Imagine the following question on a PhD comprehensive exam:
"Using a macroeconomic model with monopolistically competitive firms, explain how an increase in the expected future price level will cause an increase in the current price level. Also explain whether there is an effect on real output.
Your answer must use words only, with no diagrams or equations. Be very precise about all the mechanisms that would be involved in this interdependent system of simultaneous causation. Your answer must assume no previous knowledge of economic theory or familiarity with economic concepts on the part of the reader. Try to make your answer as realistic as possible, using 10 real-world goods as examples. These should be goods that a homeowner with liquid domestic currency assets living in Sao Paulo Brazil in 1979 might want to buy in response to an increase in the expected future price level. Any transactions in your explanation must be shown to be consistent with double-entry bookkeeping. Please write clearly.
You have 2 hours to answer this question.
Your answer will be graded by a committee composed of: an accountant; a businessman; a Russian day-trader; an economics professor; and anyone else who happens to wander by. You must satisfy all these examiners in order to pass the exam, including follow-up questions in the oral.
Your answer, and the comments of your examiners, will be a permanent part of the public record."
I was foolish enough to try something like this (though I cheated a lot). (Sorry Winterspeak, but when I thought about what I was trying to do, it did seem rather funny, and I couldn't resist posting this, though the joke's really on me.)
Worthwhile Canadian Initiative 
Nick, I rather meant all comments from all posts in one RSS feed. I find it very cumbersome to subscribe to every post every time. But I also find comments here quite interesting to miss an opportunity
Sorry RSJ: Perhaps you do understand my point 2 above. That’s maybe what you meant by “NK models — and all “non-heterodox” models, rule out asset bubbles as a result of how they model the law of motion for capital.”
But that’s not an issue of “heterodox” vs “orthodox”. It’s whether you have a simple production function or have a more complicated one with 2 goods. Wlarasian GE theory is very orthodox, but has n goods.
“It is invisible to the NK model, as the NK model does not allow for an increase in asset values without this being matched by an equal increase in actual investment”
if that’s the case, thank goodness
enough of a mess between accounting and economics
keep the NK model NIPA consistent and adjust for asset values from there
the important point is that capital gains in aggregate are not available for the purchase of GDP
“the NK model does not allow for an increase in asset values without this being matched by an equal increase in actual investment”
this statement is patently false.
Adam: Isn’t it true in a simple NK model (actually, in any simple model, NK or not), that has the technology Kdot + C = Y(K,L) ?
But sure, there is no problem in building an NK model with I and C being two different goods. Or even adding land into an NK model. It’s not an “essential” feature of NK models.
anon: “the important point is that capital gains in aggregate are not available for the purchase of GDP”
Agreed. But asset prices may affect the demand for GDP, in much the same way that interest rates affect the demand for GDP. (Not that you would deny this, presumably, but just to remind ourselves.)
“Isn’t it true in a simple NK model (actually, in any simple model, NK or not), that has the technology Kdot + C = Y(K,L) ?”
No, anytime the natural interest rate changes the value of all assets, bonds and equities, changes in exactly the right way to keep investment unchanged.
If the natural rate of interest has fallen then all asset prices increase with no change in investment.
“the important point is that capital gains in aggregate are not available for the purchase of GDP”
You are confusing an ex-post accounting identity with an ex-ante constraint, as well as confusing the balance sheet of the individual with the balance sheet of the group.
In the example I gave, when you aggregate A and B’s balance sheets, then there is no (net) capital gain. The house increases in value, but net indebtedness increases by the same amount.
In terms of NIPA, savings = 0 in this economy. But each actor saves .5X.
Ex-ante at the level of the individual consumer, investment income is an important contributor to the individual’s income, and income from any source is available for any use, including the purchase of goods which contribute to national output.
At the end of your accounting period, once you’ve aggregated all the transactions for the group, and have aggregated the balance sheets of the group, then you then classify all the expenditures that occurred on final output as consisting of national income over that period, and everything else you classify as a balance sheet adjustment.
That is an ex-post classification, not an ex-ante constraint.
