Macroeconomics
The GDP: National Economic Measurement
Gross Domestic Product
The GDP
• To compare our system with other countries’ systems, and to compare
the strength of our own economy year to year, economists use something
called the
• Gross Domestic Product (or GDP), which is the total dollar value of all
final goods and services produced within a country during one
calendar year
How economists calculate the GDP:
• They use final output: total production within the nation’s borders in
one year without counting products more than once.
• Which of these would be counted in the GDP?
• A. A tree cut by a woodcutter who sells it to a lumber yard.
• B. The lumber bought by the lumber yard who then sells it to a furniture manufacturer.
• C. A table made by the manufacturer now sold to a couple in Detroit, Michigan.
• The answer is C.
Calculating the GDP
• They use only products produced in the current year. This would
exclude things bought at yard sales.
• Which of the following was used in the calculation of the GDP in 1999?
• A car manufactured in 1998 but sold in 1999.
• A used 1993 Toyota that was sold to Ms. Simpson in Memphis in 1999.
• A Ford F150 produced in 1999 but sold in 2000.
• The answer is C
Calculating the GDP
• They use only items produced within national borders.
• Would this include or exclude Coca-Cola (a U.S. company)
produced at a plant in Russia?
• Exclude
• GDP: A measure of the strength of our economy
Famous Economic Formula
• GDP= C+I +G+(X-M)
• C= Personal consumption expenditures (consumer spending).
Includes
• durable goods: a lifetime of more than one year, and
• non-durable goods: a lifetime of less than one year, and services.
I = Gross Investment
• Total value of all capital goods produced in a given nation during one
year.
• Fixed investment: Buildings, machinery, equipment
• Inventory investment: raw materials, intermediate goods, final goods
G = Government Purchases
• the dollar amount that federal, state, and local governments spend on
items
• IE: highways, education, defense, etc.
Net Exports
• X=Exports: the value of goods and services produced domestically
but sold in other countries.
• M=Imports: the value of goods and services produced in other
countries, but bought domestically.
Using the figures for 1995, calculate the GDP
for that year.
• 1995: C=4.9 I =1.1 G=1.4 X-M= -.1
• 7.3 billion
• If we begin comparing GDP for each year, will price increases (inflation)
cause more recent years to appear “inflated?”
• YES
Real vs. Nominal GDP
• To adjust GDP for price increases economists calculate both
• NOMINAL GDP: the current GDP expressed in current prices
• REAL GDP: which is adjusted for price increases-inflation
“Real” GDP
• GDP for one year expressed in the dollar of another, base year
• Ex: 2010 GDP in 2000 dollar value
Also known as Constant GDP
“Nominal” GDP
• GDP expressed in the dollar value of a given year.
• Ex: 2010 GDP in 2010 dollar value
Also known as Current GDP
GDP measures economic growth or decline
• Changes in Real GDP helps to determine if the economy has
increased or decreased its actual production of new products
Limitations of GDP
• Non-market activities: GDP does not include goods and services that
people make or do themselves
• i.e. baby-sitting, mowing the lawn, cooking dinner, washing cars
• Underground economies: production and income not reported to the
government
• i.e. black market products: illegal drugs, weapons, stolen goods, exotic pets
Limitations of GDP
• Negative Externalities: unintended economic side effects, or
externalities that have monetary value not reflected in the GDP
• Quality of Life: Some things that improve well-being cannot be
included in GDP
• i.e. pleasant surroundings, ample leisure time, personal safety
GDP does NOT include:
•
•
•
•
•
value of used products
value of volunteer work
purely financial transactions
value of intermediary goods
Transfer of assets
GNP
• Gross National Product: annual income earned by U.S. owned firms
and U.S. citizens
• Market value of all goods produced by Americans all over the world in
one year
Business Cycles
Business Cycles
• Fluctuations in Real GDP are referred to as Business Cycles.
• The duration and intensity of each phase of the Business Cycle are not
always clear.
• Business Cycles are typical of Market, Capitalistic economies due to
the free nature of those economic systems
Phases of the Business Cycle
• Expansion
• Peak
• Contraction
• Trough
Expansions
• Expansions are periods of increasing Real GDP.
• Unemployment decreases, businesses expand, and Personal
Consumption increases.
• As expansions continue, there tend to be upward pressures on prices
(inflation) and interest rates.
A Word About Interest Rates
• The amount of money charged as a fee for lending money.
• The price of borrowing money.
