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Explorations in Economics
Alan B. Krueger & David A. Anderson
Chapter 13: Exploring Economics
- Module 38: Measuring National Output and Income
- Module 39: Economic Growth
- Module 40: Business Cycles
MODULE 38:
Measuring National Output and
Income
KEY IDEA:
Gross domestic product, a measure of the value of goods and
services produced in the economy each year, is the most
widely used gauge of economic activity.
OBJECTIVES:
•To explain what gross domestic product is and how it is
measured.
•To identify what is not included in gross domestic product.
•To discuss the difference between real and nominal values.
•To explain why real gross domestic product is the most useful
measure of a country’s total output.
Great Depression
• Millions of people lost their jobs and were driven into sudden
poverty.
• During the Great Depression the U.S. congress lacked
adequate measures of economic performance.
• In 1932, the U.S Congress invited leading economists to
answer some basic questions about the state of the economy.
The information was not available
• To fix this knowledge gap, the U.S. government set up a
national income accounting system to measure the country’s
production and income in a timely manner.
• At the center of this accounting system is a measure of a
country’s production called Gross Domestic Product.
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GROSS DOMESTIC PRODUCT
DEFINED
A nation’s gross domestic product (GDP) is the total
dollar value of all final goods and services produced
within the country’s borders in a given year.
GDP is about domestic production as measured
through transactions. How many tractors produced at
their market price? How many haircuts at the market
price? How many apples produced at the market
price?.
GDP
Dollar Value
The dollar price is the measurement, not
quantity.
i.e. a good with a higher price (computer chip) will contribute more
to GDP than a good with a lower price (a tortilla chip)
Goods and Services
GDP includes both tangible goods and intangible
services.
Production includes services, such as the work performed by
plumbers, airline pilots, truck drivers, and doctors
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GROSS DOMESTIC PRODUCT
DEFINED
• Final Products
A final good or service is one that is sold to its final user, rather than to
a firm that will use it to make something else.
An intermediate product is a product that becomes part of a final good
or service, or is used up in the production process.
* not counted in GDP because they are already included in the
dollar value of the final good.
GDP DEFINED
• Within a Country’s Borders
The “D” in GDP stands for domestic so it is what products are produced
with a country’s borders.
*production that takes place in the country, regardless of the citizenship
of those who produce it. (GDP includes all production by firms that
operate in the United States, even if they are foreign owned)
*production that takes place in a other countries is not counted as part
of U.S. GDP even if it occurs in firms owned by U.S. citizens.
• In a Given Year
Products finished and ready for sale, not just sold, count within the
given year.
*Items made in one year and sold in the next are counted in GDP in the
year in which they are made.
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GDP DEFINED
•GDP only counts finished products and their value.
•Why don’t we count the value of the steel used in car
manufacturing when it is produced at the steel mill?
•Why don’t we count the wheat produced by the farmer when it
is used in the production of loaves of bread?
•What about the production of a new scarf that your
grandmother knitted for you and gave you for your birthday? Is
it counted as GDP?
•What about goods produced by an American company at their
facility in Asia?
•How do we handle the goods that are produced this year but
not sold until next year?
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THE EXPENDITURE
APPROACH
GDP =
Consumption + Investment + Government + (Exports-imports)
The expenditure approach to calculating GDP is to add up the spending on
everything included in GDP. * The most direct method
•Consumption —household purchases made by families and individuals.
(largest component of GDP)-food, clothes, furniture, movie tickets, gasoline
•Investment — business spending on physical capital (equipment), new homes,
and inventories (any goods produced but not sold during the year).
•Government — goods and services purchased by any level of government.
•Exports (X)— goods, services, and intermediate products bought by people in
other countries. Imports (M) —goods, services, and intermediate products
produced in other countries.
The Expenditure Approach
GDP =
Consumption + Investment + Government + (Exportsimports)
GDP = C + I + G (X-M)
• The expenditure approach counts the value of
everything we spend for in the economy. We count
the dollar price of all of these goods and services.
We use these categories so we can track changes and
pinpoint the areas of a lack of demand.
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THE EXPENDITURE APPROACH
Consumption by
households “C”
+
Gross Investment by
firms “I”
+
Government purchases
+ “G”
Exports minus Imports
(X-M)
= GDP
THE EXPENDITURE
APPROACH
United States GDP in 2011
INCOME APPROACH
(Less Direct)
The income approach to calculating GDP is to add up all the income earned
during the year by people who are involved in the production of goods and
services. Both the income and expenditures approach add up to the same
number. Money spent is money earned
GDP = wages + rent + interest + profit
WHAT’S NOT INCLUDED
IN GDP?
