1. Unit 2: Economic Indicators and the Business Cycle1
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2. The Circular Flow and GDP
Topic 2.1-
The Circular Flow and GDP
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3. What is Macroeconomics? Why study the whole economy?
Macroeconomics is the study of the large economy as a whole. It is the study of the big picture.
Instead of analyzing one consumer, we analyze everyone.
Instead of one business, we study all businesses.
Why study the whole economy?
The field of macroeconomics was born during the Great Depression.
Government didn’t understand how to fix a depressed economy with 25% unemployment.
Macro was created to:
Measure the health of the whole economy.
Guide policies to fix problems. 3
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4. Resource Market DEMAND SUPPLY Individuals Businesses Government SUPPLY
$$$ Income $$$
(Factor payments)
$$$ Costs $$$
Resources
Resources
(Factors of
Production)
$$$
Taxes
Taxes
Subsidies
Welfare
Public Goods
Public Goods
Individuals
Businesses
Government
$$$
Goods and
Services
Goods and
Services
$$$ Revenue $$$
SUPPLY
$$$ Spending $$$
DEMAND
Product Market 4
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5. Circular Flow Model Vocab
Private Sector- Part of the economy that is run by individuals and businesses.
Public Sector- Part of the economy that is controlled by the government.
Factor Payments- Payment for the factors of production, namely rent, wages, interest, and profit.
Transfer Payments- When the government redistributes income (ex: welfare, social security).
Subsidies- Government payments to businesses. 5
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6. How would each event below affect the Circular Flow Model?
Trace the effects using the model.
Consumers begin to save more and spend less.
2. The government increases taxes on consumers.
3. Businesses lay off workers in order to cut costs.
4. The government increases subsidies to farmers.
5. A gas line breaks and causes a gas shortage.
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7. All countries have three macroeconomic goals:
Promote Economic Growth
Limit Unemployment
Keep Prices Stable (Limit Inflation)
In this unit we will analyze how each of these are measured. 7
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8. How do we measure economic growth?
Economists collect statistics on production, income, investment, and savings.
This is called national income accounting.
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9. The most important measure of growth is GDP.
Gross Domestic Product (GDP) is the dollar value of all final goods and services produced within a country in one year.
-Dollar value- GDP is measured in dollars.
-Final goods- GDP only counts NEW goods and services
-Within a country- GDP measures production within the country’s borders
-One Year- GDP measures annual economic performance. 9

10. Which 15 countries have the highest GDP?
What does GDP tell us?
Just like calculating your own income, GDP measures how well the U.S. is doing financially.
How do you use GDP?
Compare to previous years (Is there growth?)
Compare policy changes (Did a new policy work?)
Compare to other countries (Are we better off?)
What do you think?
Which 15 countries have the highest GDP?
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11. How can you measure growth from year to year?
% Change
in GDP =
Year 2 - Year 1
Year 1
X 100
Mordor’s GDP in 2014 was $4000
Mordor’s GDP in 2019 was $5000
What is the % Change in GDP?
Transylvania’s GDP in 2014 was $2,000
Transylvania’s GDP in 2019 was $2,100
Mordor = 25% Change
Transylvania = 5% Change 11
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12. Does GDP accurately measure standard of living?
Standard of living can be measured, in part, by how well the economy is doing…
But it needs to be adjusted to reflect the size of the nation’s population.
GDP Per Capita (per person)
GDP divided by the population. It identifies on average how many products each person makes.
GDP per capita is the best measure of a nation’s standard of living. 12
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13. Why do some countries have higher GDPs?
1. Economic System- Capitalism promotes innovation and provides incentives to improve productivity.
2. Rule of Law- Countries with solid institutions and political stability have historically had more economic growth.
3. Capital Stock- Countries that have more machines and tools are more productive.
Example#1: India has a relatively low GDP because they have a lot of labor but not very much capital.
Example#2: Japan has few natural resources but a high GDP.
4. Human Capital- Countries that have better education and training are more productive.
5. Natural Resources- In general, countries that have access to more natural resources are more productive.
It all boils down to productivity!
Productivity- Output per unit of input

