Chapter 13Chapter 13Economic PerformanceEconomic Performance

Vocabulary – Chapter 13Vocabulary – Chapter 13• Gross Domestic Product (GDP) Gross Domestic Product (GDP) • Net Exports of Goods and Services Net Exports of Goods and Services • Price IndexPrice Index• Market Basket Market Basket • Consumer Price IndexConsumer Price Index• Real GDP Real GDP • Real GDP per Capita Real GDP per Capita • Standard of LivingStandard of Living• Labor ProductivityLabor Productivity

Measuring a Nation’s OutputMeasuring a Nation’s OutputThe GDPThe GDP

• Gross domestic product (Gross domestic product (GDPGDP)) is the is the total market value of all the final goods and total market value of all the final goods and services produced services produced within a countrywithin a country in a in a given year.given year.

• GDP is the GDP is the quantityquantity of goods of goods multipliedmultiplied by by their respective prices (market value)their respective prices (market value)

• Intermediate goodsIntermediate goods are excluded. are excluded. They are goods that are used in the They are goods that are used in the production process. It is not the final good production process. It is not the final good or service. The totals for the intermediate or service. The totals for the intermediate goods are assumed to be included in the goods are assumed to be included in the price of the final good.price of the final good.

• Only newly produced goods are included in Only newly produced goods are included in GDP (GDP (no usedno used or secondhand goods). or secondhand goods).

What’s What’s NOTNOT Included in the Included in the GDPGDP

What’s Excluded (contd.)What’s Excluded (contd.)

• Non-market Non-market TransactionsTransactions (e.g. (e.g. sales of stocks, sales of stocks, bonds, transfer bonds, transfer payments, etc.). payments, etc.). These activities These activities involve payments of involve payments of money and not the money and not the production of production of goods/services.goods/services.

Inside Wall StreetInside Wall Street

• Underground Economic TransactionsUnderground Economic Transactions (gambling, drugs, etc.) are excluded(gambling, drugs, etc.) are excluded

U.S. Real GDP, 1930-2003U.S. Real GDP, 1930-2003• The graph shows that The graph shows that

real GDP has grown real GDP has grown substantially over this substantially over this period.period.

• This is what economists This is what economists call call economic growth.economic growth.

•Economic Growth: sustained increases in the real production of an economy over a long time. In the U.S., the optimum rate of GDP growth is about +3.5% per year.

C + I + G + F = GDPC + I + G + F = GDP(The Output - Expenditure Model)(The Output - Expenditure Model)• Economists divide GDP into four broad Economists divide GDP into four broad

spending categories:spending categories:

1.1. Consumer Sector: purchases by Consumer Sector: purchases by consumers/householdsconsumers/households

2.2. Investment Sector- : purchases by firms.Investment Sector- : purchases by firms.

3.3. Government Sector: purchases by federal, Government Sector: purchases by federal, state, and local governments.state, and local governments.

4.4. Foreign Sector: (exports minus imports).Foreign Sector: (exports minus imports).

The Expenditure Approach to The Expenditure Approach to Computing GDPComputing GDP

GDP = C + I + G + F (or X – M)

GDP and Changes in Price GDP and Changes in Price LevelsLevels

• Inflation is a rise in the general price Inflation is a rise in the general price level. Generally in the U.S. an inflation level. Generally in the U.S. an inflation rate of 2-3% is optimal. To measure rate of 2-3% is optimal. To measure inflation we create ainflation we create a• Price IndexPrice Index

• A price index measures changes in A price index measures changes in prices in a given year compared to prices in a given year compared to a base year.a base year.

To Construct a Price IndexTo Construct a Price Index

• Using the market basket for that index, Using the market basket for that index, add ALL add ALL pricesprices (not goods produced). (not goods produced).

• Divide the prices of the market basket in Divide the prices of the market basket in the current year by the prices of the the current year by the prices of the same market basket in the base year. same market basket in the base year.

• Real GDPReal GDP is a measure of GDP that is a measure of GDP that takes into account price changes. This takes into account price changes. This measure of total output does not measure of total output does not increase just because prices increase.increase just because prices increase.

• When we use current prices to measure When we use current prices to measure GDP, that is what we call GDP, that is what we call Current (or Current (or nominal) GDPnominal) GDP, which can increase as a , which can increase as a result of higher production or higher result of higher production or higher prices.prices.