If B would have elected to spend more of his gain on consumption, then national income would have increased. National savings would still be zero, but the sum of individual’s savings would decrease.
And this conflation between national income, national savings, and individual income and individual savings is at the heart of the matter.
What drives economic activity in a model with micro roots?
Do you first aggregate the income and then apply an euler equation to national income, or do you apply the euler equation against individual’s household income and savings, and then aggregate to get the law of motion?
It makes a material difference, even if all consumers are identical. This has nothing to do with making abstractions or simplifications, it’s just a question of improper aggregation.
“You are confusing an ex-post accounting identity with an ex-ante constraint, as well as confusing the balance sheet of the individual with the balance sheet of the group”
2nd point first – I said “in aggregate”, so I’m not confusing anything
1st point – it’s both an ex post identity and an ex ante constraint.
It’s an ex ante constraint because for any prospective accounting period, expenditure will be equal to income, in aggregate. Any individual who consumes from capital gains will force some other individual to save from income; that forces the expenditure/income identity ex ante, which means capital gains are not a part of it in aggregate.
Capital gains are not a part of macroeconomic income.
P.S.
Capital gains are not paid from producers to the factors of production.
That’s why capital gains are not part of macroeconomic income.
“I said “in aggregate”, so I’m not confusing anything”
In aggregate, capital gains are ZERO in the example. In aggregate, “the economy” is NOT obtaining national income from capital gains. So you must be confusing individual with aggregated balance sheets, otherwise you wouldn’t be complaining that the individual capital gain cannot add to national income.
“Capital gains are not paid from producers to the factors of production.”
Never said that.
“Capital gains are not a part of macroeconomic income.”
Correction — and really, for the last time:
“Capital gains OF THE AGGREGATED BALANCE SHEET are not part of NATIONAL income”.
That is a true statement, which does not contradict the following true statement:
“Capital gains OF THE INDIVIDUAL can contribute to NATIONAL income”
“It’s an ex ante constraint because for any prospective accounting period, expenditure will be equal to income, in aggregate. Any individual who consumes from capital gains will force some other individual to save from income;”
Then how do you explain the example? You are assuming — and this is where you are confusing ex-post with ex-ante — that individuals are paid with some share of national income.
But it’s really the other way around.
National income is unknown until all the micro decisions are made.
It cannot be an ex-ante constraint on individual’s incomes.
In the example, once B sold the house, he had complete freedom to spend all of the gain on consumption, some on consumption, or none on consumption. Based on B’s choice, A’s savings would adjust, and national income would adjust.
And this consumption decision completely determines national income ex-post.
B obtained the gain not from A’s saving, but from A taking out a loan to buy the house.
The bank created the money that went to B.
The corresponding deposits were then distributed among both A and B based on their own consumption/savings choices.
The development of your argument is not consistent
You interjected at my:
“the important point is that capital gains in aggregate are not available for the purchase of GDP”
that statement is true and you’ve done nothing to disprove it
you’re confusing aggregate demand with the identities that constrain the equivalence of output and income; the identities hold ex post and ex ante even if capital gains cause an increase in aggregate demand at the micro level
you have a minor case here of Krugman’s “Dark Age of Macro” infliction
Look, this is really simple.
If you calculate each individual’s income, and add that up for all the individuals, you will not (in general) get national income. The reason is that due to credit growth, individual’s incomes may increase more than national income. And if credit is contracting, then they will decrease faster than national income.
I gave a very simple example illustrating this, and you haven’t pointed out any errors with it. No one has.
Obviously the expenditures of each individual, on all sources, are equal to individual income.
But the sum of individual expenditures is not national output, and the sum of individual income is not national income.
If you agree to the above statements, then we have no argument.
In that case, it’s another example of pointless disputation.
I’m beginning to suspect that this is the case. I should have known, of course.
But if I’m wrong, and you really believe that the sum of individual incomes must equal the national income, then I would like to see your “proof”, as well as where the example I gave makes an error.
