Circular Flow & GDP How the U.S. Economy works

Branches of Economics Microeconomics --studies economic behavior & decision making of small units: individuals, families, businesses Macroeconomics --studies economic behavior & decision making of entire economies Analyzing Sony’s $100 price cut for PS3 Analyzing how a federal income tax cut has affected unemployment

Key Concept: Circular Flow Describes how goods, services and money flow through a free market economy

Circular Flow PRODUCERSCONSUMERS Factor Market Product Market

Circular Flow PRODUCERS CONSUMERS Factor Market (Factors of Production) --land, labor, capital, education/skills are exchanged Product Market Where goods & services sold The U.S. Free Market Economy labor Wages/paycheck Make products Pay for products Boeing cuts 1000 jobs Income tax rebate $700 Interest rates go up Price of oil goes down

Measuring the Circular Flow: GDP The total dollar value of economic output of the circular flow is called Gross Domestic Product (GDP) Dollar Value of all FINAL new goods & services produced in USA over one year

GDP = C + I + G + (X-M) How to Calculate GDP

GDP is a very IMPERFECT measure—it does NOT Measure: Leisure time v. hours worked What is produced—shoes, guns, toys count the same How happy or content people are

GDP Growth Rate Instead we use the percentage growth rate (measured quarterly and annually) –Example: GDP grew last year at a +2.2% rate last quarter GDP #s are hard for our minds to grapple with: GDP increased from $13.2 trillion to $13.5 trillion; DOES NOT COMPUTE!

GDP growth: Speed Limits Too fast: If GDP grows above 5.0%, the economy may experience inflation –Prices rise Too slow: If GDP grows below 2%, not enough jobs are created –Unemployment rate increases

Gross Domestic Product (GDP) Growth Rate Slowest ever -13.0% (1932) Fastest ever +18.5% (1942) Historical average: +2.5%-3.0% Recent GDP Growth Rates: 1Q 2008: +0.9% 2Q % 3Q % 4Q % 1Q 2009: -6.4% 2Q % 3Q %