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Principles of UNIT II – MEASURING NATIONAL INCOME, INFLATION AND UNEMPLOYMENT BABY THOMAS 2016 6/15/2016 BABY THOMAS 2016 1 UNIT II – MEASURING NATIONAL INCOME, INFLATION AND UNEMPLOYMENT 1. Gross Domestic Product (GDP), components of GDP, real and nominal GDP 2. Measurement of Gross Domestic Product 3. Components of GDP, real and nominal GDP 4. Gross National Product (GNP), Net National Product (NNP) 5. Meaning of inflation, types of inflation, economic effects of inflation 6. Meaning of unemployment, measuring unemployment rate Kinds of unemployment 6/15/2016 BABY THOMAS 2016 2 GROSS DOMESTIC PRODUCT (GDP) • GDP is the total market value of all final goods and services produced within a country in a given period of time. • Gross domestic product (GDP) is a measure of the income and expenditures of an economy. 6/15/2016 BABY THOMAS 2016 3 THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “GDP is the Market Value . . .” – Output is valued at market prices. • “. . . Of All Final . . .” – It records only the value of final goods, not intermediate goods (the value is counted only once). • “. . . Goods and Services . . . “ – It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). 6/15/2016 BABY THOMAS 2016 4 THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . Produced . . .” – It includes goods and services currently produced, not transactions involving goods produced in the past. • “ . . . Within a Country . . .” – It measures the value of production within the geographic confines of a country. 6/15/2016 BABY THOMAS 2016 5 THE MEASUREMENT OF GROSS DOMESTIC PRODUCT • “. . . In a Given Period of Time.” – It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). 6/15/2016 BABY THOMAS 2016 6 THE ECONOMY’S INCOME AND EXPENDITURE • For an economy as a whole, income must equal expenditure because: – Every transaction has a buyer and a seller. – Every dollar of spending by some buyer is a dollar of income for some seller. • The equality of income and expenditure can be illustrated with the circular-flow diagram. 6/15/2016 BABY THOMAS 2016 7 The Circular-Flow Diagram MARKETS FOR GOODS AND SERVICES •Firms sell Goods •Households buy and services sold Revenue Wages, rent, and profit Goods and services bought HOUSEHOLDS •Buy and consume goods and services •Own and sell factors of production FIRMS •Produce and sell goods and services •Hire and use factors of production Factors of production Spending MARKETS FOR FACTORS OF PRODUCTION •Households sell •Firms buy Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars 6/15/2016 BABY THOMAS 2016 8 Copyright © 2004 South-Western THE COMPONENTS OF GDP • GDP includes all items produced in the economy and sold legally in markets. • What Is Not Counted in GDP? – GDP excludes most items that are produced and consumed at home and that never enter the marketplace. – It excludes items produced and sold illicitly, such as illegal drugs. 6/15/2016 BABY THOMAS 2016 9 THE COMPONENTS OF GDP • GDP (Y) is the sum of the following: – Consumption (C) – Investment (I) – Government Purchases (G) – Net Exports (NX) Y = C + I + G + NX 6/15/2016 BABY THOMAS 2016 10 THE COMPONENTS OF GDP • Consumption (C): – The spending by households on goods and services, with the exception of purchases of new housing. • Investment (I): – The spending on capital equipment, inventories, and structures, including new housing. 6/15/2016 BABY THOMAS 2016 11 THE COMPONENTS OF GDP • Government Purchases (G): – The spending on goods and services by local, state, and federal governments. – Does not include transfer payments because they are not made in exchange for currently produced goods or services. • Net Exports (NX): – Exports minus imports. 6/15/2016 BABY THOMAS 2016 12 GDP and Its Components 6/15/2016 BABY THOMAS 2016 13 Copyright©2004 South-Western GDP and Its Components (2001) Government Purchases 18% Net Exports -3 % Investment 16% Consumption 69% 6/15/2016 BABY THOMAS 2016 14 REAL VERSUS NOMINAL GDP • Nominal GDP values the production of goods and services at current prices. • Real GDP values the production of goods and services at constant prices. 