If you define “income” as “income from the sale of newly-produced goods”, and “expenditure” as “expenditure on newly-produced goods and services”, and include accumulated unsold inventories as pert of “expenditure” (you sold it to yourself), and add in net exports of newly-produced goods and services,…… then all three are equal. (Unless I’ve forgotten something). Ex post, but not ex-ante.
Nick @ 6:35,
“If you define “income” as “income from the sale of newly-produced goods”, and “expenditure” as “expenditure on newly-produced goods and services”, and include accumulated unsold inventories as pert of “expenditure” (you sold it to yourself), and add in net exports of newly-produced goods and services,…… then all three are equal. (Unless I’ve forgotten something). ”
The problem with this is that you cannot make up your own definition of income.
An income statement is the Profit and Loss over a period, showing revenues and expenditures according to some basic conventions that involve properly recognizing revenues in a consistent and rational way.
That is the definition.
You can’t change the definition.
Saying that income is the income from sale of newly produced goods is the result of applying this definition to the national level, where one firm has revenues of X_1 and expenses of X_2, which accrue as revenues to another firm, which has X_2 as revenues and expense of X_3, etc.
So the total national income is a telescoping series in which you can deduce that P&L for the nation as a whole consists of, on the revenue side, “income from the sale of newly-produced goods. ”
But that’s not the definition of income, it’s the algorithm for aggregating incomes of disparate groups within an economy.
You cannot apply that algorithm to an individual actor — it doesn’t make sense. You would get all sorts of violations in which expenditures are not equal to revenues for each individual actor. For example, in the example I gave, B would have expenditures of X, and income of .5X, which necessarily means that B is dissaving and that should show up on his balance sheet. But B isn’t dissaving. It’s because you are using an inconsistent definition.
Both in the case of a group of individuals and in the case of a single individual, you apply the same definition of income.
This is just common sense.
In any case, you want a model that has micro-foundations, right?
If a household is receiving wages and capital income, then their income statement has a specific meaning that is not equal to “income from the sale of newly produced goods”. The household may not be producing much in the way of newly produced goods. Nevertheless it will not be selecting it’s consumption and savings plans based on that (inconsistent) definition of income, but based on it’s actual expected income.
In other words, whenever you want to calculate an income statement or balance sheet, you have to define the accounting boundary.
If I take $1 out of my left pocket and put it into my right pocket, that is not income.
If you take $1 out of your left pocket and give it to me, then it is income for me and an expense for you.
But then if we were to consolidate our balance sheets, it would stop being income. My income would cancel with your expenditures.
You would need to subtract out the revenues A receives from B if both A and B are being consolidated.
That is how you “prove” the telescoping result that national income is the revenues from newly produced goods. It’s not a definition of income, but an algorithm derived from the actual definition of income, which is just revenues.
But when looking at euler equations, if I expect to get a dollar from your pocket, I will absolutely take that into account when forming my consumption and investment plans.
So the appropriate scope for balance sheet consolidation in a macro model is the economic decision maker.
Even if you select a representative agent, it is not the case that the accounting boundary is for the entire household sector, or even for the entire private sector.
The appropriate boundary remains that of the individual household, and you just happen to be using a contrivance in which each household is identical. That is not the same as assuming some sentient “household sector” that is optimizing.
By the way, the above observation is a problem I have with the MMT view of the importance of “net financial assets” for the private sector as a whole. No one makes decisions based on net financial assets of the private sector. But that’s a whole separate story 🙂
“A borrows 2X from the bank in order to buy B’s house. B spends X on goods from the firm and saves the remainder of his income.”
For starters, that 2X is not income. It’s the value involved in the exchange of capital assets.
“But the sum of individual expenditures is not national output, and the sum of individual income is not national income.”
Do you have any idea how absurd that is?
Nick –
“If you define “income” as “income from the sale of newly-produced goods”, and “expenditure” as “expenditure on newly-produced goods and services”, and include accumulated unsold inventories as pert of “expenditure” (you sold it to yourself), and add in net exports of newly-produced goods and services,…… then all three are equal. (Unless I’ve forgotten something). Ex post, but not ex-ante.”
