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Part 1: Economy

Lesson 02GDP（１） The three sectors of the economy
When conducting economic analysis, it is common to divide the economy into several economic entities(sectors). In such cases, the major categories are generallyHousehold Sector (Personal Income)

Corporate Sector (Corporate Profit)

Government Sector (Government balance)

In the common sense, the economic activities of the“government,”households and businesses aside, may notring a bell, but if we consider that we receive various services from the government in exchange for payment of“taxes,”we can understand that the“government”is responsible for economic activities. These three economic
sectors do not operate separately, but depend on each other to shape Japan's economic activities as a whole.

Figure 4 Relationship between the three sectors in the economy (economic expansion/contraction spiral)

economic
improvement
Government
Sectoreconomicdecline

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Household
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Chapter 1 How to understand the economy（２） GDP and value added
Various economic indicators are published by many ministries and agencies that are useful for understanding
economic trends, but the most important one for analyzing the economic trends of the country as a whole is theGDP (Gross Domestic Product). GDP is a value that shows how much economic production activity took place
in a country during a year. It is not, however, the sum of a company's sales, but rather the total“value added”
produced in a country during the year. More specifically, it is the sum of what each person produces minus the costof raw materials purchased for that production.
For example, let us assume an economy consisting of only three parties: “Mr. A, who produces wheat,”“Mr.
B, who makes flour from that wheat,”and“Mr. C, who makes bread from the flour.”Mr. A sows seeds from the wheat harvested last year, grows wheat, and sells it to Mr. B for 20 million
yen.

Mr. B makes flour from wheat purchased from Mr. A and sells it to Mr. C for 30 million yen.



Mr. C made and sold 40 million yen worth of bread using flour purchased from Mr. B.

Suppose this is the only economic activity in this country during the year. Then the GDP of this country is

Mr. A’s value added: 20 million.



Mr. B’s value added: 30 million – 20 million = 10 million.

Mr. C’s value added: 40 million – 30 million = 10 million.

The total amount of value added is 40 million yen.

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Part 1: Economy

Figure 5

Value added and GDP calculation

10 million

10 million

10 million
40 million

20 million

20 million

20 million

Mr.A
grows wheat

Mr.B
makes flour

Mr.C
makes BreadGDP

For example, the sum of the sales of each of A, B, and C,i.e., 20 million + 30 million + 40 million = 90 million.
is not GDP, because Mr. B's sales of 30 million yen includes the value added created by Mr. A and Mr. C's sales of40 million yen includes the duplicated value added created by both Mr. A and Mr. B.
In addition, in the above example, there is no raw material cost for Mr. A's wheat production, but if, for example,
Mr. A had purchased wheat seeds from a foreign country for 5 million yen,
Mr. A’s value added: 20 million – 5 million = 15 million.
and the country's GDP = 35 million.
If you purchase goods produced in a foreign country, they are deductible because they are not part of theproduction activity in this country.

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Chapter 1 How to understand the economy

Lesson 03

GDP and the principle of the three-sided equivalence（１） The principle of the three-sided equivalence of GDP
GDP represents a country's“production.”The production activity also generates profits, which are“distributed”
in some form to companies, households, the government, and so on. In addition, in order for production to takeplace in the first place, there must be a background of“demand.”GDP is analyzed not only in terms of“production”
but also in terms of“distribution”and“demand.”And if we consider that the profits generated by production must surely be distributed to someone, and that there
is always demand to back up production, the following equation holds.
GDP (Production) = GDP (Distribution) = GDP (Demand)
Figure 6

Principle of GDP triadic equivalence

Total value
added inproduction
activities(calculation
methodexplained in
Lesson 2)
GDP(Production)=Householdincome +corporate
income +government
incomePersonal
consumption+ business= equipment =investment +government
spendingGDP(Distribution)

GDP(Demand)

GDP

This is called the“three-sided equivalence principle”of GDP. In actual corporate activities, it is not correct
to say that production and demand are equal, since it is possible that a company may misread demand, produce
goods, and store them in a warehouse without selling them. In this case, however, GDP statistics treat the demand
as“investment in inventories,”and the figures are consistent with GDP from the production side.