Not counted as part of GDP
• Unpaid work: household chores, volunteer work
• Purely financial transactions: purchase of corporate
stock, bonds, gold, or real estate
• Sale of used goods: secondhand cars, furniture, or
homes, already counted in GDP
• Foreign production
• Transfer payments such as Social Security payments
The underground economy represents business activity
conducted without the knowledge of the government. I.e. sale of
items by unlicensed street vendors, or barter exchanges
NOMINAL AND REAL GDP
Nominal GDP values each good at the dollar price it actually sold for in the
year in which it was produced.
Real GDP measures total production in dollars after removing the distorting
effect of price changes.
NOMINAL AND REAL GDP
The numbers are the same in 2005: Random Base Year
A change in Nominal GDP could be caused by a change in output,
a change in prices or a combination of change in price and output changes.
A change in Real GDP is always caused by a change in output.
When we hear reports of changes in the GDP, most often we mean changes in the
Real GDP.
Nominal and Real GDP are important for them to see how
inflation can destroy economic growth.
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MODULE 38 REVIEW
What is…
A. Gross domestic product
(GDP)?
B. Final good or service?
C. Intermediate product?
D. Expenditure approach?
E. Consumption?
F. Investment?
G. Government purchases?
H. Exports?
I. Imports?
J. Income approach?
K. Underground economy?
L. Nominal GDP?
M. Real GDP?
MODULE 39:
ECONOMIC GROWTH
KEY IDEA:
Economic growth— when it arises from growth in productivity—
raises living standards, although some countries have had great
difficulty achieving this kind of growth.
OBJECTIVES:
•To explain what economic growth is and how it is measured.
•To compare economic growth in countries across the globe.
•To identify the four factors that cause growth in productivity.
•To evaluate some of the controversies over economic growth.
STANDARD OF LIVING
• The standard of living is the level of material wealth
as measured by the consumption of goods and
services.
• Today, the American worker has a higher standard of
living than in the past, meaning more goods and
services and more wealth to purchase them with.
• What is responsible for these dramatic changes in the
average worker’s standard of living? The answer is
growth in real GDP per person.
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ECONOMIC GROWTH
DEFINED
Economic growth
is a sustained
increase in real
GDP over time.
Economic growth is
about trends; not
ups and downs.
Economic Growth
• The general, long-run trend in real GDP is upward.
• Since the beginning of the Great Depression in 1929,
real GDP in the United States has grown by more
than 3 percent per year on average.
• The rate at which real GDP increases is called the
economic growth rate.
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ECONOMIC GROWTH
DEFINED
Rule of 70
Divide 70 by the real GDP growth rate to find the
number of year for an economy to double in size.
Example:
70 divided by 3 equals 23.3 years for the economy to
double in size.
Example:
2012
USA 2.2% 70 / 2.2 = 31.1 years to double in size
China 7.8% 70 / 7.8 = 8.9 years to double in size
Germany .9% 70 /. 9 = 77.7 years to double in size
Panama 8.5% 70 / 8.5 = 8.23 years to double ( the
best real GDP growth rate in the world for 2012)
TRACKING LIVINGSTANDARDS
Real GDP per capita is
output per person, calculated
as real GDP divided by the
total population. Where real
GDP per capita is high ,
people generally live more
comfortable lives.
Notice “rich” countries are
associated with higher real
GDP.
Other standards:
•Under 5 yrs. Mortality
•Life Expectancy
•% Living on $1.25 per day
•Adult Literacy Rate
Real GDP per Capita
• Real GDP tells us how fast the entire economy is
growing, but it cannot, by itself, tell us whether living
standards are improving.
• The standard of living is determined by Real GDP
per Capita.
• It is not a perfect indicator, but the large differences
in real GDP per capital among countries are
important signals about living conditions for people
in those countries.
• Where real GDP per capita is very low, most people
are poor and vice versa.
GROWTH IN GDP PER CAPITA:
INTERNATIONAL COMPARISONS
Searching for sources of economic
growth.
• Discovery of new natural resources sometimes create
a temporary spurt of economic activity.
– Can explain a high GDP, but it cannot explain a continually
growing real GDP
• Another possible source of growth is a rising
population.
– Can cause real GDP to grow, but does not cause real GDP
per Capita to grow.
These both above factors do not explain the rising standards.
PRODUCTIVITY does.