How and Why We Adjust the How and Why We Adjust the GDPGDP

Per Capita GDPPer Capita GDP

• Real Per Capita GDPReal Per Capita GDP: Real GDP divided by : Real GDP divided by the population.the population.

• GDP figures are useful for obtaining an GDP figures are useful for obtaining an estimate of the productive capabilities of an estimate of the productive capabilities of an economy economy but they do not necessarily but they do not necessarily measure happiness or well beingmeasure happiness or well being..

• Per Capita GDP is the best measure of Per Capita GDP is the best measure of economic progresseconomic progress

Economic GrowthEconomic Growth

• Why it’s important?Why it’s important?• Increased/higher standard of livingIncreased/higher standard of living

• Is your standard of living different Is your standard of living different than your parents at your agethan your parents at your age

• Government Revenue is increasedGovernment Revenue is increased• Domestic problems declineDomestic problems decline• Global role modelGlobal role model

Economic GrowthEconomic Growth

• How Growth Occurs:How Growth Occurs:

• Increase in the 4 factors of productionIncrease in the 4 factors of production

• Land, labor, capital, entrepreneursLand, labor, capital, entrepreneurs

• Increase in productivityIncrease in productivity

• Output of goods is increased with Output of goods is increased with the same amount of inputsthe same amount of inputs

Important QuestionsImportant QuestionsChapter 13Chapter 13

• Know the components of the Output-Know the components of the Output-Expenditures Model.Expenditures Model.

• Explain how GDP is measured.Explain how GDP is measured.

• Explain the importance of GDP.Explain the importance of GDP.

• Know the difference between Current Know the difference between Current (Nominal) and Real GDP.(Nominal) and Real GDP.

Chapter 14Chapter 14Economic Instability Economic Instability

Pg 375-393

Chapter 14 VocabularyChapter 14 Vocabulary

• Business cycleBusiness cycle• RecessionRecession• Index of leading indicatorsIndex of leading indicators• UnemployedUnemployed• Unemployment rateUnemployment rate• Frictional unemploymentFrictional unemployment• Structural unemploymentStructural unemployment• Cyclical unemploymentCyclical unemployment• Inflation Inflation

The Phases of the Business Cycle

recession

Ups and downs of the Business Ups and downs of the Business CycleCycle• PeakPeak:: at the peak of the business cycle, Real at the peak of the business cycle, Real

GDP is at a temporary high.GDP is at a temporary high.• Recession Recession (or Contraction): A decline in the (or Contraction): A decline in the

real GDP. real GDP. If it falls for two consecutive If it falls for two consecutive quarters, it is said the economy to be in a quarters, it is said the economy to be in a recession.recession.

• TroughTrough: The Low Point of the GDP, just : The Low Point of the GDP, just before it begins to turn up.before it begins to turn up.

• RecoveryRecovery (or Expansion): When the GDP is (or Expansion): When the GDP is rising from the trough.rising from the trough.

Why we have business cyclesWhy we have business cycles

Possible causes of business cyclesPossible causes of business cycles

1. slowing of business spending1. slowing of business spending

2. technology/innovations2. technology/innovations

3. changes in money supply/credit3. changes in money supply/credit

4. inventory adjustments4. inventory adjustments

5. external shocks5. external shocks

Predicting Business CyclesPredicting Business Cycles

• Using the Index of Leading IndicatorsUsing the Index of Leading Indicators• These are 10 statistical indicators which These are 10 statistical indicators which

predict future economic activity. Some of predict future economic activity. Some of these indicators are:these indicators are:• New orders New orders • Stock Market IndexesStock Market Indexes• Building permitsBuilding permits• Consumer expectationsConsumer expectations• Unemployment claimsUnemployment claims

Examining UnemploymentExamining Unemployment

• The The unemployedunemployed are those individuals who do are those individuals who do not currently have a job but who are not currently have a job but who are activelyactively looking for work.looking for work.

• The The employedemployed are individuals who currently are individuals who currently have jobs.have jobs.

• The employed The employed plusplus the unemployed comprise the unemployed comprise the the labor forcelabor force..

Examining UnemploymentExamining Unemployment• The The unemployment rateunemployment rate is the is the

percentage of labor force unemployed percentage of labor force unemployed and and lookinglooking for work. for work.