Right. But it holds ex ante as well. It’s an accounting identity that must hold for any future accounting period. That doesn’t tell you anything about what the numbers are – just the relationship that must hold by identity between the numbers.
If you really think accounting identities won’t hold for future accounting periods, I’d like to know why.
No, Anon,
“For starters, that 2X is not income. It’s the value involved in the exchange of capital assets.”
I didn’t say 2X was income. You don’t know the the B’s income yet, because it depends on how much wages and interest income each person receives, which in turn depends on how much B and A decide to spend (in this simple model). So B’s income will depend on the choices made by A.
But B bought the house for X and sold it for 2X, so he does have X of investment income. He will get more income from wages and interest, of course. How much more, we don’t know yet. But he chooses to spend X on consumption and no more. This is perfectly plausible (and there is no error here).
I’m sorry if you find this too confusing or “absurd”.
anon: “If you really think accounting identities won’t hold for future accounting periods, I’d like to know why.”
Because of monetary exchange. Desired aggregate expenditure on newly-produced goods and services is not identically equal to expected income from the sale of newly-produced goods and services. They are only equal in equilibrium. Say’s law is false.
continued; “ex ante” is a crude way of saying “planned” or “desired”, or, in normal microeconomic language, “demanded”. Quantity demanded is not identically equal to quantities supplied, or to quantity transacted. They are only equal in equilibrium.
“But B bought the house for X and sold it for 2X, so he does have X of investment income”
That is completely wrong.
Sorry, but there’s no point in continuing this. You simply don’t know what the definition of income is, including investment income.
Nick,
Think about it. Accounting identities hold for all periods – past, present, and future.
It’s got nothing to do with Say’s Law or planned or desired this or that. Those things end up determining the numbers that make up the accounting identities, but not that the identities are a constraint for any given measurement period – past, present, or future.
This is a variation on what Krugman was talking about in “Dark Age”. That was all about Chicago guys misinterpreting accounting identities, although in a different way than here.
RSJ,
Re the definition of income – I find it absolutely staggering that you would consider the sale of a house as “investment income”. I sincerely hope somebody else comes along and corrects you on this, since you write a lot around this sort of thing on these blogs and clearly have a lot to offer.
Accounting identities always hold. Income statements are a way of aggregating transactions that occur over a period of time, say Q1 2011.
If B had decided to spend X/2 on consumption in January, and no other transactions occurred in Feb. or March, then national income would have been X/2 in that quarter. You will need to wait until April 1 to find out. That is what I mean by ex-post.
In general, under the assumptions of the model (A is deciding go into debt to buy B’s house for 2X, triggering investment income of X, of which B spends a portion, C; the bank is willing to finance A’s purchase; A decides to save all of his income during the quarter; firms do not invest) then for any number C between 0 and X, we have A’s income = A’s savings = C/2. B’s income = X + C/2, of which C is spent on consumption and X – C/2 is saved, and national income = C.
Therefore A’s income + B’s income = national income + X, where X = B’s investment income = the net amount of new money created by the bank during the course of the accounting period = the amount of financial savings realized by the sum of A, B.
The point here is not to argue that economies always follow these rigid rules, but to highlight that applying the euler equations to the individual will yield different results than applying the same equations to the aggregated group.
If you just look at the national income, you only see C — X disappears. The role of debt growth in fulfilling financial savings demands disappears, as does the pain of de-leveraging.
Blogging is hard, Nick, but I admire your courage and creativity in constantly coming out with your thoughts to a public audience. This is how ideas get refined, so thank you for your efforts in this debate. The important thing is not to have the right answer all the time, but to be involved in the most fruitful efforts in the search for answers.
My take on this is close to RSJ’s, I think. Debt does make a difference. Inflationary measures can be hindered in a recession economy with a lot of debt, because the indebted that are undergoing deflation, i.e. balance sheet recession, will not be induced to make more purchases if paying off the debt is already eating up much of their income. They will hope that the non-indebted ones will come to the rescue, and be induced to consume more via increased inflation expectations. But then, the non-indebted have to be convinced that the ongoing balance sheet recession among the indebted will not counteract any of the inflationary measures.
