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Measuring a Nation’s Economic Health GDP Gross Domestic Product (measures national growth) CPI Consumer Price Index (measures inflation) UNEMPLOYMENT Problems measured in Macroeconomics We will cover the following: 1) Economic Growth (measured by looking at GDP) 2) Unemployment (measured by US Census) U.S. Department of Labor Bureau of Labor Statistics 3) Inflation (measured with the CPI) 4) Deficits (means a negative amount) International Trade Deficit (more imports than exports) Federal Budget Deficit (government debt for spending on social programs and military) Measuring Economic Health When you go for a checkup, the doctor looks at several indicators: • heart rate, blood pressure, and body temperature - to help determine your basic level of health. The general economic health of a nation can also be judged by looking at several economic indicators, which include: 1. the Gross Domestic Product (G.D.P.) "economic heartbeat of a nation" 2. the Consumer Price Index (C.P.I.) 3. the Unemployment Rate. Gross Domestic Product Gross domestic product (GDP) is the aggregate (total) market value of all final goods and services produced within a country in a given period of time. Sometimes the measurement is looked at on a per person scale, which is known as… Real GDP per capita (per person) It is the GDP divided by the population. Example: When a country has a low GDP per person, it tells us a lot about conditions in that country. How to measure GDP? 1) Output of the products/services is always valued at market prices. (not sale/discounted prices) 2) It records only the value of final goods, not intermediate goods. Intermediate goods: those goods used to produce a finished good. No double counting of goods: the value of a good is counted only once. Example: fuzz used in Fuzzy Wuzzy would NOT be counted in GDP, but the toy would be. Let’s see another example of this… Fuzzy Wuzzy How to measure GDP? Golden Rule: No double counting of goods: such as used goods, intermediate goods (goods used in production process), money spend on depreciation (replacing old worn-out items) Example of the correct way to count a good into GDP: A wooden desk sold to you for $200. You would figure $200 into the GDP? Example of Double Counting a desk (the wrong way): Timber sold to a mill: After it was milled it was sold to manufacture: Manufacture built the desk and sold to a retailer: Retailer marks it up and sells it to you: If all transactions were added up then total would be: $20 $50 $120 $200 $390 How to measure GDP? 3) It includes goods and services currently produced, not transactions involving goods produced in the past or money spent on replacing old goods. NO USED GOODS ARE COUNTED BECAUSE THEY HAVE ALREADY BEEN COUNTED IN A PREVIOUS YEAR (OR QUARTER) 4) It measures the value of production within the geographic confines of a country. ONLY WITHIN A NATION’S BORDERS Example: A Wal-Mart in Mexico, would its sales be counted in the U.S. GDP? NO How to measure GDP? 5) It excludes government TRANSFER PAYMENTS (social security & Welfare). COUNTING THIS WOULD NOT INDICATE GROWTH IN OUR NATION’S ECONOMY! “Now that I’ve gotten my welfare check, I can get an iPhone” How to measure GDP? 6) GDP includes all items produced in the economy and sold legally in markets NO BLACKMARKET TRANSACTIONS 7) GDP excludes items that are produced and consumed at home and that never enter the marketplace. Example: growing crops for your own use. The Formula for GDP "economic heartbeat of a nation" GDP (Y ) is the sum of the following: Consumption (C) all consumer spending Investment (I) investment in new capital Government Purchases (G) spending Net Exports (X-N) (Exports – Imports) Y = C + I + G + (X-N) The Components of the GDP Formula 1.) Consumption (C): The spending by households on goods and services (except the purchases of new housing). New homes are considered under Investment ( I ) 2.) Investment (I): Only counts the spending on NEW capital (i.e. equipment, company inventories, and structures), including new housing. The Components of the GDP Formula 3.) Government Purchases (G): The spending on goods and services by local, state, and federal governments. Remember: GDP Does not include transfer payments (such as Welfare and Social Security to the people). These people will in turn spend the money on goods so it will be counted only once as consumption. THINK ABOUT IT! NEVER VIOLATE THE DOUBLE COUNTING RULE! 4.) Net Exports (X-N): Exports minus Imports ONLY COUNT WHAT IS MADE HERE! Economic Growth in the United States Real GDP per year Peak Peak Trough Time One Cycle (Have averaged five years) Peak: real GDP reaches its maximum. Recession: real GDP declines. Trough: real GDP reaches its minimum. Recovery: an upturn - real GDP rises. Review: • What is GDP? • What is the GDP formula? Other Measures of a Nation’s Health Other Measures of a Nation’s Health 1.) National Household Income: is the total income earned by a nation’s permanent residents. 