6/15/2016 BABY THOMAS 2016 15 REAL VERSUS NOMINAL GDP • An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator. 6/15/2016 BABY THOMAS 2016 16 Real and Nominal GDP 6/15/2016 BABY THOMAS 2016 17 Copyright©2004 South-Western GDP Deflator • The GDP deflator is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. • It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced. 6/15/2016 BABY THOMAS 2016 18 The GDP Deflator versus the Consumer Price Index • The GDP deflator is calculated as follows: Nominal GDP GDP deflator = 100 Real GDP 6/15/2016 BABY THOMAS 2016 19 Real and Nominal GDP 6/15/2016 BABY THOMAS 2016 20 Copyright©2004 South-Western GROSS NATIONAL PRODUCT (GNP) Gross National Product (GNP) is the total market value of goods and services produced by all nationals of a country within and outside the country for a given period. 6/15/2016 BABY THOMAS 2016 21 NET NATIONAL PRODUCT (NNP) • Net National Product (NNP) is the total market value of goods and services produced by all nationals of a country within and outside the country for a given period after deducting depreciation. 6/15/2016 BABY THOMAS 2016 22 INFLATION • Inflation is the percentage change in an economy’s overall price level. 6/15/2016 BABY THOMAS 2016 23 TYPES OF INFLATION Demand pull inflation • Demand pull inflation occurs when aggregate demand exceeds the aggregate supply • Demand pull inflation is commonly referred to too much money chasing after too few goods and services • Rise in aggregate demand may be due to a rise in consumer demand or level of government expenditure or investment by firm or country’s exports or a combination of the four 6/15/2016 BABY THOMAS 2016 24 TYPES OF INFLATION • Cost-push inflation • Cost-push inflation refers to an increase in the general price level associated with an increase in the cost of production. • Inflation occurs due to the increase in the costs or supply prices of goods caused by increase in the cost of inputs. 6/15/2016 BABY THOMAS 2016 25 ECONOMIC EFFECTS OF INFLATION The economic effects of inflation are as follows: 1. 2. 3. 4. 5. Inefficient market Hoarding of Commodities Discourages investment & saving Higher income tax rates Increased imports and reduced exports. 6/15/2016 BABY THOMAS 2016 26 UNEMPLOYMENT Unemployment is the inability of labor-force participants to find jobs. 6/15/2016 BABY THOMAS 2016 27 MEASURING UNEMPLOYMENT RATE • The labor force is defined as the sum of the employed and unemployed. • The unemployment rate is defined as the percentage of the labor force that is unemployed. Unemployment Rate = Example: Number of Unemployed 100 Labor Force Labor Force = 145.0 + 10.1 = 155.1 million Unemployment rate = (10.1/155.1) x 100 = 6.5% 6/15/2016 BABY THOMAS 2016 28 Kinds of Unemployment There are four types of unemployment: 1. 2. 3. 4. Seasonal Unemployment Frictional Unemployment Structural Unemployment Cyclical Unemployment 6/15/2016 BABY THOMAS 2016 29 Seasonal Unemployment Seasonal unemployment is unemployment due to seasonal changes in employment . 6/15/2016 BABY THOMAS 2016 30 Frictional Unemployment Frictional unemployment is a brief period of unemployment experienced by people moving between jobs or into the labor market. People have the skills and knowledge necessary to get a job, and the jobs are available. Examples of frictionally unemployed people include new college graduates and people quitting a job and looking for something different or better. 6/15/2016 BABY THOMAS 2016 31 Structural Unemployment Structural unemployment is unemployment caused by a mismatch between the skills or location of job seekers and the requirements or location of available jobs. Jobs may be available in other geographic areas or for individuals with specific skills and abilities. Examples include laid off steelworkers in the 1980s and defense contractors in the 1990s. Also teenagers and others with a lack of job skills are included. 6/15/2016 BABY THOMAS 2016 32 Cyclical Unemployment Cyclical unemployment is unemployment caused by lack of job vacancies; an inadequate level of aggregate demand. Cyclical unemployment commonly occurs during recessions. Companies cut back on workers due to reduced sales, fears of an economic recession, and insufficient consumer demand. 6/15/2016 BABY THOMAS 2016 33 Principles of UNIT II MEASURING NATIONAL INCOME, INFLATION AND UNEMPLOYMENT BABY THOMAS 2016 6/15/2016 BABY THOMAS 2016 34