Anon,
Bombast is not helpful here.
The investment income is the income from the disposition of the asset, which was purchased for X and sold for 2X, for investment income of X. Not 2X, as you keep trying to suggest. I never said the investment income was 2X.
If you want to learn more about investment income, please consult any accounting text.
It is not staggering at all.
It is not even confusing.
Anyone with a rudimentary knowledge of accounting will be able to help you understand this concept, if you remain confused about the possible existence of investment income.
It doesn’t matter if it’s X, 2X, or zero. The sale of a house for X, 2X, or zero does not constitute income. If there is a capital gain, it is a capital gain, not income.
Income is rental on a capital property (such as a house) – not the sale of a house or the capital gain on a house.
If tax authorities include capital gains as income in whole or in part, that’s for purposes of calculating taxes, not to define economic for economic purposes. The fact is that capital gains must be excluded from the calculation of economic income at the micro and macro levels as well as NIPA at the macro level.
You can call it income if you like, but it just confuses things and doesn’t contribute to the explanation of economics – just muddies it. At the end of the accounting period, capital gains are excluded from national income and nothing of any economic consequence is gained by defining it as income at one level and not income (properly) at the aggregated level.
Demonstrating the economic effect of capital gains (e.g. increase aggregate demand) from selling a house doesn’t require that you classify it as income and conclude that there is some asymmetry between micro summation and macro.
Any expenditure of capital gains at the micro level forces an equivalent amount of marginal negative saving somewhere else. It must be so, because macroeconomic income cannot exceed the totality of income that is generated excluding capital gains. If you think otherwise, you’d have to include the capital gain on the house as part of GDP, in order to balance your accounts at the macro level, and including capital gain on a house as part of GDP is also nonsense.
anon: “Nick, Think about it. Accounting identities hold for all periods – past, present, and future. It’s got nothing to do with Say’s Law or planned or desired this or that.”
I know that accounting identities always hold, past, present, and future.
But the conventional meaning of “ex ante” in economics is “planned” or “desired”, or “demanded”. And that has to do with Say’s Law.
RSJ and anon: there is more than one way to do accounting. And there is more than one definition of income. The National Income Accounting definition of income (which is a convention among most economists) is very different from the way my tax accountant measures my income. For example, NIA excludes capital gains, and my accountant includes realised capital gains.
There is no one right definition of income. Different definitions may be useful for different purposes.
Thanks rogue!
“Any expenditure of capital gains at the micro level forces an equivalent amount of marginal negative saving somewhere else.”
I meant an equivalent amount of marginal saving somewhere else. Expenditure from capital gains at the macro level constitutes marginal negative saving (spending from zero income).
Nick,
What’s your interpretation of Krugman’s Dark Age post?
(It certainly has something to do with the relationship between accounting identities and economics):
http://krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of-macroeconomics-wonkish/
anon: Yes, it does. Here’s PK’s Dark Age post in a nutshell:
“Quantity bought is identically equal to quantity sold. That’s an accounting identity. Some people get confused into thinking that that means that quantity demanded is identically equal to quantity supplied”.
BTW: your only two mistakes in the above exchange, as far as I can see:
1. You misused the words “ex ante”. (You are not alone, and those are very misleading words.)
2. You forgot that non-economists may use different accounting conventions.
In my various arguments with those coming from an accounting background, the mistakes they most frequently make are:
1. They think that accounting identities are statements about the world, as opposed to a set of consistent definitions of words.
2. They have difficulty distinguishing “quantity demanded” from “quantity bought”, and “quantity supplied” from “quantity sold”.
I’m cross posting between two posts now.
[No worries. I have unpublished the other one. NR]
Here’s a repeat:
BTW, here’s how I’d construct a much simpler example to illustrate these points.
Suppose we have a two person economy with macro output (GDP) and income of X.
Each person’s income is X/2.
