Chapter 13 Measuring the Economy

What is GDP? The Gross Domestic Product is the value of all final goods and services produced by a country within a specified time period. It allows us to compare our economy over time or between countries – we will generally look at the Per Capita GDP (the GDP divided by the population) Components of GDP Definition Final Goods – not intermediate goods (those that are used for the production of a product – Steel for a car) Eliminates multiple or double counting Within the borders Time Frame (usually one year but measured every three months)

What is NOT included in GDP… Used goods, such as cars or houses Craig’s List, E-Bay, garage sales, etc Financial assets – stocks and bonds Anything not produced within the country’s borders Imports Household production or subsistence farming Fixing your own plumbing Changing your oil Underground markets or unreported economic activities Black market Lemonade Stands The amount or distribution of wealth in a country

Three methods for calculating GDP Production Approach What is the value of the final goods produced within an economy? Expenditure Approach How much did we spend? Income Approach How much did we earn?

Expenditure Approach-C+I+G+Nx Add all the money SPENT on final goods and services. Spending is divided into four categories. Consumption Consumer spending on final goods and services This is the largest category – about 70% Government Spending The government purchasing final goods and services Investment Spending Firms spend money on final products – “capital goods” – factories and equipment. NOT financial investment Net Exports Some products are bought by other countries but we must subtract products we buy from countries + + +

The Income Approach + + + The third method to calculate GDP is to add up all of the INCOME received by firms from the sale of final goods and services. Wages - LABOR Some of the money earned by the firms goes to the workers in the form of wages (salary) Rent - LAND Some of the money must be paid to rent the land used for production Interest - CAPITAL Some of the money earned by firms must get paid to the people who have lent the firm money Profit - ENTREPRENEURSHIP Once wages, interest and rent have been paid, all of the remaining income is considered profit. + + +

Nominal v. Real GDP NOMINAL GDP is the current dollar value for one year’s GDP. REAL GDP is used more because it is adjusted for inflation. How much of a change in GDP is due to a change in output For example: Suppose in Year 1, 50 apples are sold for $1 a piece Suppose in Year 2, 60 apples are sold for $2 a piece What is the nominal GDP for Year 1 and Year 2? What is the GDP for each year if we only use the price from year 1? Year 1 Year 2 Quantity of apples 50 60 Price of Apple $1 $2 Nominal GDP $ Real GDP

Nominal v. Real GDP NOMINAL GDP is the current dollar value for one year’s GDP. REAL GDP is used more because it is adjusted for inflation. How much of a change in GDP is due to a change in output For example: Suppose in Year 1, 50 apples are sold for $1 a piece Suppose in Year 2, 60 apples are sold for $2 a piece What is the nominal GDP for Year 1 and Year 2? What is the GDP for each year if we only use the price from year 1? Year 1 Year 2 Quantity of apples 50 60 Price of Apple $1 $2 Nominal GDP $50 $120 Real GDP $60

Real GDP Per Capita Key statistic used for tracking the Health (how well it is doing) and the growth of an economy Divide Real GDP by the population US real GDP per capita has increased steadily over time The US has almost three times as much purchasing power per person as it had in 1960 Other countries continue to have a low real GDP per capita

Inflation

How to measure inflation? The most important measure of prices in the United States is the CPI (consumer price index) – a market basket of goods is used for its calculations The market basket will consist of items that an average family of four would purchase in a city What is included in CPI? Food and Beverages (breakfast, chicken, full service meals, snacks) Housing (rent, furniture and fuel) Apparel (clothing) Transportation (new vehicles, airline fares, gas and insurance Medical Care – drugs and supplies Recreation – televisions, toys, pets, sports equipment Education and communication – tuition, postage, telephone, computers Other goods and services – tobacco and smoking products, haircuts, funerals

Causes of Inflation Demand Pull Inflation – we want more and more so prices increases Cost Push Inflation – the cost of making a product increases (supply decreases) Money Supply Increases “too many dollars” for “too few goods”

What are the costs of inflation? Negative and Positive impacts with inflation “Shoe Leather Costs” – due to value of money declining people do not hold it – they spend it “Menu Costs” – the cost of changing prices – high inflation makes this job take place more often Unit of Account Costs – inflation is making money less reliable

Relationship of Inflation and Unemployment Phillips Curve shows the relationship along with the business cycle High Inflation – Low unemployment Low Inflation – High unemployment

How to control inflation? “Disinflation” – dealing with the reduction of inflation Keep unemployment above the natural rate – “necessary evil” to have people out of a job for lower prices Inflation is high and unemployment is high is called Stagflation How to handle – fiscal (Congress acts) or monetary (the Fed acts) policy

Optimal Rate of Inflation Positive Inflation (called “creeping inflation) of between 1 and 3 percent Hyperinflation – severe and rapid rise in prices – Zimbabwe and Germany had issues with this If price levels are not increasing, called deflation – seen in the Great Depression

Calculating Unemployment Unemployment rate = Unemployed/Employed workers + Unemployed Who are employed workers? Did work for pay in the last week Have a job but may have been on sick leave, vacation, etc. At least 16 years old Who are unemployed workers? Worked less than an hour last week Have actively looked for work in the last four weeks Are available for work Not in the military or an institution

Sample problem Unemployment Rate = Suppose that there are 8 unemployed workers in an economy that has 24 employed workers. What is the unemployment rate in this economy? Unemployment Rate = 25 %

Shortfalls of the Unemployment Rate Discouraged Workers Capable workers but have given up looking for a job – not counted Underemployed workers These are people with a job which is below their wage and skill level

Types of unemployment Cyclical Loss of jobs due to a change in the business cycle When prices deflate, unemployment will rise Seasonal “Mother Nature” plays a role in this form on unemployment Santa Claus in the summer time Frictional When people are fired, laid off or quit there is a period of time when they must look for a job College Graduates looking for their first job Structural Change in skills required for a particular job ATMs v. bank tellers

Natural Rate of Unemployment Includes: Frictional, Structural and Seasonal Unemployment Cyclical Unemployment is the difference between the natural rate of unemployment and actual unemployment Keep Cyclical Low Natural Rate Actual Rate

Unemployment as an indicator There is a relationship between unemployment rate and recessions Increases during recessions; decreases during economic growth There is a relationship between the unemployment rate and GDP growth Increase unemployment, decrease real GDP growth