1. Measuring Economic Activity: GDP and Unemployment Principles of Macroeconomics Dr. Gabriel X. Martinez Ave Maria University

2. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment2 Introduction “Real GDP, the value of goods and services produced in the U.S., grew at an annual rate of 1 percent in the fourth quarter….” “Real GDP, the value of goods and services produced in the U.S., grew at an annual rate of 1 percent in the fourth quarter….” “The unemployment rate last month rose to 6.1 percent, its highest level since….” “The unemployment rate last month rose to 6.1 percent, its highest level since….” “Inflation appears subdued as the consumer price index registered an increase of only 0.2 percent last month…” “Inflation appears subdued as the consumer price index registered an increase of only 0.2 percent last month…”

3. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment3 Gross Domestic Product: Measuring the Nation’s Output Measuring economic variables is essential. Measuring economic variables is essential. –You are a tenth-century doctor. –Your best guess at human anatomy is pig’s anatomy. –Your best guess at a good cure is leeches.

4. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment4

5. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment5 Gross Domestic Product: Measuring the Nation’s Output Measuring economic variables is essential. Measuring economic variables is essential. –We cannot understand the economy without precise measurement of economic activity. –Governments cannot use economic policy if they don’t know what is happening. –Firms and individuals need precise information.

6. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment6 The Three Faces of GDP == Market value of all final goods and services produced in a country during a given period ProductionExpenditureIncome Investment Consumption Governmentpurchases Net exports Capital Income Labor Income

7. The Production Approach to GDP

8. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment8

9. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment9 Gross Domestic Product: Measuring the Nation’s Output Gross Domestic Product (GDP) Gross Domestic Product (GDP) –The market value of the final goods and services produced in a country during a given period. –We’ll examine each part of this definition in detail.

10. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment10 Gross Domestic Product: Measuring the Nation’s Output The Market Value … The Market Value … –Market value is used to aggregate the quantities of different goods and services into one measurement. –We use prices, at current levels, for aggregation. E.g., we could use today’s prices to measure today’s GDP. E.g., we could use today’s prices to measure today’s GDP.

11. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment11 Market Value and GDP Quantity Unit Price Market Value P x Q Apples4$0.25$1.00 Bananas6$0.50$3.00 Shoes3$20.00$60.00 Total$64.00

12. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment12 Gross Domestic Product: Measuring the Nation’s Output Market Value Market Value –More expensive items receive a higher weight than cheaper items. –Suppose production of cheap items falls but production of expensive items rises: GDP will often rise.

13. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment13 Market Value and GDP Quantity Unit Price Market Value P x Q Quantity Unit Price Market Value P x Q Apples4$0.25$1.003$0.25$0.75 Bananas6$0.50$3.003$0.50$1.50 Shoes3$20.00$60.004$20.00$80.00 Total$64.00$82.25

14. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment14 Gross Domestic Product: Measuring the Nation’s Output Market Value Market Value –Many goods and services that do not have market value are not counted in GDP. That is, goods and services that cannot be bought and sold (such as care of one’s own children and homemaking) do not count. That is, goods and services that cannot be bought and sold (such as care of one’s own children and homemaking) do not count. If I pay someone to take care of my children, the quality of child care may decline, but GDP will rise. If I pay someone to take care of my children, the quality of child care may decline, but GDP will rise.

15. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment15 Percentages of American Men and Women over Age 16 Working Outside the Home, 1960 - 2001. Increase in female labor force participation increases the demand for housekeeping and child care. Unpaid household work is not counted in GDP. Paid household work is counted in GDP. The increase in female labor force participation has overstated GDP growth.

16. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment16 Gross Domestic Product: Measuring the Nation’s Output Market Value Market Value –Goods and services provided by the Government do not have market value, but they are counted in GDP. But they do have dollar figures attached to them. But they do have dollar figures attached to them. One could imagine that these goods and services could be bought and sold, even if they often are not. One could imagine that these goods and services could be bought and sold, even if they often are not.

17. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment17 See Excel Handout “Calculating Nominal GDP”

18. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment18 Gross Domestic Product: Measuring the Nation’s Output … of Final Goods or Services … … of Final Goods or Services … –Not all goods and services that can be bought and sold are counted. –Intermediate goods (non-durable goods used to produce other goods) are not counted.

19. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment19 Gross Domestic Product: Measuring the Nation’s Output Final Goods or Services Final Goods or Services –Goods or services consumed by the ultimate user; because they are the end products of the production process, they are counted as part of GDP. Intermediate Goods or Services Intermediate Goods or Services –Goods or services used up in the production of final goods and services and therefore not counted as part of GDP.

20. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment20 Gross Domestic Product: Measuring the Nation’s Output Final Goods and Services: Example Final Goods and Services: Example Milling Co. pays $0.50 for wheat to make flour. Milling Co. pays $0.50 for wheat to make flour. Bakery pays $1.20 for flour to make bread. Bakery pays $1.20 for flour to make bread. Bakery sells bread for $2.00 Bakery sells bread for $2.00 Contribution to GDP = $2.00 Contribution to GDP = $2.00

21. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment21 Gross Domestic Product: Measuring the Nation’s Output Value Added Value Added –For any firm, Market Value of Good or Service Cost of Inputs bought from other firms Value Added

22. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment22 Value Added in Bread Production Company Revenues – Cost of purchased inputs = Value added ABC Grain$0.50$0.00$0.50 General Flour$1.20$0.50$0.70 Hot’n’Fresh$2.00$1.20 $0.80 Total$2.00 The grain and flour are produced in 2002 Bread is produced in 2003 $1.20 is added to 2002 GDP $0.80 is added to 2003 GDP

23. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment23 Gross Domestic Product: Measuring the Nation’s Output Final Goods and Services Final Goods and Services –Getting a haircut Barber charges $10 for a haircut Barber charges $10 for a haircut Barber pays his assistant $2 Barber pays his assistant $2 Contribution to GDP = $10 Contribution to GDP = $10 –The contribution of the assistant is included in the final market value of the haircut.

24. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment24 Gross Domestic Product: Measuring the Nation’s Output Example: Example: –Capital Good A long-lived good, which is itself produced and used to produce other goods and services. A long-lived good, which is itself produced and used to produce other goods and services. –Tools. –Buildings. –Factories. –Machines. –Software. Newly produced capital goods are classified as final goods. Newly produced capital goods are classified as final goods.

25. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment25 Gross Domestic Product: Measuring the Nation’s Output … Produced Within a Country … … Produced Within a Country … –Domestic Only production that takes place within a country’s border. Only production that takes place within a country’s border. Examples Examples –Cars produced in the U.S. by foreign owned companies are counted. –Car produced in Mexico by U.S. owned companies are not counted.

26. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment26 Gross Domestic Product: Measuring the Nation’s Output … During a Given Period … During a Given Period –Given Period Counts only goods produced during the defined period such as a calendar year. Counts only goods produced during the defined period such as a calendar year. Examples Examples –The sale of used goods is not counted. –Real estate commissions, earned this year, on a house produced 3 years ago, are counted (but the sale of the house is not).

27. The Expenditure Approach to GDP

28. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment28 The Expenditure Method for Measuring GDP Every good that is produced must be purchased. Every good that is produced must be purchased. –If it is a consumer good, by consumers. –If it is a capital good, by firms. –If it is a government good, by governments. So measuring the market value of production is identical to measuring the dollar value of expenditures. So measuring the market value of production is identical to measuring the dollar value of expenditures.

29. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment29 Expenditure Components of U.S. GDP, 2001 (billions of dollars) Consumption6,987.069.30% Durable goods835.9 Nondurable goods2,041.3 Services4,109.9 Investment1,586.015.73% Business fixed investment1,201.6 Residential investment444.8 Inventory investment-60.3 Government purchases1,858.018.43% Net exports-348.9 -3.46% Exports1,034.1 Imports-1,383.0 Total: Gross domestic product10,082.2 100.00%

30. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment30 The Expenditure Method for Measuring GDP Consumption Expenditure, or simply Consumption Consumption Expenditure, or simply Consumption –Spending by households on goods and services, such as food, clothing, and entertainment. Consumer durables Consumer durables Consumer nondurables Consumer nondurables Services Services

31. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment31 The Expenditure Method for Measuring GDP Investment Investment –Spending by firms on final goods and services, primarily capital goods and housing. Business fixed investment Business fixed investment –Increases the country’s capacity to produce. Residential investment Residential investment Inventory investment Inventory investment –Inventories accumulate if sales are less than production. –Inventory is treated as “bought” by firms.

32. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment32 The Expenditure Method for Measuring GDP Investment Investment –Purchases of new capital (durable goods used to produce other goods). Financial investment Financial investment –Purchases of stocks (and so), which involve buying existing capital. –This is not investment in our sense.

33. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment33 The Expenditure Method for Measuring GDP Government Purchases Government Purchases –Purchases by federal, state, and local governments of final goods and services. Does not include transfer payments. Does not include transfer payments. Does not include interest paid on government debt. Does not include interest paid on government debt.

34. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment34 The Expenditure Method for Measuring GDP Net Exports Net Exports –Exports minus imports Exports Exports –Goods and services produced domestically but sold abroad. Imports Imports –Goods and services produced abroad but bought domestically.

35. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment35 The Expenditure Method for Measuring GDP Y = gross domestic product, or output Y = gross domestic product, or output C = consumption expenditure C = consumption expenditure I = investment I = investment G = government purchases G = government purchases NX = net exports NX = net exports

36. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment36 The Expenditure Method for Measuring GDP The Expenditure Method for Measuring GDP The Expenditure Method for Measuring GDP

37. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment37 The Expenditure Method for Measuring GDP Example Example –An economy produces 1 million cars valued at $15,000 each. From the production side, this is … From the production side, this is … –GDP = 1 million x $15,000 = $15 billion

38. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment38 The Expenditure Method for Measuring GDP From the Expenditure side … From the Expenditure side … –700,000 sold to consumers C = 700,000 x $15,000 = $10.5 billion C = 700,000 x $15,000 = $10.5 billion –200,000 sold to businesses I = 200,000 x $15,000 = $3.0 billion I = 200,000 x $15,000 = $3.0 billion –50,000 sold to government G = 50,000 x $15,000 = $.75 billion G = 50,000 x $15,000 = $.75 billion –30,000 exported – 5,000 imported NX = 25,000 x $15,000 = $.375 billion NX = 25,000 x $15,000 = $.375 billion

39. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment39 The Expenditure Method for Measuring GDP From the Expenditure side (cont.)… From the Expenditure side (cont.)… –975,000 sold –25,000 inventory Additional I = 25,000 x $15,000 = $0.375 billion Additional I = 25,000 x $15,000 = $0.375 billion GDP = C + I + G + NX GDP = C + I + G + NX –$10.5 + (3.0 +0.375) +.75 +.375 = $15.0 billion

40. The Income Approach to GDP

41. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment41 The Income Method for Measuring GDP Every purchase means someone earns income: Every purchase means someone earns income: –If I buy a pen, the bookstore earns $0.60. –If Ford buys a factory, the builder earns $60 million. –If the government buys a highway, the contractor earns $600 million. –If Americans buy French computers, the French earn $50,000.

42. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment42 GDP and the Incomes of Capital and Labor GDP = Labor Income + Capital Income GDP = Labor Income + Capital Income –Labor income Equals 75% of GDP Equals 75% of GDP Includes: Includes: –Wages –Salaries –Income of the self-employed

43. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment43 GDP and the Incomes of Capital and Labor GDP = Labor Income + Capital Income GDP = Labor Income + Capital Income –Capital income Equals 25% of GDP Equals 25% of GDP Includes: Includes: –Profits –Rent –Interest –Royalties

44. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment44 Percentage of Aggregate Income Received by Income Quintiles, 2001 Quintiles Lowest 2 nd 3 rd 4 th Highest Perfect Equality 2020202020 A “Quintile” is a fifth of the population. So the poorest 20% of all Americans is the “lowest quintile”; the next-poorest 20% is the “second quintile,” and so on. The richest 20% is the “highest quintile.”Income3.58.814.523.150.1 Source: US Census Bureau, Current Population Survey, 2002 Annual Demographic Supplement

45. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment45 The Three Faces of GDP == Market value of final goods and services ProductionExpenditureIncome Investment Consumption Governmentpurchases Net exports Capital Income Labor Income

46. Nominal GDP versus Real GDP

47. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment47 Prices and Quantities in 2000 and 2004 Quantity of pizzas 2000(10x$10)+(15x$5)= $175 2004(20x$12)+(30 x$6)= $420 Price of pizzas Quantity of calzones Price of calzones Observations Physical production of each good doubled GDP increased by 2.4 times Aha!! Prices also rose Market-Value GDP overstates economic growth GDP

48. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment48 Nominal GDP versus Real GDP Nominal GDP Nominal GDP –A measure of GDP in which the quantities produced are valued at current-year prices. –Nominal GDP measures the current dollar value of production.

49. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment49 Nominal GDP versus Real GDP Real GDP Real GDP –Real GDP measures the actual physical volume of production. –To do this, we must eliminate the effect of changing prices. How? –The quantities produced are valued at the prices in a base year rather than at current prices. This is Real GDP.

50. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment50 Prices and Quantities in 2000 and 2004 Quantity of pizzas 2000(10x$10)+(15x$5)= $175 2004(20x$12)+(30 x$6)= $420 Price of pizzas Quantity of calzones Price of calzones Observations Physical production of each good doubled Real GDP also doubles. We use the prices of the year 2000. GDP X X (20 x $10) + (30 x $5) = $350 X

51. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment51 See Excel Handout “Real versus Nominal GDP”

52. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment52 Nominal GDP, Real GDP, and Inflation Real GDP Growth Rate  Nominal GDP Growth Rate – Inflation Rate

53. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment53

54. GDP and Well-Being

55. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment55 Real GDP is not the Same as Economic Well-Being GDP doesn’t take into account GDP doesn’t take into account –The increase in Leisure Time. –Nonmarket Economic Activities. –Environmental Quality and Resource Depletion. –Increases or decreases in the Quality of Life –Poverty and Economic Inequality

56. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment56 Real GDP is not the Same as Economic Well-Being GDP doesn’t take into account the increase in Leisure Time. GDP doesn’t take into account the increase in Leisure Time. Now we can: –Have a Shorter work week –Start working later –Retire earlier

57. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment57 Real GDP is not the Same as Economic Well-Being Economic Naturalist Economic Naturalist –Why do people work fewer hours today than their great-grandparents did? The opportunity cost of working is now higher. The opportunity cost of working is now higher.

58. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment58 Real GDP is not the Same as Economic Well-Being GDP doesn’t take into account Nonmarket Economic Activities. GDP doesn’t take into account Nonmarket Economic Activities. –Household production –Volunteer services Nonmarket activities are more important in poor countries. Nonmarket activities are more important in poor countries. –Underground economy

59. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment59 Real GDP is not the Same as Economic Well-Being GDP doesn’t take into account Environmental Quality and Resource Depletion GDP doesn’t take into account Environmental Quality and Resource Depletion –Costs of reduced environment quality are not measured. –GDP is not adjusted for resource depletion.

60. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment60 Real GDP is not the Same as Economic Well-Being GDP doesn’t take into account increases or decreases in the Quality of Life GDP doesn’t take into account increases or decreases in the Quality of Life –Crime rates –Traffic congestion –Civic organizations –Open space Poverty and Economic Inequality Poverty and Economic Inequality –GDP does not capture the effects of income inequality

61. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment61 Real GDP is related to Economic Well-Being Higher GDP often leads to more Higher GDP often leads to more –Life expectancy at birth –Doctors per person –School enrollments –Literacy Higher GDP also leads to less Higher GDP also leads to less –Infant mortality –Incidence of AIDS –Undernourishment

62. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment62 GDP & Basic Indicators of Well- Being Indicator All developing countries GDP per person 3,5301,17025,860 (U.S. dollars) Life expectancy at 64.551.778.0 birth (years) Infant mortality rate 611006 (per 1,000 live births) Under-5 mortality rate 891596 (per 1,000 live births) Doctors 7830252 (per 100,000 people) Incidence of HIV/Aids1.34.30.3 (% in 15-49 age group) Undernourished1838Negligible people (%) Primary enrollment85.760.499.9 rate (as % of age group) Secondary enrollment60.431.296.2 rate (as % of age group) Adult literacy rate (%)72.951.798.6 Least developed countries Industrialized countries

63. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment63 But GDP is Related to Economic Well-Being Economic Naturalist Economic Naturalist –Why do far fewer children complete high school in poor countries than in rich countries? Again, consider the opportunity cost of not working: for a poor family in a poor country, a child who goes to school and doesn’t work may starve. Again, consider the opportunity cost of not working: for a poor family in a poor country, a child who goes to school and doesn’t work may starve.

64. Unemployment

65. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment65 The Unemployment Rate Measuring Unemployment Measuring Unemployment –The Bureau of Labor Statistics (BLS) surveys 60,000 randomly selected households each month. –Those 16 years and over are placed in one of three categories: Employed Employed Unemployed Unemployed Out of the labor force Out of the labor force –The BLS estimates how many people in the U.S. fit into each category.

66. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment66 The Unemployment Rate Measuring Unemployment Measuring Unemployment –Labor force = employed + unemployed

67. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment67 Ages 0 - 15Homemakers, Retired People, Disabled, Discouraged Workers, Students UnemployedEmployed Labor Force Cyclical Frictional Working-Age Population Structural

68. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment68 U.S. Employment Data, July 2002 (in millions) Employed134.04 Plus: Unemployed8.35 Equals: Labor force142.39 Plus: Not in labor force71.63 Equals: Working-age (over 16) population214.02 Unemployment rate = unemployed/labor force = 8.35/142.39 = 5.9% Participation rate = labor force/working-age population = 142.39/214.02 = 66.5%

69. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment69 The U.S. Unemployment Rate since 1960

70. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment70 The Unemployment Rate The Cost of Unemployment The Cost of Unemployment –Economic People don’t receive income. Resources are not utilized. People don’t receive income. Resources are not utilized. –Psychological Loss of self-esteem, depression, suicide. Loss of self-esteem, depression, suicide. –Social Increases in crime, drug use, etc. Increases in crime, drug use, etc.

71. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment71 The Unemployment Rate The Duration of Unemployment The Duration of Unemployment –The impact of unemployment is influenced by how long individuals have been unemployed. The unemployment spell: time without employment while in the labor force. The unemployment spell: time without employment while in the labor force. The duration of unemployment: length of spell. The duration of unemployment: length of spell. Long-term unemployed: 6 mths or more Long-term unemployed: 6 mths or more Chronically unemployed: in and out of work, in and out of the labor force. Chronically unemployed: in and out of work, in and out of the labor force.

72. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment72 The Unemployment Rate In July 2002: In July 2002: –Official unemployment rate = 5.9% –Including discouraged workers and involuntary part-time worker = 9.4% Discouraged Workers Discouraged Workers –People who say they would like to have a job but have not made an effort to find one in the last four weeks

73. Workers, Wages, and Unemployment in the Modern Economy Unemployment: Types, Causes, and Costs

74. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment74 Types of Unemployment and Their Costs Three kinds of unemployment Three kinds of unemployment –Frictional Unemployment Due to minor problems Due to minor problems –Structural Unemployment Due to lack of skills, etc. Due to lack of skills, etc. –Cyclical Unemployment Due to recessions Due to recessions

75. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment75 Types of Unemployment and Their Costs Frictional Unemployment Frictional Unemployment –The short-term unemployment associated with the process of matching workers with jobs

76. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment76 Types of Unemployment and Their Costs Characteristics of Frictional Unemployment Characteristics of Frictional Unemployment –Short-term –May lead to a better match between the worker and job –Necessary in a dynamic economy

77. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment77 Types of Unemployment and Their Costs Structural Unemployment Structural Unemployment –Long-term and chronic unemployment that exists even with the economy is producing at a normal rate

78. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment78 Types of Unemployment and Their Costs Causes of Structural Unemployment Causes of Structural Unemployment –Lack of skills, language barrier, discrimination –Long-term mismatch –Structural features of the labor market, such as technological change.

79. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment79 Types of Unemployment and Their Costs Cost of Structural Unemployment Cost of Structural Unemployment –Loss in economic output –May not develop new skills –Psychological damage

80. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment80 Types of Unemployment and Their Costs Cyclical Unemployment Cyclical Unemployment –The extra unemployment that occurs during periods of recession –May lead to discouraged workers –But it may be an occasion for far-reaching change and re-training.

81. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment81 Unemployment Impediments to Full Employment Impediments to Full Employment –Assuming labor markets are perfectly competitive, Minimum Wage Laws: Benefit workers who are employed. Benefit workers who are employed. Hurt those who lose their jobs. Hurt those who lose their jobs. Create economic inefficiency. Create economic inefficiency. –The opposite may be true if labor markets are not perfectly competitive.

82. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment82 Impediments to Full Employment Labor Unions Labor Unions –Benefits Reduced worker exploitation Reduced worker exploitation Support progressive labor legislation Support progressive labor legislation Increase productivity Increase productivity Promote democracy in the workplace Promote democracy in the workplace

83. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment83 Impediments to Full Employment Labor Unions Labor Unions –Costs Unions cause otherwise competitive labor markets to function inefficiently. Unions cause otherwise competitive labor markets to function inefficiently. Unions may prevent companies from competing in the global economy. Unions may prevent companies from competing in the global economy.

84. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment84 Impediments to Full Employment Unemployment Insurance: Unemployment Insurance: –Helps to reduce the costs of unemployment. –May give the unemployed an incentive to search longer and less intensely. –Unemployment benefits must balance the benefit of providing support to the worker with the cost of reducing the incentive to work.

85. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment85 Impediments to Full Employment Other Government Regulations Other Government Regulations –Health and Safety Regulations These regulations can reduce the demand for labor by: These regulations can reduce the demand for labor by: –Increasing employer costs. –Reducing productivity. The reduction in demand will: The reduction in demand will: –Increase unemployment. –Lower wages.

86. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment86 Impediments to Full Employment Other Government Regulations Other Government Regulations –The cost-benefit criterion should be used to determine the feasibility of proposed legislation. –But remember that this analysis treats people just as if they were hairpins, tractors, or computers.

87. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment87 Unemployment Economic Naturalist Economic Naturalist –Why are unemployment rates so high in western Europe? –Europe has significant Structural Rigidities Regulated labor markets Regulated labor markets –It’s difficult to fire or hire people. High minimum wages High minimum wages Generous unemployment benefits Generous unemployment benefits Powerful labor unions Powerful labor unions

88. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment88 Unemployment Rates in Western Europe, 1980 - 2001

89. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment89 What You’ve Learned Today The meaning and measurement of GDP. The meaning and measurement of GDP. The meaning of: market value, final good, capital good, and domestic. The meaning of: market value, final good, capital good, and domestic. The components of aggregate expenditure. The components of aggregate expenditure. Basics of income distribution. Basics of income distribution. The difference between real and nominal GDP. The difference between real and nominal GDP.

90. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 18: Measuring Economic Activity: GDP and Unemployment90 What You’ve Learned Today The difference between GDP and welfare. The difference between GDP and welfare. The meaning and measurement of unemployment. The meaning and measurement of unemployment. The types, causes, and costs of unemployment. The types, causes, and costs of unemployment.