• As interest rates rise LESS consumers will borrow money IF they are
WILLING and ABLE
• As interest rates fall MORE consumers will borrow money IF they are
WILLING and ABLE
Peak
• A peak is a period when the economy starts to level off.
• Businesses postpone new investments, and consumer saving tends to
increase.
• Rising prices and interest rates tend to restrict purchases and
investments, often leading to a Contraction.
Contraction
• A Contraction is a period of declining Real GDP.
• Consumer spending decreases, and unemployment increases as
businesses layoff workers and shorten work hours.
• Interest rates and prices level off, and often decline during long
contractions.
Long Term Contractions
• Recession:
Six months of declining Real GDP
• Depression:
Twelve months of declining Real GDP coupled with at
least 15% unemployment.
Trough
• A Trough is the bottom of a Contraction. Lower interest rates and
prices bring customers back to markets.
% Change in Real GDP
Peak
Expansion
0%
Contraction
Trough
Factors That Affect the Business Cycle
• Business Investment: High levels of business investment (capital good
increases like machinery and equipment) promote expansion. Low levels of
business investment contribute to contraction.
• Money and credit: When interest rates go up, people borrow less, and this
less money is circulating in the economy, thus contributing to a contraction.
(and vise versa)
Factors That Affect the Business Cycle
• Public Expectations: People will increase their spending if they believe the
economy is strong. This helps promote expansion.
• External Factors: Like energy crisis and war.
Economic Indicators
• Economic indicators are specific economic activities that have been
historically good indicators of the general cycle of the economy.
• Three types:
• Leading
• Coincident
• Lagging
Leading Economic Indicators
• Economic activities that
tend to change 3 to 6
months before the
general economy
changes.
• Examples:
•
•
•
•
•
•
•
Stock market
Orders for durable goods
Housing Starts
Number of new businesses
Money supply
Average work week
Number of building permits issued
Coincident Economic Indicators
• Economic activities that
change at about the
same time the general
economy (GDP)
changes
• Examples:
• Personal income
• Industrial production levels
• Retail sales
• Number of employed nonagricultural workers
Lagging Economic Indicators
• Economic activities that
tend to change 3 to 6
months after the general
economy(GDP)
changes
• Examples:
• Interest rates
• Unemployment duration
• Consumer debt load
• Number of business loans to be
repaid
CLASSWORK
• Draw a business cycle (ON THE PAGE PROVIDED IN THE PACKET)
that contains all four phases. Describe the general mood that would be
present among people during each phase. Most important, include an
illustration, for each phase, of a related event to that phase of the business
cycle – Consider the factor that affect the business cycle.
Economic Challenges
Unemployment and Inflation
Unemployment
• To again monitor the health of our economy, economists measure the
Unemployment Rate.
• Each month, the Bureau of Labor and Statistics survey certain Americans to
find out their employment status.
• The U.S. Government defines “employed” as people 16 and older
meeting one or more of the following criteria.
“The Employed”
1.
Working for pay or profit for 1 or more hours this week.
2.
Working without pay in a family business 15 or more hours.
3.
Having a job, but being ABSENT due to illness, weather, vacation,
etc.
The U.S. Government defines “unemployed”
as:
1. NOT meeting any of the criteria above
AND
2. ACTIVELY looking for work during the past 4 weeks.
• The most closely watched and highly publicized labor force statistic is
the UNEMPLOYMENT RATE – the percentage of people in the
civilian labor force who are UNEMPLOYED.
Measuring
Unemployment
2015
Total
Population
267,901,000
Under 16
and
institutionalized
Not in
labor
force
64,767,000
93,671,000
148,834,000
Employed
Labor
force
157,130,000
Unemployed
8,296,000
Measuring Unemployment
Unemployment
rate
unemployed
=
labor force
x
100
4 Types of Unemployment
• Structural
• Cyclical
• Frictional
• Seasonal
STRUCTURAL
• Unemployment that occurs as a result of changes in technology,
consumer preferences, or in the way the economy is
“STRUCTURED.”
• EX: Many TV repairmen had to find new work as televisions are now built with
transistors instead of tubes.
CYCLICAL
• This unemployment results from contractions in the economy.
• This type of unemployment HARMS the economy more than any
other types of unemployment.
• During the Great Depression, the unemployment rate reached an all time high of
about 25%.
• As recently as 2009 and 2010, the unemployment rate reached 10.2%.
FRICTIONAL
• People who have decided to leave one job and LOOK for another
typically better job.