Suppose I sell my house to the other person for X.
Suppose I purchase X – the entire economy’s output – and it is all consumption goods, no investment goods.
Then my consumption is X and my dissaving is (X/2).
The other person’s consumption is zero and his saving is X/2.
Macro consumption is X and macro saving is zero.
The proceeds from selling my house arguably have boosted my contribution to aggregate demand, with the result that consumption has been skewed in my direction. This is entirely separate from the issue of how to account for the sale of my house. I have accounted for it as a capital transaction – which is correct in economic terms. Whether there is a capital gain in accounting terms is irrelevant, although in economic terms it may have affected my psychology and my behaviour in terms of my contribution to aggregate demand. It is also irrelevant whether the buyer has borrowed from the bank to purchase my house or has drawn down prior asset saving.
With reference to the accounting, it makes no sense to me that anybody who favours a coherent discussion at the macroeconomic level would deliberately force through inconsistent definitions at the micro level. That’s how I approach the subject of accounting and choices about accounting definitions.
I think the confusion here stemmed from whether to make clear distinction between flow and stock. Ordinary people do; Economics doesn’t.
If you contrast conventional concept and economic concept in regards to asset, it goes like this:
Conventional concept : Asset(Stock)
Translated into Economics : Initial endowment plus savings
Conventional concept : Asset(Stock) Price
Translated into Economics : Discounted Present Value of future cash flow
So, when the asset price changes, economics treats it as change in future cash flow and/or change in discount factor. Thus, it can be incorporated into intertemporal model such as Euler equation. If you increase current expenditure due to capital gain, in economics, it just means that you spend the future cash flow in advance.
On the other hand, ordinary people perceive the asset price change as change in the evaluation of the asset. So, to them, capital gain is something like gift from heaven, and is not so different from other forms of income.
NIck,
“The National Income Accounting definition of income (which is a convention among most economists) is very different from the way my tax accountant measures my income. For example, NIA excludes capital gains, and my accountant includes realised capital gains.”
Certainly there are different accounting conventions. But in my example, the gain was realized. I was not assuming that merely the increase in market value of the asset would generate income for the asset holder or would contribute to aggregate demand.
Moreover, the NIA accounting is really not fundamentally different from the accounting that would be used by an individual firm. Income = Revenue, but it is revenue received as a result of transactions that cross the accounting boundary of the firm. The transfer of funds from one subsidiary to another does not count as revenue for the firm.
That’s all it is.
Imagine, if one firm buys another, then what would be the revenue of the combined entity? Suppose you only had access to the income statements of both. You would need to say that the income of {A,B} = Income of A + Income of B – the expenditures of A on B – the expenditures of B on A. You subtract in order to avoid double counting. You can argue that the result is “final output” for the combined entity.
Now if you keep consolidating income statements to include every production unit, the net result is national income. It’s still just “revenue” and is defined as revenue, but if you want to calculate the revenue, given only the income statements of the constituent production units, you would need to subtract out all the income received by the unit that was an expense for some other production unit.
Now obviously you cannot argue that the individual firm (or household) is going to optimize over this (reduced) income.
But that’s just what the models do!
The reason why the national income accounts don’t need to count income received from asset sales or government transfers. It’s not because gains from asset sales or transfers are not income. They are income for the individual, but because these are transactions that do not cross the accounting boundary when the boundary constitutes every production unit.
But just because your model is using a representative agent does not mean that the accounting boundary expands to include every production unit.
The accounting boundary needs to be the same as the decision maker.
And continuing along these lines,
The key point of dispute here, is that both you and Anon are making is that the increase in income from the gain realized by B is equal to an increase in expenditures by A, so that in an economy containing both A and B, the sum of A and B’s income will be unchanged. And therefore in an economy containing a single “representative” agent, you can safely ignore realized gains.
And this false!
The reason why it is false is because of balance sheet expansion.
When A borrows to buy B’s house, that is not considered to be an expenditure on A’s income statement because it does not subtract from A’s net worth. Regardless of which accounting convention you are using, the purpose of income and expenditures is that when one is greater than the other, then net worth must change. That is why income is a non-cash measure of revenue.
