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o “Honey, what did you do in school today?” “I will tell you what I didn’t do Mom/Dad. I didn’t write my name on the ‘Earning a Living in Econoland’ paper, and I didn’t lose/steal/bend Mr. Danskin’s paperclip.” o “Oh sweetie pie, you’re the bestest little precious child an adult caregiver could ask for. Do you want to go for ice cream?” “Hooray! Ice Cream! Ice Cream! Ice Cream! Ice Cream!” Unit 2 Macroeconomic Measuring The Circular Flow Model • The circular flow of economic activity is a model of an economy showing the interactions among households, firms, and government as the exchange products and resources in markets. • Households sell their resources to businesses in the Resource Market. • Households use their income gained in the Resource Market to buy goods and services from businesses in the Product Market. Homework: • Copy the diagram on page76 in your book as it shows the government’s involvement in the circular flow model. Be sure to include an explanation similar to the one found in Figure 4.6 Macro Goals Macroeconomic Goals • A steady flow of dollars and goods must keep circulating through the economy or commerce ceases. Macro issues involve how to keep the flow going. • Main macro goals include increasing national production, full employment and stable prices. Valuing Production • It’s important to find the value of goods produced not just the amount. We need to know the prices of goods. • The following table shows the amount produced at a coffee shop. The two months produced the same sum of goods, but the mix is different. January February # of Coffees # of Café Lattes # of Scones # of Coffees # of Café Lattes # of Scones 25 25 50 30 30 40 Cont. • To more accurately reflect the coffee shop’s production, we need to add values. January Quantity Prices Value of Production Coffee 25 $3.00 $75 Café Lattes 25 $2.50 $62.50 Scones 50 $1.50 $75 Totals 100 February Quantity Prices Value of Production Coffee 30 $3.00 $90 Café Lattes 30 $2.50 $75 Scones 40 $1.50 $60 Totals 100 $212.50 $225 Aggregate • To move from the value of one firm to the entire US economy, we need to aggregate. We need to value all production of all firms and then add them up. • This aggregated measure of the total value of domestic production allows us to calculate GDP. • GDP – the market value of all final goods and services produced annually within the borders of a country. Gross Domestic Product Aggregate Spending • Since GDP is measured by adding up the value of the final goods and services produced in a given year, we just need to figure out from where this spending is coming. Spending on output is done by four sectors of the macroeconomy. • Consumer Spending (C): Largest component of GDP. Durable goods are expected to last a year or more (cars). Nondurable goods are consumed in under a year (food). Services (tax preparation). • Investment Spending (I): Current spending in order to increase output and productivity later. 3 types of Investment: ▫ New capital machinery purchased by firms: Delivery trucks for UPS or an AC unit for the Holiday Inn ▫ New construction for firms or consumers: New store built for the Gap, Residential housing like homes or apartments. ▫ Market value of unsold inventory: Goods unsold on December 31st would be added to (I) and changed back to (C) when sold the next year. • Government Spending (G):All levels of government purchasing final goods and services and investing in infrastructure: Police cars, computers for the Pentagon, Fighter jets. Infrastructure includes highways, airports, jails. (Does not include transfer payments) • Net Exports (X-M): We add any domestically produced goods consumed by foreigners (exports = X) and subtract foreign goods purchased domestically (imports=M) Table 4.2 Real gross domestic product by major demand category, 1992, 2002, 2012, and projected 2022 Contribution to percent Billions of chained 2005 dollars Annual rate of change change in real GDP 1992— 2002— 2012— 1992— Category 1992 2002 2012 2022 2002 12 22 2002 2002—12 2012—22 Gross domestic $11,543. $8,280.0 $13,593.3 $17,584.2 3.4 1.6 2.6 3.4 1.6 2.6 product 2 Personal consumption expenditures 5,503.2 8,018.3 9,603.3 12,380.1 3.8 1.8 2.6 2.5 1.3 1.8 983.1 1,800.4 1,914.4 3,038.2 6.2 0.6 4.7 1.0 0.1 0.7 683.5 718.7 1,098.4 1,646.8 1,837.4 2,238.1 3,117.7 3,296.8 4.9 8.6 5.3 3.1 5.4 3.9 0.5 -1.0 0.5 -0.5 0.8 -0.7 