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Part 1: Economy＜GDP calculation formula from the demand side＞
Y(GDP) = C(Consumption) + I(Investment) + G(Government) + X(Export) − M(Import)∙ C：Goods and services consumed in the private sector∙ I ：Goods and services used for production in the private sector(housing investment + capital investment + inventory investment)∙ G：Goods and services related to government consumption and public construction(government consumption + government investment)∙ X：Goods and services exported∙ M：Goods and services imported（２） Net Domestic Product (NDP)
Gross domestic product minus“depreciation”is“Net Domestic Product (NDP).”Depreciation is an annual
charge to expense the depreciated portion of an asset that is used continuously over time, such as plant andequipment. When a factory is built to produce a new product, the factory is not a“raw material”and the money
spent to build the factory is not recognized as“cost of sales”in corporate accounting. However, in reality, thefactory is considered to be gradually becoming“raw material”because the factory equipment becomes old andobsolete through use over time. Therefore, the basic idea behind depreciation is to recognize the money invested
to build the factory as“depreciation”expense little by little. In terms of the original meaning of“value added,”the value added should be the remainder after deducting not only raw materials but also depreciation from sales.
Net Domestic Product (NDP)

GDPDepreciation（３） Gross National Income (GNI)
Another concept that is very close to GDP is Gross National Product (GNP). While GDP represents“domestic”
production activities, GNP represents“national”production activities. In the past, GDP ≒ GNP, and GNP wasoften used because there was little need to be aware of the difference between“domestic”and“national,”butrecently GDP, which indicates“domestic”economic activity, is more commonly used. However, the SNA (Systemof National Accounts), which was established by the United Nations, is used as the standard for calculating GDP.
(System of National Accounts, 1993), the concept of GNP has been eliminated, and the concept of Gross National
Income (GNI), which is almost the same as GNP, is used. GNI is the Gross Domestic Product (GDP) plus income
received by the Japanese from abroad, minus expenditures paid to foreigners in Japan.

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Chapter 1 How to understand the economy

GNI = GDP+ (Compensation for work and services performed overseas by Japanese nationals and Japanesecompanies, Property income such as dividends and interest received as a result of overseasinvestments)− (Compensation for work and services rendered in Japan by foreigners and foreign companies,
Property income such as dividends, interest, etc. paid as a result of investments in Japan)

Figure 7 Types of economic scale concepts

Depreciation

GDP=NDP

Depreciation

NDP

Compensation for workand services performed
overseas by Japanese+Property income such as
dividends and interestreceived as a result ofoverseas investments

Compensation for workand services rendered inJapan by foreigners‐Property income such as
dividends, interest, etc.
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Part 1: Economy

Lesson 04

GDP statistics and GDP deflator（１） Real GDP and Nominal GDP
After World War II, until around the time of high growth, we were in a situation where the prices of many things
were rising every year. When prices are rising rapidly in this state, it is necessary to consider the impact of prices
on the value of money as well. For example, if our salary doubled from 200,000 yen per month last year to 400,000
yen per month this year, but prices in the world also doubled compared to last year, we should consider that oursalary is essentially the same whether it was last year or this year. In such a case, the economic analysis will showthat our salary for this year is“400,000 yen in nominal terms, 200,000 yen in real terms.”“Nominal”refers tothe figure“before taking into account the effect of prices,”while“real”refers to the figure“after taking into
account and adjusting for the effect of prices.”Some economic indicators provide two figures: the“nominal”
figure before reflecting changes in prices and the“real”figure after reflecting changes in prices.
GDP also includes nominal GDP and real GDP (GDP recalculated using prices in a certain base year).
Although real GDP should be looked at in order to understand more essential economic trends, it is possible tounderstand the movement of prices and other factors by comparing nominal GDP with real GDP. The value
obtained by dividing nominal GDP by real GDP is called the“GDP deflator.”The GDP deflator is particularly
noteworthy as it shows price movements in the economy as a whole. When“nominal GDP > real GDP,”it indicatesthat prices are rising. When“Nominal GDP = Real GDP,”the GDP deflator is 100.
Figure 8 GDP deflator trends (FY1994-FY2021)
120115110
105
100
959085
1994

1998

2002

2006

2010

＊ Fiscal year deflator = nominal GDP / real GDP x 100＊ Compiled from Cabinet Office data1620142018

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Chapter 1 How to understand the economy

Figure 9

Real GDP trends (FY1994-FY2021) (Unit: trillion yen)

（２） Ratio of personal consumption to real GDP
Figure 10 shows real GDP and its breakdown. It should be noted that private final consumption expenditures
account for more than 50% of the total. This is the reason why it is often said that“a recovery in private
consumption is important for economic recovery.”The growth rate of real GDP is called the“economic growthrate.”

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Part 1: Economy

Figure 10

Real GDP trends (FY1994-FY2021)（３） Real GDP and private final consumption expenditure growth
Check out the significant drop in consumer spending during the Lehman and Corona shock. The economy andpersonal consumption are thus closely related.
Figure 11

Real GDP and private demand growth vs. previous year (FY1994-FY2021)

Related Sites
・Cabinet Office: National Accounts (GDP Statistics) https://www.esri.cao.go.jp/jp/sna/menu.html

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