Problems measuring unemploymentProblems measuring unemployment

• Individuals who are not currently Individuals who are not currently looking for work are called looking for work are called discouraged workersdiscouraged workers. These . These individuals are not included in individuals are not included in unemployment data.unemployment data.

• Workers who hold part-time jobs Workers who hold part-time jobs ARE included as employed ARE included as employed workers in unemployment data.workers in unemployment data.

Four Types of UnemploymentFour Types of Unemployment• Cyclical unemploymentCyclical unemployment is the is the

unemployment that occurs during unemployment that occurs during recessions.recessions.

• Frictional unemploymentFrictional unemployment is the is the unemployment that occurs naturally during unemployment that occurs naturally during the normal workings of an economy. People the normal workings of an economy. People are searching for jobs/better jobs.are searching for jobs/better jobs.

• Structural unemploymentStructural unemployment occurs when occurs when the economy evolves. Workers skills the economy evolves. Workers skills become obsolete.become obsolete.

• Seasonal UnemploymentSeasonal Unemployment occurs due to occurs due to changes in seasons and demand for changes in seasons and demand for workers.workers.

Full EmploymentFull Employment• The level of unemployment at which there The level of unemployment at which there

is no cyclical unemployment is considered is no cyclical unemployment is considered the “Full Employment (or the Natural Rate the “Full Employment (or the Natural Rate of Unemployment”)of Unemployment”)

• In the U.S. the natural rate of In the U.S. the natural rate of unemployment is around 4.5-5%.unemployment is around 4.5-5%.

• Frictional + Structural unemployment = Frictional + Structural unemployment = Full Employment (or the Natural rate of Full Employment (or the Natural rate of unemployment)unemployment)

• Why might a lower unemployment rate Why might a lower unemployment rate cause problems for the U.S. economy?cause problems for the U.S. economy?

InflationInflation• Consumer Price IndexConsumer Price Index (CPI) (CPI): the : the

weighted average of prices of a weighted average of prices of a market basket of goods and services market basket of goods and services purchased by a typical urban purchased by a typical urban household.household.

• The Consumer Price Index is what is The Consumer Price Index is what is used to measure inflation.used to measure inflation.

• In the U.S., an inflation rate of 2-In the U.S., an inflation rate of 2-3% per year is desirable3% per year is desirable

Degrees of InflationDegrees of Inflation• Creeping inflation or 1-3% per Creeping inflation or 1-3% per

yearyear• Galloping inflation or 100-300% Galloping inflation or 100-300%

per yearper year• Hyperinfation or 500+% per year.Hyperinfation or 500+% per year.• The current inflation rate in The current inflation rate in

Zimbabwe is about 1Million%Zimbabwe is about 1Million%• Let me check… yep Cowboys Let me check… yep Cowboys

still suckstill suck

Causes of InflationCauses of Inflation

• Demand Pull Inflation (caused by an Demand Pull Inflation (caused by an increase in aggregate (total) increase in aggregate (total) spending)spending)

• Excessive growth of the money Excessive growth of the money supplysupply

• Per unit production costs increasePer unit production costs increase

• Natural resource cost increasesNatural resource cost increases

• Wages increase (wage spiral)Wages increase (wage spiral)

Effects of InflationEffects of Inflation

• Rule of 70Rule of 70 • Divide 70 by inflation rate to determine how Divide 70 by inflation rate to determine how

long it will take prices to double.long it will take prices to double.• If inflation is 5%, then 70/5 = 14If inflation is 5%, then 70/5 = 14

• Prices will double in 14 yearsPrices will double in 14 years• Rule of 70 can also be applied to measure Rule of 70 can also be applied to measure

how much savings/investments will increase how much savings/investments will increase at a given return rate.at a given return rate.

• If $2000 is invested at a 10% rate of return, If $2000 is invested at a 10% rate of return, the $2000 will be $4000 in 7 years.the $2000 will be $4000 in 7 years.

Important Questions Important Questions Chapter 14Chapter 14

• Define the 4 phases of the business Define the 4 phases of the business cyclecycle

• Know the causes of the Business CycleKnow the causes of the Business Cycle

• Describe the kinds of unemploymentDescribe the kinds of unemployment

• Know the causes of inflationKnow the causes of inflation

• What is the optimal unemployment rate What is the optimal unemployment rate and inflation rate for the U.S.?and inflation rate for the U.S.?