign
aid)
• (Capital account: records special transfers of assets, but this is a minor account for the most
developed economies)
• Financial account: accounts for flows of financial assets (financial capital).
Example
• You import a DVD of Japanese computer game by using your debit card.
• The Japanese producer of the computer game deposits the money in its bank account in San
Francisco. The bank credits the account by the amount of the deposit.
Debit: DVD purchase –$30
(current account: US good import)
Credit (“sale”) of deposit in account by bank +$30
(financial account: US asset sale)
• You buy a share of BP
• BP deposits the money in a US bank
Debit: Stock purchase –$90
(financial account: U.S. asset purchase)
Credit: Bank deposit +$90
(financial account, U.S. asset sale)
Financial account
Financial account: the difference between sales of domestic assets to foreigners and purchases of foreign
assets by domestic citizens.
Financial inflow
• Foreigners lend to domestic citizens by buying domestic assets.
• Domestic assets sold to foreigners are a credit (+) because the domestic economy acquires money
during the transaction. [every export (credit) leads to money inflow]
Financial outflow
• Domestic citizens lend to foreigners by buying foreign assets.
• Foreign assets purchased by domestic citizens are a debit (-) because the domestic economy gives up
money during the transaction. [every import (debit) leads to money outflow]
Types of financial (capital) flows
Portfolio investments:
• Aim is to acquire a reasonable return given the risks involved.
Foreign Direct Investments:
• International capital flow by a firm in one country to create or expand a subsidiary in another country:
aim is to acquire control of the foreign firm’s management
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