• Also, new entrants and re-entrants into the LABOR FORCE.
• Economists consider frictional unemployment as a NORMAL part of a
healthy and changing ECONOMY.
SEASONAL
• This predictable unemployment fluctuates as a result of HOLIDAYS,
school breaks, and industry PRODUCTION schedules.
Inflation
An increase in the average price level of all products in an
economy
INFLATION
• As prices increase, the amount that a dollar buys decreases.
• Inflation reduces the real purchasing power of the dollar.
• Real GDP removes inflation.
Demand-Pull Inflation
• Inflation that occurs when demand for goods and services exceeds
existing supplies
• Heavy demand make items more valuable, forcing prices up.
Effects of Inflation
• Decrease in purchasing power
• Erodes fixed income
• Interest Rates
• Savings Investments lose value
• Loaners lose profit
Cost Push Inflation
• Occurs when producers raise prices in order to meet increased costs
• Factors of production increase (commonly labor) which forces prices
to rise.
DEFLATION
• A decrease in the average price level of all goods and services in an
economy.
• The most prolonged and most recent deflationary period in the U.S.
occurred during the Great Depression, when the unemployment rate was
high and wages were low
• How do they measure prices of all goods?
• How do they know that prices are going up or down?
Price Indexes
• A price index is a number that tells us how
much prices have changed (%) since a base
year
Price Index Example
• If the 1998 price index is 128, and the base year is 1992, then prices have
increased 28% between 1992 and 1998
1998 Index = 128
1992 Index = 100
Price increase= 28
General price rises are called
INFLATION
CPI
• Economists use the Consumer Price Index or the CPI to measure the
average change over time in the price of a fixed group of products.
• To measure the CPI, the Bureau of Labor Statistics first chooses a
base year against which to measure price changes.
• Second, they select a representative sample of commonly purchased
consumer items, called the market basket. They then set that base
year to 100, so that other years can be compared to it easily.
• To calculate the CPI, take the price of this year’s cost of the market
basket.
•
•
•
•
Divide it by the cost of the basket in the base year.
Multiply the result by 100.
This year’s cost / base year’s cost x 100
For ex. Use the formula to determine the CPI if the year’s cost is $7000 and
the base year’s cost was $4000.
• This year’s cost= $7000
• Divided by base year’s cost($4000) = 1.75
• 1.75 x 100 = 175
• See the Inflation Rates for 1970-2004 on page 341.
GDP Per Capita
• Used to compare different national economies on a per person basis.
𝑮𝑫𝑷
• 𝑮𝑫𝑷 𝒑𝒆𝒓 𝒄𝒂𝒑𝒊𝒕𝒂 = 𝒕𝒐𝒕𝒂𝒍 𝒑𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏
POVERTY
• The poverty rate: the percentage of individuals or families in the total
population that are living below the poverty threshold
• Poverty threshold: the lowest income as determined by the
government that a family or household of a certain size needs to
maintain a basic standard of living.
2015/2016 Poverty Threshold
2016 Poverty Guidelines for the 48 Contiguous
States and the District of Columbia
Poverty Threshold
Persons in Household
Poverty Guideline
For households of >8 persons, add $4,160/person
• In 2015, the poverty threshold for a
family of four (two adults, two
kids) was $24,036
1
$11,880
2
16,020
3
20,160
4
24,300
5
28,440
6
32,580
7
36,730
8
40,890
Aggregate Demand
and Aggregate Supply
Aggregate Demand is:
• A schedule, graphically represented as a curve, which
shows the various amounts of goods and services--the
amounts of real domestic output--which domestic
consumers, businesses, governments, and foreign
buyers collectively will desire to purchase at each
possible price level
**Assumes a constant Money Supply**
Price Level
AD
Real Domestic Output (Real GDP)
Less Domestic output will be produced and purchased at higher price levels and
visa-versa
Determinants of A.D.
• Wealth Effect – different price levels either increase or decrease the
purchasing power of accumulated assets
• Interest Rate Effect – different interest rates (due to different price levels)
will either increase or decrease consumption of domestic output
• Foreign Purchases Effect – different price levels will either increase or
decrease foreign purchases of domestic output (net exports)
Factors that Shift
Aggregate Demand
• Changes in Consumer Spending
• Consumer Wealth
• Consumer Expectations
• Consumer Indebtedness
• Taxes (Changes in...)
