Saturday, March 31, 2012

Hooray for the Income Approach!?

The total value of a country's economic activity in a given time period - its Gross Domestic Product - can be calculated in a number of ways.  The most common is the "expenditure" approach, which involves adding up the purchases of new final goods and services ('new' to avoid wrongly counting re-sales of previously produced goods and 'final' to avoid double-counting input goods, like the glass in a car).  These purchases fall into three broad categories, consumption (C), government purchases (G) and investment (I).  Adding those up and accounting for net exports (NX; exports - imports) gives the familiar relation GDP = C+I+G+NX.

When I teach macroeconomics, I also go over the "income" approach, which calculates GDP based on all the incomes generated for the people who supply the resources used to produce goods and services (the "factors of production", primarily capital and labor).  I don't think the students particularly like this part of the class (and many instructors skip it), because its a bit trickier to do it that way.  I persist with it because I believe there's a valuable point, which is to show how income comes from the act of producing stuff, and to show how that income is distributed among the suppliers of various factors.

There may be another reason why its valuable - some have argued that income-based measures are more accurate in the short run (in principle, they should be the same, but, in practice the data is reported with a "statistical discrepancy" to reconcile them).  Moreover, the latest BEA release suggests that GDP growth is looking somewhat less anemic by the income approach.  Binyamin Applebaum at Economix explains:
There is a pleasant surprise in the latest batch of economic data released Thursday by the Bureau of Economic Analysis. Buried deep inside the government’s revised estimate of fourth-quarter growth (revised but unchanged at 3 percent annualized) is an alternate measure of economic activity that is winning increased attention. And by that alternate measure, gross domestic income, the annualized pace of growth in the final three months of 2011 actually climbed to 4.4 percent.

That’s the kind of growth we usually see during an economic recovery, the kind of growth that’s fast enough to create new jobs. Indeed, it suggests that we may have learned the answer to a fretful mystery. Until now, economists have struggled to explain why unemployment was falling so fast when the major measure of growth, gross domestic product, was rising at an exceedingly modest pace.
Appelbaum explained more in this article last year.  See also: Calculated Risk. However, Dean Baker disputes

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