But if you look at A’s balance sheet, both liabilities and assets grow by the same amount. The acquisition of capital is not an expenditure for A, and so it is not the case that B’s investment income from the disposition of the must be “paid for” by A’s expenditure. The two items do not cancel.
“Suppose we have a two person economy with macro output (GDP) and income of X.”
That’s not how it works.
You don’t know the aggregate income until the transactions have occurred. You are confusing (again) ex-post with ex-ante. Income is measure of revenue between two time periods. It is determined by individual behavior over the course of the time period. It does not determine individual behavior prior to the end of the reporting period.
Accounting constraints are nothing more than consistency constraints on models. They are not behavioral constraints, they are constraints on how you measure behavior.
“Whether there is a capital gain in accounting terms is irrelevant, although in economic terms it may have affected my psychology and my behaviour in terms of my contribution to aggregate demand.”
“Macro consumption is X and macro saving is zero.”
OK, making up your own terms is not helpful.
Households do not have “macro savings”.
They have savings.
The “macro savings” is an attribute of the macro balance sheet, not the individual’s balance sheet. There is no such thing as “macro savings” of a household.
The economically relevant factor is the income statement and the balance sheet of the individual, not that of the group.
The macro phenomena arise from and are determined by the behavior of individuals, not the other way around.
“Whether there is a capital gain in accounting terms is irrelevant”
No, it is not. If there was a capital gain, then your net worth has increased. An increase in net worth is not “irrelevant” in accounting terms. You can debate whether to use accrual or cash-basis — my example uses a cash basis. If you are using accrual accounting, then the increase in net worth occured when the market price went up. But in any case, an increase in net worth is not “irrelevant” from an accounting sense.
“although in economic terms it may have affected my psychology and my behaviour in terms of my contribution to aggregate demand. ”
No, an increase in net worth is not “psychological”. It really means that you have saved. Your assets are greater than your liabilities. You have received income. Now you can debate as to which accounting standards you should use as to when you realize the gain. In my example, the gain was realized when the house was sold. But whenever you realize the gain, it is a real gain. It’s not psychological. This gain does not come at the expense of a decline in net worth by someone else.
A’s savings are not “paid for” by the purchaser of the house.
RSJ,
I’m amazed at your durability. Do you come with rust proofing and snow tires as well?
“Income = Revenue”
No its not. Not for a firm.
“you would need to subtract out all the income received by the unit that was an expense for some other production unit”
You’re confusing revenue and income for a firm.
“and so it is not the case that B’s investment income from the disposition of the must be “paid for” by A’s expenditure”
The sale of a property is not investment income for a household. Rent is investment income.
Anyway, you’re just making up your own accounting definitions here. You could make whatever point you’re trying to make by constructing a flow of funds statement without resort to definitions of income.
“You don’t know the aggregate income until the transactions have occurred. You are confusing (again) ex-post with ex-ante.”
Why are you not allowed to simulate scenarios of future transactions in your world?
“It is determined by individual behavior over the course of the time period. It does not determine individual behavior prior to the end of the reporting period.”
It’s determined according to feasible outcomes that are as always constrained by accounting identities within the future scenario that is being simulated. If all output within the period by construction of the simulation has been purchased at time epsilon minus one second, somebody who hasn’t yet purchased may well be forced to save by accounting identity under consistent scenario construction. Production and consumption won’t be infinite just because the accounting period we specify is in the future.
“They are not behavioral constraints, they are constraints on how you measure behavior.”
They’re behavioural constraints whenever you simulate future behaviour for a future defined accounting period. You can’t simulate a feasible future outcome that doesn’t adhere to accounting identities. That constrains your assumption for future behaviour. The constraint is on the simulator, such as yourself.
“OK, making up your own terms is not helpful.”
LOL, pot!
Suppose I cave momentarily and allow you any definition of income you like, including any inconsistency of definition you choose between micro and macro.