1,893.2 2,279.7 2,481.1 2,487.0 1.9 0.9 0.0 0.3 0.2 0.0 549.8 505.3 677.2 560.0 -0.8 3.0 -1.9 -0.1 0.2 -0.1 233.3 274.0 347.1 302.1 1.6 2.4 -1.4 0.0 0.1 0.0 State and local 1,107.6 1,500.7 Residual2 -61.8 -6.9 Addendum: GDP per capita, chained 32,226.7 40,090.9 2005 dollars 1,461.7 -9.7 1,615.1 -132.1 3.1 - -0.3 - 1.0 - 0.3 - 0.0 - 0.1 - 0.7 1.9 - - - Gross private domestic investment Exports Imports1 Government consumption expenditures and gross investment Federal defense Federal nondefense 43,152.3 51,834.7 2.2 GDP: What’s Not Counted • Intermediate goods are those that require further processing. ( Tomatoes in ketchup, windshield wipers for new cars.) • This avoids double counting as a tomato may be sold several times before it ends up in the ketchup bottle. • Second-hand sales are not counted. • Nonmarket transactions do not count. Fixing your broken sink does not count towards GDP. • Underground economy – Sorry drug dealers, prostitutes, and baby-sitters who accept cash; none of your low life actions count in GDP. Homework: • Read pages 106 – 113 and answer questions 1, 2, 3, and 4 on page 122 Real and Nominal GDP • When calculating GDP we must take into account price changes. • Reporting a rise or fall in GDP doesn’t mean a lot if prices have changed from year to year. • Nominal GDP – The value of current production at current P • Real GDP – The value of current production using P at a fixed point in time Price Index • To calculate GDP we need a price index. This index is a measure of the P of a good when compared to the P of that good in a base year. • In this table the base year is 2000. The Price index is the percentage change from the Price ($2) in that year Year # of Lattes Price per Cup Nominal GDP Price Index Real GDP 2000 1000 $2 $2000 100 $2000 2001 1200 $3 $3600 150 $2400 2002 1800 $4 $7200 200 $3600 2003 1600 $5 $8000 250 $3200 Deflating Nominal GDP • To deflate nominal value or adjust for inflation, you do simple division: ▫ Real GDP = 100 × (Nominal GDP)/(Price Index) • In the table above, while nominal GDP appears to be rising rapidly, in real terms the value of latte production is more modest from 2000-2002 and fell in 2003. • Another way to see the relationship between a price index, real GDP and nominal GDP: %Δ Real GDP = %Δ Nominal GDP - %Δ Price Index • Example: If nominal GDP increased by 5% and the Price Index increased by 1%, real GDP increased by 4% The GDP Deflator • GDP is found by aggregating the consumption of 1000’s of goods and services • The prices of these goods are used to construct a price index informally called the GDP price deflator. • Nominal GDP is deflated to create real GDP which economists use to look for signs of economic growth and recession. Classwork: Real vs. Nominal GDP • Read pages 116-119 in your book and answer questions 11,12 and 13 on page 122. Inflation and the Consumer Price Index Consumer Price Index (CPI) • The GDP price deflator measures the increase in the price level of items that compose GDP. • Not all goods in GDP are goods that the everyday household shops for. A Boeing 747 comprises GDP but does not fall within consumer spending. • We need a statistic that focuses on consumer prices. • The Bureau of Labor Statistics (BLS) selects a base year and a market basket of approx. 400 consumer goods and services bought in that year. A monthly survey is conducted in urban areas around the country to find average prices. 2000 (Base Period) Items in Quantity the Basket Purchased 2001 (Current Period) Price Spending Price Spending on 2000 Quantities Chocolate Bars 12 $1.50 $18 $1.75 $21 Concert Tickets 4 $45 $180 $60 $240 Compact Disks 18 $16 $288 $15 $270 Total Spending = $486 = $531 Inflation • Price Index Current Year = 100 × (Spending Current Year) (Spending Base Year) • 2001 Price Index = 100 × (531)/(486) = 109.26 • In the above example the price index increased from 100 to 109.26, or the average price level increased 9.26%. • The annual inflation rate is the % change in the CPI from one year to the next. GDP Deflator vs. CPI • GDP deflator includes more than just consumer goods, it is a broader measure of inflation, while the CPI is a measure of inflation of only consumer goods. Homework: • Read pages 134 – 137 (up to and including Quick Review7.3), answer questions 10,11, and 12 on page 144 in the notes section of your notebook. Effects of Inflation Nominal vs Real Income • Rising prices are bad