AP Macroeconomics Credit: Ms. McCarthy Defining GDP AP Macroeconomics Credit: Ms. McCarthy

Three Main Goals of Economic Policy 1. Sustainable economic growth 2. Full employment 3. Price stability How do we know if we’re achieving our goals? Economic Indicators

Economic Indicators Statistics that help to predict economic trends and analyze current economic performance. Three General Categories: Leading indicator: predict future trends Coincident indicator: occur at the same time as the related economic activity Lagging indicator: only become apparent after the activity

Government Reporting of Economic Indicators 1. Bureau of Labor Statistics: http://www.bls.gov/ 2. Bureau of Economic Analysis: http://www.bea.gov/ 3. Economics & Statistics Administration: http://www.esa.doc.gov/about-economic-indicators 4. United States Census: http://www.census.gov/cgi-bin/briefroom/BriefRm

Leading indicators Average workweek (manufacturing) Initial unemployment claims New orders for consumer goods Plant and equipment orders Building permits Stock prices (S&P 500) Index of consumer expectations

Coincident indicators GDP Retail sales Personal income Number of employees on payrolls Industrial production Manufacturing and trade sales

Lagging indicators The average duration of unemployment The value of outstanding commercial and industrial loans The change in the CPI The ratio of consumer credit outstanding to personal income The average prime rate charged by banks

One indicator changing does not accurately predict anything, you need to consider the “big picture”.

Gross Domestic Product GDP: is the total market value of all final goods and services produced in the economy during a given year. There are three ways to measure GDP: Value added Aggregate spending Aggregate income

Changes in GDP GDP is a measure of a nation’s prosperity and economic growth As GDP grows the burden of scarcity is lessened for a society GDP per capita provides a better measure of individual well-being than GDP

Connection to the business cycle The United States’ GDP is not constant from year to year. Instead, the GDP grows most years and then shrinks in some years. The ups and downs in GDP over time is referred to as the business cycle.

The Business Cycle

Nominal v. Real GDP Nominal GDP is current GDP measured at current market prices Nominal GDP may overstate the value of production because of the effects of inflation Real GDP is current GDP measured with a fixed dollar Real GDP holds the value of the dollar constant and is useful for making year to year comparisons Real GDP is the IMPORTANT ONE!!!

Measuring GDP Value Added Aggregate Spending Aggregate Income

Value Added Approach: Stage of Production Sales Value of Materials or Product Value Added $0 Firm A, sheep ranch $120 $120 ($120 - $0) Firm B, wool processor $180 $60 ($180 – $120) Firm C, suit manufacturer $220 $40 ($220 - $180) Firm D, clothing wholesaler $270 $50 ($270 – 220) Firm E, retail clothier $350 $80 ($350 – 270) Total $1140 Assume there are five stages needed to manufacture a wool suit and get it to the consumer, the final user. Stage 1: Sheep ranch produces wool from sheep. Stage 2: Firm A, a sheep ranch, sells $120 worth or wool to firm B, a wool processor. Firm A pays out the $120 in wages, rent, interest, and profit. (Circular Flow) Stage 3: Firm B processes the wool and sells it to firm C, a suit manufacturer, for $180. What does firm B do with the $180 it receives? It pays $120 to firm A for the wool and uses the remaining $60 to pay wages, rent, interest, and profit for the resources used in processing the wool. Stage 4: Firm C, the manufacturer, sells the suit to firm D, a wholesaler, which sells it to firm E, a retailer. Stage 5: Then at last a consumer, the final user, comes and buys the suit for $350. The $350 includes all the intermediate transactions leading up to the product’s final sale.

Aggregate Spending GDP = C + IG + G + XN C = Consumption IG = Gross Private Investment G = Government Spending XN= Net Exports = Exports (X) – Imports (M)

Aggregate Income Income = r + w + i + p = factor payments r = rent (payment for natural resources) w = wages (payment for labor) i = interest (payment for capital) p = profits (payment for entrepreneurship)

Counted or Not Counted? GDP counts all final, domestic production for which there is a market transaction in that year. Used and intermediate goods are not counted in order to avoid double-counting. Non-market production is not counted. Underground or ‘black market’ activity is not counted.

Counted or Not Counted? Which of the following are counted or not counted in U.S. GDP and why? New U.S. manufactured Goodyear tire sold to the General Motors Corporation New U.S. manufactured Goodyear tire sold to your mom Child care services provided by my daughter for a kid in my neighborhood A new Boeing 787 airplane My mom sold her childhood home this year New BMW 7-series manufactured in San Antonio A U.S. company located in London that sells high-end handbags. A sale of Google stock. A man grows fresh herbs in his backyard and sells them to friends in his neighborhood.

Shortcomings of GDP Nonmarket Activities Underground Economy Improved product quality Environmental Damage Leisure meaning GDP understates well-being by ignoring leisure’s value. Nor does GDP measure the satisfaction people may or may not derive from their work

Shortcomings of GDP Composition and Distribution of Output we have no way to know if the current mix of produced goods and services is enriching or potentially detrimental to society. Why? GDP assigns equal weight to an assault rifle and a set of encyclopedias, as long as both sell for the same price. Moreover, GDP reveals nothing about the way output is distributed. Does 90% of the output go to 10% of the households, for example, or is the output more evenly distributed?

Shortcomings of GDP Noneconomic Sources of Well-Being There are a number of things that could make members of society better off that would not be included in GDP. a reduction in crime and violence peaceful relations with other countries better understanding between parents and children, etc.