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SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
The Central Role of Productivity
Productivity is the amount of output the average worker can
produce in an hour. Calculated by dividing a country’s total
output of goods and services by the total number of hours.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
The Four Pillars of Economic Growth
Pillar 1: Physical Capital
A country’s capital stock is the total amount of physical capital
in the country. Think of all the factories, tools, machines etc.
Capital deepening is
an increase in a country’s
capital per worker.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 1: Physical Capital
Investment and the Capital Stock
Economic infrastructure is physical capital, such as communications systems
and power systems, that provides a basic foundation that users share for many
types of economic activity. Capital increases the productivity of labor.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 1: Physical Capital
Investment and Depreciation
Depreciation is the amount of capital that is used up each year. Total
Investment spending must be greater than depreciation. If not, capital stock
declines. We must engage in capital deepening in order to provide more
capital to grow.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 1: Physical Capital
The Role of Saving
The portion of a country’s total income that is not paid in taxes or spent by
households on consumption goods.
Business investment for new capital and
depreciation is funded mostly with Domestic
Saving, which flows in to banks where loans
are made to businesses.
Money that is saved is borrowed by businesses
to fund new capital ; the borrowed money has
to be repaid. In order to repay these debts
companies invest in their capital stock to be
able to earn more.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 2: Human Capital
The Investment in Human Capital
Human Capital is the knowledge and skills of workers
Education creates a productive workforce.
Human Capital
• There are more ways to raise knowledge and skill besides
college. Vocational schools, training programs and hands-on
experience can all be ways to gain skill.
• Note that we still have high school graduation rates less than
90% in the US.
• College completion is growing at a faster rate as noted by the
steeper curve.
• The investment in human capital is important for the
individual and the country.
• More productive people are great for an economy.
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SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 3: Technological Change
Firms conduct research and development activities to discover
or improve products or procedures.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 4: Sound Governance
The rule of law is the principle that no person is above the law.
A fair legal system consists of laws and
methods of law enforcement. It fights
theft, protects property rights and
enforces contracts. Intellectual
property is protected with patents,
trademarks, and copyrights.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 4: Sound Governance
The rule of law is the principle that no person is above the law.
A fair regulatory system is a
variety of government
agencies that work to protect
people and natural resources
from harm by making and
enforcing regulations.
SEARCHING FOR SOURCES OF
ECONOMIC GROWTH
Pillar 4: Sound Governance
The rule of law is the principle that no person is above the law.
A fair tax system means that
the government must collect
taxes from individuals and
firms in a consistent, fair
manner.
BENEFITS OF
ECONOMIC GROWTH
Economic growth that is based on increases in productivity
rather than increases in population, increases living
standards in developed and developing countries alike.
MODULE 39 REVIEW
What is…
A. Standard of living?
B. Economic growth?
C. Rule of 70?
D. Real GDP per capita?
E. Productivity?
F. Capital stock?
G. Capital deepening?
H. Economic infrastructure?
I. Rule of law?
J. Research and development?
K. Depreciation?
L. Intellectual property?
MODULE 40:
BUSINESS CYCLES
KEY IDEA:
Economies go through ups and downs as the result of changes
in the overall, or aggregate, supply and demand for goods and
services in the economy.
OBJECTIVES:
•To describe the business cycle.
•To explain the general causes of economic expansions and
contractions.
•To identify the specific causes of the recession of 2007– 2009.
WHAT ARE BUSINESS CYCLES?
Business cycles are alternating periods of rising and
falling real GDP.
An expansion is a phase of the business cycle during which real
GDP rises.
Income levels
rise, firms hire
more and
more workers.
WHAT ARE BUSINESS CYCLES?
Business cycles are alternating periods of rising and
falling real GDP.
When an expansion is ending and the economy will proceed to a
contraction, the peak occurs.
A peak is at
the highest
level of real
GDP.
WHAT ARE BUSINESS CYCLES?
Business cycles are alternating periods of rising and
falling real GDP.
A contraction is a phase of the business cycle during which real
GDP falls.
Income levels fall,
more and more
workers are
unemployed.
WHAT ARE BUSINESS CYCLES?
A recession is a contraction severe enough to last several
months or longer and have widespread effects on
production, real income, employment, and sales across
the economy.
The National Bureau of Economic Research has the say of
whether a contraction has become a recession.
WHAT ARE BUSINESS CYCLES?
Business cycles are alternating periods of rising and
falling real GDP.
When a contraction ends and the economy will proceed to an
expansionary phase, the trough occurs.
A trough is
at the
lowest level
of real GDP.
WHAT ARE
BUSINESS CYCLES?
Five business cycles
in the U.S. economy
since 1980.
