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Gross Domestic Product and Growth Chapter 12 GDP Analysis (Handout) For Section – Create a mathematical problem … Review the example (Figure 12.3) in your textbook on page 311. Consider using the following format to write up your problem: Country __ produces ____________. During the year, it produced __________ units.The current year (year 2) sales value is $ _______ per unit produced.The base year (year 1) sales value is $ _________ per unit produced. Section 1 – Gross Domestic Product (GDP) Objectives 1. Explain how gross domestic product (GDP) is calculated. 2. Distinguish between nominal and real GDP. 3. List the main limitations of GDP. 4. Identify factors that influence GDP. 5. Describe other output and income measures Introduction What does GDP show about a nation’s economy? GDP measures the amount of money brought into a nation in a single year through the selling of that nation’s goods and services. GDP measures how well a nation’s economy is doing for a particular year. A high GDP means the nation is doing well. A low GDP means the nation is doing poorly. National Income Accounting Economists use a system called national income accounting to monitor the U.S. economy. They collect macroeconomic statistics the Government uses them to determine economic policies. The most important of the data economists analyze is GDP the dollar ($) value of all final goods and services produced for sale within a country’s borders in a given year. What is GDP? – Breaking it down Dollar value – total cash value of all sales of goods and services produced in a calendar year. 1. Sales value; not cost of production Donated or charitable items not included Final goods and services – does not include intermediate goods 2. To avoid double counting Produced within a country’s borders 3. Excludes goods imported from other countries In a given year – doesn’t include sale of used items produced in a prior year 4. Sale of 2012 Chevy Impala in 2015 (not included) Included in GDP? Or Not? 1. 2. 3. 4. 5. Shoes manufactured in U.S. Shoes made in Korea for a U.S. company Cotton cloth manufactured in Mississippi and sold to manufacturers in India to make sweaters Computer parts sold to a foreign computer manufacturer to be included in computers sold at Best Buy Legal services from major Chicago law firm sold to McDonald’s Corporation Included in GDP? Or Not? 6. 7. 8. 9. 10. 11. Wireless mouse made in China but sold by Microsoft Corporation in the U.S. Cars made in factory in Louisiana owned by Korean auto company Purchases made by shoppers at Fox Valley Mall of jeans made in China A 2015 Ford truck made this year but not sold Childcare provided by a parent Childcare provided by a daycare center Methods to Calculate GDP Expenditure Approach Estimate the annual expenditures on four categories of final goods and services: Consumer goods Durable vs. nondurable Business goods and services Government goods and services Net exports Income Approach Adding up all the incomes in the economy. exports – imports Wages and salaries paid Corporate profits Interest and miscellaneous investment income Farmers’ income Income from non-farm unincorporated businesses Nominal vs. Real GDP Nominal GDP measured in current prices uses current year’s prices to calculate the value of the current year’s output The problem: it does not account for the rise in prices (inflation). If output is the same but prices are higher, nominal GDP will be higher Real GDP expressed in constant, or unchanging, prices. More accurate reflection of productivity GDP – Nominal Base Year Current Year GDP – Real Base Year Current Year Price 1 GDP - U.S. Real GDP Real GDP per Capita $16.3 Trillion (2014) $15.9 Trillion (2013) $15.5 Trillion (2012) Represents total Real GDP divide by the nation’s population $50,855 (Apr 2015) $49,998 (Oct 2013) Nominal GDP $17.7 Trillion (2014) $17.1 Trillion (2013) $16.4 Trillion (2012) US GDP – Nominal vs. Real (2006-2012) Limitations of GDP Nonmarket Activities The Underground Economy GDP does not account for black market activities or people paid “under the table” without being taxed Negative Externalities GDP does not measure goods and services that people make or do themselves. Unintended economic side effects, like pollution, are not subtracted from GDP Quality of Life High GDP does not necessarily mean people are happier Other Output and Income Measures Gross National Product Represents the annual income earned by firms and citizens of a nation Does not account for depreciation Net National Product National Income Personal Income Disposable Income Personal income – income taxes Influences on GDP What is Aggregate Supply? The total amount of goods and services in the economy available at all possible price levels. As the price level rises, aggregate supply rises. Producers willing to produce more As the price level falls, aggregate supply falls. Producers willing to produce less Influences on GDP What is Aggregate Demand? The amount of all goods and services that will be purchased at all possible price levels. As the price level rises, purchasing power drops (quantity demanded decreases) As price levels decline, demand increases Purchasing power is greater Falling prices = increases in wealth and demand (aka wealth effect) Section 2 – Business Cycles Objectives 1. Identify the phases of a business cycle. 