Can you then summarize the point of economics you are making? And can you make that point independent of and beyond the accounting definition for income or anything else? That might be more productive.
Anon, you are the one arguing that households are receiving “macro income” and obtaining “macro savings”.
That’s inventing your own (inconsistent) accounting. Households receive income and save. They do not “macro save” or receive “macro income”.
In terms of revenue versus income, this is going to depend on which standard you are using. It is the top line of the income statement according to most definitions; you are not really making a substantive point here by arguing that according to GAAP, you would make a distinction between operating income and total income. In NIPA accounting, you don’t have this distinction, because in general they don’t face the same issues that investors face in trying to determine the quality of income.
That’s more pointless disputation, IMO, but I’ll leave it at that.
“They do not “macro save” or receive “macro income”.”
You’re making up stuff I never said.
I constructed a simple example in which one person consumes all the output.
So you transpose that event to misleading generic vocabulary, because you didn’t follow the specific example, and it suits your theme not to do so, I guess.
Anon:
““Income = Revenue”
No its not. Not for a firm.
”
I must be missing something here. It’s simple accounting isn’t it ?
“Revenue” is the amount the firm realizes when it sells goods or services.
“Expense” is what is spent to produce goods and services.
“Profit” is “Revenue” minus “Expense”.
On the firm income statement, “net income” is the amount of profit earned during a fiscal period. Is anyone disputing these well-known definitions ?
”
The sale of a property is not investment income for a household.
”
For the firm, a property sale transaction result would be recorded as investment income(or loss) in the non-operating part of the income statement (other revenues & income). Why should the household be any different ?
Is this macro vs. micro accounting difference ?
I grow 100 apples, eat 60, and sell the remaining 40 at $1 each, and buy $40 bananas at $1 each.
What’s my income? $40, or $100? Do I sell those 60 apples to myself?
Who cares?
It really doesn’t matter, as long as we define expenditure the same way. We get exactly the same answer when we maximise utility, a function of apples and bananas consumed, subject to either of the two budget constraints.
I earn $100, and my house appreciates by $20 over the year. I decide to stay in my house, and spend the $100 on food.
What’s my income? $100, or $120? Do I sell my house to myself, to realise the capital gain?
Again. Who cares?
So to sum up, economics is not accounting?
It matters
– if you’re aggregating
– if you’re having a discussion around the economic effects of aggregation
– if you’re using the vocabulary of income and logically related measures in that discussion
– if you want consistent logic and math for aggregation in that discussion
– if you want to have consistent communication in that discussion
In other words, given the interest of this blog in macroeconomics, and given that list of issues, it matters tremendously
anon: OK. Now we’re getting somewhere.
So, your answer is that some definitions of income will aggregate up, and others won’t. And it is useful/convenient/good insurance against errors/etc., if we choose a definition of “income” such that when we add up each individual’s “income” we get aggregate “income”, without switching definitions.
Makes sense.
Now, can you: give me examples where a definition of “income” won’t aggregate up? That way, we can see what’s at stake.
(I think both my definitions in the “apples” example aggregate up OK. What about in the “house” example?)
If we define “income” as “value added” (sales minus purchases from other firms) it aggregates up across firms. If we define it as “gross sales”, it doesn’t. That’s one example. That’s what you were arguing with RSJ about, right?
Nick,
If you include capital gains in household income, it won’t aggregate up to aggregate income.
There is no payment from factors of production, just because a stock goes up in value.
So GDP won’t equal aggregate income if you include capital gains.
anon: that’s true, of course. But maybe we should re-define aggregate income to include aggregate capital gains? “Income”=GDP+Capital gains? Pros and cons of doing this?
P.S.
The logical reason to exclude capital gains from a uniform (micro and macro) definition of income is that capital gains are a function of the value of assets that have already been recorded in the past as part of GDP production. Income corresponds to the value that is being produced in the current accounting period. So there is a mismatching of purpose when you mix capital gains on old assets in with the value thats being produced by the creation of new assets.
Would you rather have GDP = income, or GDP = income – capital gains?