14. What is NOT included in GDP?
Intermediate Goods
Goods inside the final goods don’t count.
Ex: Price of finished car, not the stock radio or tires.
2. Nonproduction Transactions
Financial Transactions (nothing produced)
Ex: Stocks, bonds, real estate
Used Goods
Ex: Old cars, used clothes
3. Nonmarket and Illegal Activities
Things made at home- household production
Ex: Unpaid work, black markets, drugs 14
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15. Each of these methods should generate the same number.
Three Ways of calculating GDP:
Expenditures Approach-Add up all the spending on final goods and services produced in a given year.
Income Approach-Add up all the income earned from selling all final goods and services produced in a given year.
Value-added Approach-Add up the dollar value added at each stage of the production process.
Each of these methods should generate the same number. 15
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16. Expenditures Approach
Four components of GDP:
Consumer Spending- ≈ 70% of U.S. GDP Purchases of final goods and services by individuals. Ex: $5 Sandwich at Subway
Business Investment- ≈ 16% of U.S. GDP
Businesses spending on tools and equipment.
Ex: Walmart buys self checkout machines.
3. Government Spending- ≈ 17% of U.S. GDP
Ex: Schools, roads, tanks (NOT transfer payments)
4. Net Exports- Exports (X) – Imports (M) ≈ -3%
Ex: Value of 3 Fords minus 2 Hondas.
GDP (Y) = C + I + G + NX 16
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17. https://www. financialsense

18. Income Approach
The income approach adds up all the income earned from producing goods and services.
Labor Income - Wages earned from performing work.
Rental Income - Income earned from property owned by individuals.
3. Interest Income- Interest earned from loaning money to businesses.
4. Profit - Money businesses have after paying all their costs.
These are called FACTOR PAYMENTS. Labor earns wages, land earns rent, capital earns interest, and entrepreneurship earns profit. 18
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19. Consumer Spending (C) Explained
Consumer spending is made up of three components:
1. Durable goods- (ex: washing machines, refrigerators, cars)
2. Non-durable goods- (ex: food, clothes, toilet paper)
3. Services- (ex: dental work, repairs, tutoring)
What do you think?
What percent of U.S. consumer spending is made up of durable goods, non-durable goods, and services? 19
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20. How has the US economy changed over time?
46%
14% 7% 20
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21. Investment (I) Explained
In economics we use the word “investment” differently than you usually hear it. Be careful!
- Investment is NEVER when individuals buy assets like stocks and bonds.
- Investment is ALWAYS when businesses buy capital like machines, resources, and tools.
Does the purchase of a new oven produced in America count as consumer spending or investment spending?
It depends. Why?
If the oven is purchased for a home then it would be C
If the oven is purchased by a business the it would be I 21
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22. What can a drastic change in inventories mean?
Is the production of a new home Consumer Spending (C) or Investment Spending (I)?
New real estate counts as investment spending since a new home can potentially be rented out.
What if a business produces something one year, but doesn’t sell it until the next year?
Inventories- Goods produced and held in storage in anticipation of later sales.
Inventories are counted in the year they are produced, not the year they are sold. The change in inventories is a valuable economic indicator.
What can a drastic change in inventories mean? 22
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23. Why is a change in inventory investment often called a “leading indicator”?23
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24. Government (G) Explained
Government expenditures tracks the spending made in the “public sector”.
-This includes payments made by the government for goods and services.
Ex: the price of fighter jets and the salaries of the pilots.
-It does not include money spent on transfer payments like welfare, social security, and subsidies.
-It also does not include interest payments on the national debt.
What percent of the US GDP is made up of government spending? 24
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25. U.S. government's percent share of GDP25
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