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The BIG Picture MACROECONOIMCS The Big Picture Circular Flow Model - Simplified Shows how people and business interact in the market Focus on the private sector Participants: Households & Firms Two Markets Factor Market – inputs/factors of production Product Market – finished goods & services The Big Picture More Complete Circular Flow Shows how a domestic economy functions within the context of the larger global economy Includes: Private and Public sectors Participants: Households, Firms, Government, Banks, International Trade Shows: Flow of products & factors, money, taxes and government services, imports & exports, savings and investments Leading Economic Indicators Indicators that help us determine the health of the overall economy include… Gross Domestic Product Inflation Rates & Consumer Price Index Unemployment Rate Interest Rates GDP – Gross Domestic Product Total market value of a nation’s final output of goods and services What length of time is GDP calculated? 1 Year 4 business quarters 1st quarter – January to March 2nd quarter – April to June 3rd quarter – July to September 4th quarter – October to December 2 ways to calculate GDP Income Approach - Total of all income earned in a year. Measured by totaling wages, interest, profits, rents, (anything that brings in income) Expenditure Approach - Total spending for new goods and services produced in a year. Measured by totaling consumer spending, business investments, government spending, and net foreign spending (difference between exports and imports) Consumer Spending Total spending on all durable goods, nondurable goods, and services Toothpicks to Homes Nondurable = do not last a long time, consumed as soon as purchased, ex: food Durable = last for a long time, used over again, ex: cars, homes, appliances Biggest part of GDP; takes up about 2/3 in US Business Investments The physical investment in capital (inputs) to make business better Buying a new factory or office building Buying new technologies to improve research and development Buying new tools/machines for production Government Spending Guns vs. Butter Guns = military spending Butter = social policy spending Note: Discretionary spending = Expenditures within the U.S. budget that are negotiated between the Branches of Congress and the President's Office each year. Mandatory spending is not up for debate. GUNS – Military Spending Net Foreign Exports The difference between exports and imports Negative number = Trade Deficits occur when a country imports more than it exports Positive number = Trade Surpluses occur when a country exports more than it imports US Balance of Trade 1970-2006 GDP is not perfect …problems with the calculation Double Counting Underground Economy GDP per capita Inflation Double Counting Occurs when the value of a contributor is counted more then once into GDP Buying a used car – the value of that car should not be added to GDP because the value of its production was already counted Underground Economy Unpaid house work Barter Black market GDP per capita (per person) Assume GDP is the same in two countries $500 billion Country A has a larger population than country B A = 200 million B= 80 million Country B is going to have a larger GDP per capita A = $2500 B = $6250 Country B by comparison is therefore more well off Inflation Inflation – A rate of increase in the general price level of all goods and services Makes figures appear higher than they really are Nominal (current dollar) vs. Real (constant dollar) GDP Nominal does not adjust for inflation Real adjusts for inflation Consumer Price Index (CPI) is the measure of the average price level in the economy. US Annual Averages through history ; Inflation Rate Causes of Inflation Too much money in the economy Federal Reserve prints money People continue to make more money & spend it Demand exceeds supplies - demand can't keep up, business raise their price to adjust to the shortage Cost of inputs goes up and those increases get passed on to the consumer with higher prices on products Hyper and Deflation Hyperinflation Excessive & rapid rise in price levels Money rapidly looses its value 100% inflation – something that cost $100 on Monday costs $200 Tuesday Deflation Decline in price levels Usually cause by a reduction in spending Historical look at US inflation For the past 20 years, inflation in the US has been less than 5%, typically falling between 2-3%. Computing Real GDP Real GDP = Current Dollar (nominal) GDP Adjustment for inflation Calculating Real GDP 1994 real GDP $625 billion 1995 GDP $640 billion – inflation was 4.8% Was there really an increase of $15 billion? If inflation was 4.8% (.048), then prices the second year were 1.048 times the prices in the first year = Actually there was a ___________ Unemployment Rate The percentage of the labor force that does not have a paying job. Labor force includes those 16+ years old: who are working who are actively looking for a job Low unemployment is desirable; high is undesirable. US Unemployment rates ; by president The Business Cycle Peak Peak Trough Trough A series of rises and falls in the overall level of economic activity, measured by real GDP Expansion Economic recovery People begin _______ money and opening businesses Demand brings _______ production Employment _______ People begin to invest Peak Period prior to contraction/shrinking economy– as good as it is going to get A period of prosperity People are spending money on ________ goods Economy is very productive Unemployment is _________ People are investing Contraction Prosperity begins to wear off – economy begins to _________ Production begins to ________ People aren’t buying as much as they normally do Unemployment is _______ If contractions last long enough they can be considered recessions and potentially become depressions Recession Any period of at least 6 months (2 business quarters) in which the economy does not grow (negative growth) Characterized by slowing business, consumption, and investment Depression A severe and prolonged decline in the level of economic activity Characterized by falling prices, business failures, surpluses, and high unemployment Trough Period before expansion/economic recovery – as bad as it is going to get Extreme _______of the economy People are not typically spending money on _______goods; demand in general is _______ Productivity is at its ________ Unemployment is ________ than normal Pains of Market Fluctuations High unemployment during recessions Unemployment results in lower production (real GDP) and therefore lower income and consumption levels High inflation during big expansions People on fixed incomes who can’t buy as many goods & services What can be done to help the economy? Stabilizers: Fiscal Policy - Changes in government spending and/or taxes Automatic Discretionary Monetary Policy Federal Reserve System Fiscal Policy – Automatic Stabilizers Some government expenditure and tax revenues automatically rise or fall with changes in the economy If the economy suffers a recession, government spending for unemployment and welfare increases revenues from income and sales taxes fall. If the economy experiences a great expansion, vice versa. Fiscal Policy – Discretionary Government can adopt countercyclical changes in spending and taxes Increasing spending or cutting taxes during recessions Decreasing spending or increasing taxes during periods of high inflation. Monetary Policy – the FED Objective: to influence the availability and cost of money and credit as a means of helping to promote national economic goals promote "maximum" sustainable output control inflation and stabilize prices The FED manipulates interest rates to improve the economic condition Interest Rates A rate which is charged or paid for the use of money Change as a result of inflation and FED policies. Increase rates to keep prices affordable (control inflation) Decrease rates to encourage spending