1. Chapter 13
Measuring the Economy

2. 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)

3. 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

4. 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?

5. 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 + + +

6. 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. + + +

7. 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

8. 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

9. 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

10. Inflation

11. 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

12. 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”

13. 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

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

15. 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

16. 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

17. 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

18. 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 %

19. 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

20. 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

21. 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

22. 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