2. Describe four key factors that keep the business cycle going. 3. Explain how economists forecast fluctuations in the business cycle. 4. Analyze the impact of business cycles in U.S. history. Business Cycle Introduction What factors affect the phases of a business cycle? Economic growth and decline Business investments Interest rates and credit Consumer expectations External shock Phases of a Business Cycle Business cycles are made up of major changes in real GDP above or below normal levels. The business cycle consists of four phases: Expansion Peak Businesses doing well, unemployment low, real GDP no longer rising Contraction Businesses doing well, unemployment dropping, real GDP rising Business production down, unemployment rising, real GDP falling Trough Unemployment high, no business investment, real GDP no longer falling Contractions There are three (3) types of contractions: Recession 1. a prolonged economic contraction that generally lasts from 6 to 18 months and is marked by a high unemployment rate (8-10+%). Depression 2. a recession that is especially long and severe characterized by very high unemployment and very low economic output. Stagflation 3. a decline in real GDP (output) combined with a significant rise in price levels, or high inflation. What Keeps a Business Cycle Going? There are 4 main economic variables which affect business cycles: Business Investment Interest Rates and Credit Consumer Expectations External Shocks Business Investment When the economy is expanding Businesses do well (sales & profits) Business investment increases Buy new equipment, build or improve facilities, add workers This increases GDP and helps maintain the expansion. At some point firms decide to decrease or stop spending Demand for products is dropping Firms cut back on business spending The result is a decrease in GDP and the price level. Interest Rates and Credit Consumers often use credit to buy new cars, a home, electronics, and vacations. If the interest rates are rising, consumers are less likely to buy them. The same principle holds true for businesses who are deciding whether or not to buy new equipment or make large investments. If interest rates go up, consumers and businesses buy less Government policy in recent years Keep interest rates low to encourage or increase spending Mortgage rates at historic lows Consumer Expectations If people expect that the economy is going to start to contract, they may reduce spending. This occurred during the summer of 2007 – consumer confidence fell, which contributed to the current recession Why do people reduce spending when they feel the economy is slowing down? High consumer confidence, though, will lead to people buying more goods They expect more job opportunities (& job security) and rising incomes This increases GDP. Consumer Confidence – 1966 to 2011 External Shocks Negative external shocks, like war breaking out in a country where U.S. banks and businesses have invested heavily, can have a great effect on business, causing GDP to decline. Another example: hurricane on East Coast Positive external shocks, like the discovery of large oil deposits, can lead to an increase in a nation’s wealth. Business Cycle Forecasting To predict the next phase of a business cycle, forecasters anticipate movements in real GDP Economists use leading indicators to help them make these predictions. GDP The stock market Housing starts, existing home sales Retail sales Jobless claims Factory orders reports Activity – Recessions In class Use the handout ‘Recessions in the U.S. (since the mid 1960’s)’ and a blank sheet of paper Create 10 good questions from which the answers are on the handout - cover all of the recessions (both sides) Example of good question: Print (write neatly) the questions on the front of the sheet Write out answers on the back of the sheet Which recession(s) had the longest duration? What were the main causes of the 1973-75 recession? Example of ‘not so good’ question: How long did the 1980 recession last? Activity – Recessions since the mid 1960’s Computer Lab You are a senior analyst working in the Finance Department of a large company. The CEO has given you a handout which contains 2 pages of data related to all of the recessions in the U.S. since the mid 1960’s The CEO wants the information summarized on 1 page Executive Summary using a graph, chart(table), timeline or other