The shaded periods
are contractions; the
un-shaded periods
are expansions.
WHAT CAUSES
BUSINESS CYCLES?
Aggregate supply is the total output a country’s firms
are willing and able to produce, contingent on the
price level.
Short run: price level rises but changes in wages and other
input prices lag behind; firms can increase profit by selling
more.
Long run: an increase in the price level leads to increases in
wages and other input prices; the incentive to produce more
fades with the profit.
WHAT CAUSES
BUSINESS CYCLES?
Changes in aggregate supply can cause expansions
or contractions.
External Shocks: uncontrollable events, negative and positive
• Weather Changes
• Changes in the Price of Oil
• Technological Changes
•Weather Changes can cause havoc in farming areas. The
drought conditions of 2012 and now into 2013 can affect
consumer products like cereal and popcorn or biofuels. Thus,
decreasing aggregate supply. Favorable weather than increase
aggregate supply.
•Changes in the price of oil is a factor of the world supply and
the cost of drilling. Events in oil producing countries that stop
the flow of oil or new demands by foreign firms and
governments can affect the price. An increase in the price of
oil will decrease aggregate supply.
•Technological changes can raise productivity and increase
aggregate supply. Economic growth is spurred by new
innovation and new more productive machines and tools.
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WHAT CAUSES
BUSINESS CYCLES?
Aggregate demand is the total amount of domestic
output purchased by all sectors of a country’s
economy, contingent on the price level.
•Moving into expansionary periods will allow for more workers
and income levels rise. More spending by both consumers and
business will increase the Aggregate Demand.
•Moving into contractionary periods means fewer workers and
income levels fall. Less spending will decrease the Aggregate
Demand.
What causes Business Cycles
• Recall that the GDP is the C + I + G + X-M. These four
categories of spending make up the four areas of
Aggregate Demand.
• When new spending happens in any of these areas,
the Aggregate Demand will increase. Price level will
rise and firms have higher input costs, decreasing
Aggregate Supply.
• When spending falls, the Aggregate Demand will
decrease. Price level will fall and firms now have
lower input costs, increasing Aggregate Supply.
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WHAT CAUSES
BUSINESS CYCLES?
Causes of Changes in Aggregate Demand
Changes in Household Wealth
• Do you feel more or less wealthier?
Changes in Confidence
• Do you feel more or less confident about future?
Government Policy
• Will the government policy be able to smooth out the
“ups and downs” of business cycle?
What Causes the Business Cycle?
• A person’s wealth is made up of everything the person owns minus what
the person owes to others.
• Confidence is related to expectations about jobs, wages, price levels,
future sales, and government rules and regulations
• Fiscal and Monetary policy are the two ways that macroeconomic ideas
can be applied to move the economic in and out of recession and
inflationary periods.
• Consumers change their habits based on their feelings of wealth,
confidence and government policy.
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THE RECESSION OF
2007– 2009
How Bad was this Recession?
The Housing Bubble
A bubble is a rapid and unsustainable increase in the price of
certain assets, such as homes, gold, or stocks.
An asset can be anything of value that is owned or controlled
with the expectation that it will provide benefits in the future.
From late 1990’s to 2006, the housing bubble raged:
• Risky loans unchecked by government supervision
• low interest rates
• speculation by investors
What Causes the Business Cycle?
• Worst since the Great Depression. External shocks and deep cuts in
consumer and investment spending coupled with a doubling in price of oil
over the 2 years.
• Fewer buyers had desire or means to pay the higher prices in the housing
market. Prices fell as buyers disappeared. Speculators and those who had
the risky loans defaulted. Banks sold the homes for lower and lower
prices. Banks became reluctant to issue any new loans or save those still in
homes with risky loans. Those wanting to sell could not afford to sell since
they had loans to pay that were greater than the amount to be realized by
the sale. Aggregate demand fell nationwide and pushed us further into
recession.
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THE RECESSION OF
2007– 2009
The Housing Bust
THE RECESSION OF
2007– 2009
Other Factors behind the Recession
•A financial crisis in banking—many bank failures due to
bad loans and bad lending practices
•Plunging stock prices—falling production brings down
profits
•Loss of confidence—household and business confidence
plunged on bad news, massive layoffs, business closures
and drops in home prices.
MODULE 40 REVIEW
What is…
A. Business cycle?
B. Expansion?
C. Contraction?
D. Recession?
E. Depression?
F. Peak?
G. Trough?
H. Change in price level?
I. Aggregate supply?
J. External shocks?
K. Aggregate demand?
L. Wealth?
M. Bubble?
N. Asset?