NATIONAL INCOME ACCOUNTING COMPONENTS OF GDP

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

2. CONSUMPTION
Main component of demand is consumption (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 2007

Division of GDP in the USA from 2007 shows that:
Consumption made 68.1% of GDP in USA
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 Year to Year and country to country

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

3. GOVERNMENT
Government spending includes:
Salaries of government employees
Government spending for purchases of goods and services
Defence expenditures
Costs of transport and communication
Government transfer payments as social security and unemployment benefits

4. INVESTMENT
Investment includes:
Investment increases ability to produce output
Building of plants
Construction of factories and offices
Including new machineries
Additions to a firm's inventories
Expenditure also for education means investment
Human capital means ability to produce
Investment in education is regarded as investment in human capital
However, personal educational expenditures as consumption
But public educational expenditures is government investment spending

5. NET EXPORTS
‘Net exports’ account the difference between 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
The difference between exports and imports is ‘Net Export’
US net export is negative since the 1980s (Table-1)
It means a deficit of trade-balance
In some years net exports have been close to zero

7. SOME IMPORTANT IDENTITIES
Let us introduce some notations and conventions
It will be followed throughout the book
Let us first simplify our analysis making following assumptions:
Let us denote C for consumption and I for investment spending
Let us output produced equals output sold
Let us the economy has neither a government nor foreign trade

Hence, we can write: Y= C + I (1)
Identity (2) shows the allocation of income
It means the Nation Income could be either consumed or invested
Let us establish a relationship among saving, consumption, and GDP:
Again the National Income could be either consumed or saved
Hence, we can write: Y = C + S (2)
This (3) shows the components of demand

From (1) and (2), we have:
C + I = Y = C + S (3)
I = S (4)
It means (4), 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
The conclusion is it is better to save more, them more saving means investment & growth

3. REINTRODUCING GOVERNMENT AND FOREIN TRADE
Let us now introduce government and external
sector in the model above
Let us:
Government purchases equals G
Government taxes equals TA
Transfers (Social Transfer) to the private sector equals TR
Net exports (Exports - Imports) is NX

Output produced is either consumed, invested (saved), or used by government
Hence:
Y = C + I + G + NX (5)
Let us introduce concept of output and disposable income
We know that output equals disposable income (YD)
It means:
Y= YD (6)
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)
YD = Y + TR – TA (8)
Combination of the identities (7) and (8), we have:
C + S = Y + TR- TA (9)
C + S = Y + TR − TA (10)
From equation (5) 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)

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 imports
Apparently, it means that if more is imported more could be invested
This is correct, but more and more capital goods (and not luxury) have to be imported
However, only more and more export enables import of more and more capital goods that ensure growth
Hence, export must be enhanced, but by import in place of luxury goods import of capital goods must be ensured

Conclusion
Investment and hence growth could be
enhanced:
Minimizing government spending
Promoting export and import of more and more capital goods
Cutting tax
Increasing consumption cutting tax
Supporting income through social and other supports
All of these support consumption and saving that foster growth

4. BUDGET, TRADE, SAVING AND INVESTMENT
Let us explain impact of government spending and net export on investment with an example (Table-2)
Case-1
In case-1 saving is $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)
Y = C + I + [G + TR − TA] + NX
Y = C + I + [BD] + NX

Case-2
In case-2 there was no TBD, but Budget of $150
So, savings $150 was eaten up by BD
Hence, investment decreased to the amount of $150
If there is Budget deficit a part of saving is eaten up by BD
For growth it is better not to have any Budget deficit
Cae-3
In case-3 trade balance was 0, but there was budget surplus of $150
So, the saving and investment increased to the amount of $150.
The Investment was $1150
That means, savings were increased by the amount of trade balance surplus
So, growth is fostered by trade balance surplus

Case-4
In case 4 there was no Budget deficit, but a trade balance surplus of $150
So, the saving and Investment increased to the amount of $150. The investment was $1150.
If there is a trade balance surplus, but no budget deficit, the investment increases to amount of trade balance surplus
Case-5
In cae-5 there was no budget deficit, but a trade balance deficit of $150
So, savings was decreased by trade balance deficit of $150
So, investment was only $850 ($1000-$250)
If there is no budget deficit, but a trade balance deficit, the investment is reduced to amount trade balance deficit

Case-6
There is budget surplus of $150 and trade balance deficit of $ 100
So, savings and investment was increased by $50
The investment was $1050 ($1000+$50)
If there is budget surplus but a trade balance deficit, the saving and investment increases to the amount of budget surplus decreases to the amount of trade balance deficit

Case-7
There is budget deficit of $150 and trade balance surplus of $ 100
So, savings and investment decreases to the amount of $50
The investment was $950 ($1000-$50)
If there is budget deficit but a trade balance surplus, the saving and investment decreases to the amount of budget deficit decreases to the amount of trade balance deficit

Questions
Describe the different components of GDP and explain the relationship among the components saving, investment and government sector.
Explain the relation between savings and investment using the national income accounting identities.
Explain the impact of national budget, trade balance on savings and investment using an example.