for consumers when they cause a decrease in purchasing power. • When nominal income h slower than P, there is a i in real income, when incomes h faster, there is an h in real incomes. • Real Income = 100 × (Nominal Income)/(CPI) Expected Inflation • Many employees have a cost of living adjustment that is built into their salary negotiations. Government increases minimum wages to reflect expected inflation. • Banks acknowledge inflation by factoring expected inflation into interest rates. Unexpected Inflation • Employees and employers – If real income is i because of rapid inflation, firms are benefitting at the expense of workers. They gain by high prices and low wages. • Fixed income recipients – A retiree receiving a pension will see it slowly eroded by inflation, A landlord locked into a long term lease receives payments that decline in purchasing power. • Savers and Borrowers - If I put money in a bank for a year, when I take it out, purchasing power has diminished. If I borrow from a bank and pay back at an inflated rate, I am giving back dollars that are worth less than when I borrowed. • Fixed payments hurt lenders and benefit borrowers with unexpected inflation. Unemployment How is Unemployment Measured? • Unemployment is measured by the Bureau of Labor Statistics (BLS). It surveys 60,000 randomly selected households every month. The survey is called the Current Population Survey. The BLS considers a person an adult if he or she is over 16 years old. A person is considered employed if he or she has spent most of the previous week working at a paid job. A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job. A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force. The BLS defines the labor force as the sum of the employed and the unemployed. • The unemployment rate is calculated as the percentage of the labor force that is unemployed. Number unemployed Unemployme nt rate = 100 Labor force Homework/Classwork • Read pages 129 – 134 and answer questions 5, 6, 7 and 8 on page 144. Include this in your notes. Types of Unemployment Does the Unemployment Rate Measure What We Want It To?? • • • It is difficult to distinguish between a person who is unemployed and a person who is not in the labor force. Discouraged workers – Those who give up looking for a job Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t looking for work. Categories of Unemployment The problem of unemployment is usually divided into two categories. • The long-run problem and the short-run problem: • The natural rate of unemployment The cyclical rate of unemployment Types of Unemployment • Frictional unemployment – Occurs when people take time to find a job. • Structural unemployment – Occurs when workers skills do not match the jobs available. • Cyclical unemployment – Occurs during economic downturns and is absent when the economy improves. Business Cycles •Classwork: Read pages 125128 and answer questions 1, 2, and 4 on page 144 Business Cycles • Business cycle – Rising and falling of output in relation to potential output • Recession – Two consecutive quarters of negative growth in real GDP • 4 phases of the business cycle – Expansion, Peak, Contraction, Trough • Inflation typically comes with expansion, unemployment with contraction. • There is no consistent length of time for each phase. • Business cycles are unpredictable. • Economists can identify causes after the fact, but often have trouble identifying beforehand Notebook Check 1. 2. 3. 4. 5. 6. 7. Circular Flow Chart pg. 76 Demand - # 1-2 pg. 63 Supply - # 4-6 pg. 63 GDP - # 1-4 pg. 122 Real vs. Nominal - # 11-13 pg. 122 Unemployment # 5-8 pg. 144 Business Cycles # 1,2, 4 pg. 144 Unit 2 Notebook Check • • • • Real vs. Nominal GDP Inflation and CPI Types of Unemployment Unit 2 Notes Unit 2 Quiz 1. What types of transactions are counted in GDP? 2. What types of transactions are not counted in GDP? 3. List the formula that is given for finding nominal GDP 4. Give the formula for finding Real GDP. 5. List the groups of people who are hurt by unexpected inflation. 6. Give the reasons we need the Consumer Price Index. 7. Explain how real income is based on nominal income and price level. 8. Explain how the labor force is found. 9. Give the formula for the unemployment rate. 10. Describe the three types of unemployment. 11. Describe the need for finding Real GDP. 12. Explain the relationship between Real GDP and Nominal GDP.