professional-looking format. Summarize the key data on the Executive Summary Include 2-3 bullet points describing causes Highlight (use Bold/Color) the most significant factors Include which President(s) was in office during each recession (separate column) The CEO needs the analysis for tomorrow’s board meeting. Business Cycles in American History The Great Depression Before the 1930s, many economists believed that when an economy declined, it would recover quickly on its own. The Great Depression changed this belief. Not until World War II, more than a decade later, did the economy achieve full recovery. Declining GDP and high unemployment were two major signs of the Great Depression, the longest recession in U.S. history. The Business Cycle Today Recent Recessions 2001 – dot.com industry (internet businesses created in the late 1990’s) slowed down significantly after periods of high growth The attacks of 9/11 led to another sharp drop in consumer spending in many service industries. 2007 – subprime mortgage crisis, housing collapse, failing banks and financial institutions, automakers Government used funds for bailouts and stimulus Real GDP growing at relatively low levels Unemployment levels still haven’t recovered close to prerecession levels Section 3 – Economic Growth Objectives 1. Analyze how economic growth is measured. 2. Explain what capital deepening is and how it contributes to economic growth. 3. Analyze how saving and investment are related to economic growth. 4. Summarize the impact of population growth, government, and foreign trade on economic growth. 5. Identify the causes and impact of technological progress. Introduction How does the economy grow? An increase in capital deepening A higher savings rate Population growth along with capital growth Government involvement Technological progress Measuring Economic Growth The basic measure of a nation’s economic growth rate is the % of change in real GDP over a period of time. Economists prefer a measuring system that takes population growth into account. For this, they rely on real GDP per capita (per person) Represents total GDP divide by the nation’s population $50,855 (Apr 2015) $49,998 (Oct 2013) GDP and Quality of Life GDP measures the standard of living but it cannot be used to measure people’s quality of life. In addition, GDP tells us nothing about how output is distributed across the population. While real GDP per capita tells us little about individuals it does give us a starting point for measuring a nation’s quality of life. In general, nations with a high GDP per capita experience a greater quality of life Capital Deepening A nation with a large amount of physical capital will experience economic growth. The process of increasing the amount of capital per worker, known as capital deepening, is one of the most important sources of growth in modern economies. Increasing capital investment (technology, improvements) Paying for training to improve workers skills Allowing workers to gain experience on-the-job Capital deepening leads to increased labor productivity (amount of output produced per worker) Saving and Investment If the amount of money people save increases, then more investment funds are available to businesses. Savings rate: the proportion of disposable income that is saved Higher savings = higher business investment = higher capital per worker = capital deepening Population Growth If the population grows while the supply of capital remains constant, the amount of capital per worker will shrink, which is the opposite of capital deepening. This process leads to lower standards of living. On the other hand, a nation with low population growth and expanding capital will experience significant capital deepening. Government If government raises taxes, households will have less money. People will reduce saving, thus reducing the money available to businesses for investment. If government invests the extra tax revenues in public goods, like infrastructure, this will increase investment, resulting in capital deepening. Foreign Trade Foreign trade can result in a trade deficit, a situation in which the value of goods a country imports is higher than the value of goods it exports. Exports < Imports U.S. has operating in a trade deficit position for many years Technological Progress A key source of economic growth. It can result from Technological progress increases a nation’s productivity. new scientific knowledge new inventions new production methods Producing more with same factors of production Also results in higher GDP per capita Causes of Technological Progress Scientific research and innovation Scale of the market Larger markets provide more incentives for innovation Education and experience New products increase output and boost GDP and profits Increases human capital Natural resources Increased natural resources use can create a need for new technology