Factors that Shift
Aggregate Demand
• Changes in Investment Spending (Business)
• Interest Rates
• Profit expectations on investment projects
• Business Taxes
• Technology
• Degree of Excess Capacity
Factors that Shift
Aggregate Demand
• Change in Government Spending
• New national spending priorities
• Budgetary cutbacks
• Change in Net Export Spending
• National income abroad
• Exchange Rates
Price Level
AD+
AD
ADReal Domestic Output (Real GDP)
Examples:
• Higher consumer indebtedness from past spending will limit current spending.
What happens to AD?
• AD decreases, shifts left
• Increases in business taxes will limit current investment spending. What happens to
AD?
• AD decreases, shifts left
• Depreciation (decreasing value) of the dollar will cause foreign currencies to be
more valuable, increasing exports, decreasing imports. What happens to AD?
• AD increases, shifts right.
Examples (Cont’d):
• Decreases in interest rates, caused by changes in the money supply, will
increase consumer spending and investment. What happens to AD?
• AD increases, shifts right
• Government cutbacks in purchases (e.g. military budget) will result in lower
government spending
• AD decreases, shifts left
• New technology stimulates investment spending
• AD increases, shifts right
Aggregate Supply
Aggregate Supply
• A schedule, graphically represented by a curve, showing the level
of real domestic output (GDP) available at each possible
price level
Price Levels
Classical Range
AS
Intermediate Range
Keynesian Range
Real Domestic Output (GDP)
Aggregate Supply:
Keynesian Range
• GDP levels in this range indicate unused or idle resources
• GDP levels in this range implies economic contraction with
accompanying unemployment
• GDP output can be increased due to unused resources without an
increase in price levels, resulting in horizontal AS.
Aggregate Supply:
Intermediate Range
• Increases in Real GDP are accompanied by increases in price levels
• Uneven expansion in different product and factor markets results in
increases in price levels in some market segments but not others
• “Bottlenecks” in labor and capital use result in uneven price level
increases in different market segments.
Aggregate Supply:
Classical Range
• At some specific level of GDP output, productive capacity is fully
utilized.
• Because economy is at a level of full employment and productive
capacity, higher price levels will not result in greater production.
Factors that Shift Aggregate Supply
• Change in Input Prices
• Resource availability and prices
• Market Power of resource
providers
• Labor Unions
• Monopoly resource owners
• Changes in Productivity
• Changes in Legal-Institutional
Environment
• Business Taxes and Subsidies
• Government regulation
Price Levels
AS-
Decreased AS
Increased AS
Real Domestic Output (GDP)
AS AS+
Macroeconomic Theories
Macro Model
Equilibrium @ Full Employment
Price Levels
AS
AD = C+I+G+(X-M)
FE
Real GDP (Output)
Macro Model
Equilibrium @ Unemployment
Price Levels
AS
Solution:
Increase AD
with increased G
and decreased taxes
AD = C+I+G+(X-M)
FE
Real GDP (Output)
Classical Theory
• Jean-Baptiste Say (1767-1832)
• Assumes highly competitive marketplace with little or no government
interaction
• Assumes natural state of equilibrium at full employment
• Say’s Law: Supply creates its own Demand
• Predominant economic theory until 1930’s
Keynesian Theory
• John Maynard Keynes: The General Theory of Prices and Equilibrium
• There is no “natural” balance in the economy
• Aggregate Demand is the primary influence on employment and price
levels.
• Advocated use of “Fiscal Policy” by government to adjust equilibrium
toward full employment
Fiscal Policy is the use of government taxing and
spending authorities to achieve economic goals.
Monetary Theory (Monetarism)
• Milton Friedman (Nobel Prize)
• The supply of money in the economy will affect interest rates
therefore investment, and consumption.
• Too much money results in inflation; too little in unemployment.
• Advocated a balance between money supply and economic
productivity and less gov’t involvement
http://pw1.netcom.com/~garretc/politics/friedman.html
Interest Rate
Monetarist Model
MS MS’
i
i'
MD
M
M’
Quantity of Money
Neo-Classical
(Supply-Side)
• Gained prominence during 1970’s “Stagflation”.
• a.k.a. “Voodoo Economics”(George HW Bush)
• Re-focus on Aggregate Supply
• Advocated:
Stagflation = high inflation with
• Lower Taxes on business and investors high unemployment
• Increased privatization of gov’t programs
• Decreased regulation of business
Supply-Side Model
Price Level
FE
AS1
AS2
FE= Full Employment
PL
PL*
AD
Y
Y*
rGDP