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AP Macroeconomics
MR. GRAHAM
AP Exam Review
Unit 2:
Measurement of Economic Performance
(12-16%)
2
National Income Accounting
• Measures the flows of income and expenditures in
the economy over time.
• Serves the same purpose for the economy as a whole
as does the income statement of a firm.
• The most simplified representation of the
macroeconomy and national income accounting is
the Circular-Flow Model.
The Circular-Flow Diagram
• The model involves the following principles:
– There are two groups of decision-makers in a private
economy: households and businesses
– In every economic exchange, the seller receives exactly
the same amount that the buyer spends
– Goods and services flow in one direction and money
payments flow in the other
The Circular-Flow Diagram
FIGURE 2 The circular flow diagram expresses
the linkages between businesses and
households through the goods and factor
markets, as well as through government.
5
Gross Domestic Product (GDP)
• The most commonly presented statistic of national
income accounting is the GDP.
• Represents the total market value of all final goods
and services produced within a country in one year.
– It avoids double or multiple counting by eliminating any
intermediate goods (goods used up entirely in the
production of final goods).
• The GDP at the end of FY12 = $15.85 trillion.
Gross Domestic Product (GDP)
3 Ways for Calculating GDP
1. Production Approach:
•
Survey firms and add up the total value of their production
of final goods and services.
•
In order to avoid counting intermediate goods, only the
value added by each manufacturer is counted.
Gross Domestic Product (GDP)
3 Ways for Calculating GDP
2. Income Approach:
•
Sum the total factor income earned by households from
firms in the economy.
•
Adding up all components of national income, including
wages, interest, rent, and profits.
Gross Domestic Product (GDP)
3 Ways for Calculating GDP
3. Expenditure Approach:
•
Add up aggregate spending on domestically produced final
goods and services in economy.
•
Adding up the dollar value of all final goods and services
purchased by consumers, businesses, government, and
buyers from outside the country.
•
GDP = C + I + G + (X – M)
The Components of GDP
GDP = C + I + G + (X – M)
1. Consumption (C): Households’ purchases of final
goods and services during the year.
2. Gross Private Domestic Investment (I): Households’
savings that businesses can borrow to invest in
equipment, factories, or inventories.
3. Government Expenditures (G): consumption and
investment for all government branches.
4. Net Exports (X - M): the value of exports (X) less the
value of imports (M).
Nominal GDP and Real GDP
• Nominal GDP: GDP calculated at existing prices.
• Real GDP: Nominal GDP adjusted for inflation.
Nominal GDP
Real GDP =
x 100
GDP Deflator
•
Provides us with a scale against which to compare our
current economy with
• Economic performance of other years (Real GDP)
• Economic performance of other countries (Real GDP per capita)
8-11
The Unemployment Rate
• Unemployment Rate
– The percentage of the labor force that is unemployed.
Unemployed
Unemployment Rate =
x 100
Labor Force
• Labor Force
– Those people in the economy who are over 16, not in the
armed forces, and willing and able to work.
– 155.5 million people (February 2013)
7-12
Problems with the Unemployment Rate
•
Excludes discouraged workers
•
•
Excludes underemployed workers
•
•
individuals who have stopped looking for a job because they
are convinced they will not find a suitable one.
individuals working beneath their skill level or only able to
find part-time jobs.
Varies greatly among (and therefore misrepresents)
certain demographic groups
7-13
Categories of Unemployment
• Frictional Unemployment
– Results from workers moving from one job to another
seeking appropriate offers
• Structural Unemployment
– Results from a poor match of workers’ abilities and skills with
current requirements of employers
• Cyclical Unemployment
– Results from business recessions and economic downturns
that occur when aggregate (total) demand is insufficient to
create full employment
7-14
Natural Rate of Unemployment
• When cyclical unemployment is zero, the
unemployment rate is called the natural rate of
unemployment, because it reflects unemployment
that arises from natural features of a market society.
• It changes over time and is generally thought to be
around 5% in the U.S. today.
Inflation
• Inflation
– The situation in which the average of all prices of goods
and services (i.e. “price level”) in an economy is rising.
– Measured through the use of price indexes
• Inflation Rate
– The percentage increase in overall level of prices per year.
Inflation Rate =
Price Index in Year 2
Price Index in Year 1
-1
• Price Index
– Summarizes what happens to the prices in a constant
“market basket” of goods and services.
Nominal and Real Values
• Inflation is decline in purchasing power of money
– Nominal value: price expressed in today’s dollars
– Real value: value expressed in purchasing power
(i.e. adjusted for inflation)
– For example, a $100 bill from your grandparents this year
will have a nominal value of $100 next year but a real
value of less, assuming a decrease in the purchasing
power after a year of inflation.
"Costs" of Inflation
• Shoe-Leather Costs
– A high inflation rate discourages people from holding money
and encourages them to search out ways to combat inflation.
• Menu Costs
– A high inflation rate forces firms to change prices more often
than they would if the price level was more or less stable.
• Unit-of-Account Costs
– A high inflation rate causes a dollar next year to be worth less
than a dollar this year.
Winners and Losers from Inflation
• Economists summarize the effect of inflation on
borrowers and lenders by distinguishing between
nominal and real interest rates.
– Nominal Interest Rate
• The market rate of interest expressed in today’s dollars
– Real Interest Rate
• The nominal interest rate adjusted for inflation
(i.e. minus the inflation rate)
Winners and Losers from Inflation
• When inflation is higher than anticipated…
– Creditors lose
– Debtors gain
– Creditors lose because the debtor is charged an interest
rate that does not cover the actual inflation rate
• When inflation is lower than anticipated…
– Debtors lose
– Creditors gain
– Debtors lose because they are charged an interest rate
that is higher than the actual inflation rate
Protecting Against Inflation
• Banks attempt to protect themselves by raising nominal
interest rates to reflect anticipated inflation (i.e. ARMs)
• Workers attempt to protect themselves with Cost of
Living Adjustments (COLAs)
– Clauses in contracts that allow for increases in specified
nominal values to take account of changes in the cost of living
• Individuals attempt to protect themselves by placing
their savings into interest-bearing accounts
– Often pay nominal rates of interest that reflect anticipated
inflation
Price Indexes
• Consumer Price Index (CPI)
– A measure of the price of a fixed basket of consumer goods
designed to represent the average consumer’s expenditures
– Reported monthly by BLS; most commonly used measure.
• Producer Price Index (PPI)
– A measure of the price of a fixed basket of goods common to
industrial production.
– Used as a short-run leading indicator (before CPI)
• GDP Deflator
– A price index measuring the changes in prices of all new
goods and services produced in the economy.