The first step in constructing any macroeconomic model is to define the concepts that the model is intended to explain and to identify the definitional relationships that link those concepts to each other. Those definitional relationships are referred to as identities because since they simply define some variables in terms of others, they must always hold true. This chapter defines some key macroeconomic concepts that we will use throughout the book and introduces the definitional identities among them that comprise a country's macroeconomic accounts. The model that we will develop in Part 2 of the book will be based on this system of accounts.

The structure of the chapter is as follows: we begin by reviewing some basic conceptual underpinnings for macroeconomic models in Section I. Sections II and III describe the national income and balance of payments accounts, emphasizing the relevance of various concepts for economic welfare. Sections IV and V consider the relationship between the two types of accounts at the aggregate and sectoral levels, respectively, and Section VI summarizes.

CONCEPTUAL FOUNDATIONS

Stocks and Flows, National and Domestic

A fundamental distinction in macroeconomics is between magnitudes that are measured as stocks and those that are measured as flows. A stock is an economic magnitude that is measured at an instant of time. By contrast, a flow is measured over a period of time. An example of a stock is a country's proven reserves of some natural resource such as oil.