2.) Disposable Personal Income: is the income that household and non-corporate businesses have left after satisfying all their bills. It is basically a measurement of “free cash” Measuring a Nation’s Economic Health CPI Consumer Price Index (measures inflation) Problems with GDP GDP is not a perfect measurement Some things that contribute to economic well-being are not included in GDP. The value of a clean environment. The value and amount of leisure time. The amount of debt levels for families. The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work. The effects of inflation. Inflation Terms Inflation is a sustained increase in the average price level Hyperinflation: Extremely high inflation A sustained decline in the average price level is called deflation A period of inflation combined with high unemployment is called stagflation (can be referred to as a recession or depression) Causes of Inflation Two sources of inflation: 1) Demand-Pull Inflation 2) Cost-Push Inflation Sources of Short-term Inflation 1) Demand-Pull Inflation: inflation caused by an increase in demand or Price the supply of $ Level AS The increase in the aggregate demand curve pulls up the price level. (CPI) Basically this type of inflation is caused by consumers’ increased need for goods and services. P' P AD' AD 0 GDP Sources of Short-term Inflation Price Level (CPI) 2) Cost-push inflation: inflation caused by a decrease in supply which pushes prices up. AS' AS The increase in costs of production push up the price level. Basically, inflation is caused by increased costs that suppliers have to pay to produce their products. P' P AD 0 GDP fell: unemployment went up! GDP Real versus Nominal GDP How does inflation affect GDP? *We need to adjust the GDP for inflation to see if growth has actually occurred. Nominal GDP: values the production of goods and services at current prices. Real GDP: adjusts the values of the production of goods and services for inflation An accurate view of the economy requires adjusting Nominal GDP to Real GDP by using the CPI. Real vs Nominal GDP Inflation is not factored into GDP: Why is that a bad thing? Let’s say there is a 4% increase in GDP between Year 1 and Year 2. This appears good, but what is inflation? Based on the CPI (a tool used to measure inflation), inflation has increased 4% as well. Bummer! This means that our economy did not grow at all. Measuring the Price Level and Inflation: CPI "economic blood pressure of a nation" Consumer Price Index (CPI): Measures inflation Looks at prices of the goods and services that a typical urban family buys over time. It is used to monitor changes in the cost of living over time. How the Consumer Price Index Is Calculated? 1) Fill the Market Basket: Determine what prices are most important to the typical consumer. The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical family buys through the Consumer Expenditure Surveys. 7,000 families from around the country provided information each quarter on their spending habits in the interview survey. Goods and Services How the Consumer Price Index Is Calculated? 2) Compute the Market Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services. 2011 = $ How the Consumer Price Index Is Calculated? 3) Choose a Base Year and Compute the Index: Designate one year as the base year, making it the benchmark against which other years are compared. Compute the index (% change) by using a simple % change formula. 2011 2012 = $ = $$ Measuring a Nation’s Economic Health Measuring Unemployment (Temperature of the nation) Types of Unemployment 1) Frictional Unemployment Arises from normal labor turnover: people entering and leaving the labor force People are in-between jobs Generally short-term and voluntary People choose to do this because there are other jobs available THIS TYPE OF UNEMPLOYMENT IS NOT BAD. Types of Unemployment 2.) Seasonal Unemployment Unemployment caused by seasonal changes in labor demand during the year. For example, during the winter months the demand for farm hands declines Christmas/ Holiday Types of Unemployment 3.) Structural Unemployment Arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs Exists because unemployed workers often: 1) 2) DO NOT have the skills demanded by employers, or DO NOT live where their skills are in demand That is, there is a mismatch of skills or geographic location. EXAMPLE: As the older generation ages then they struggle to keep up with technology. They can lose there jobs to a younger generation that is familiar with technology. Types of Unemployment 4.) Cyclical Unemployment Arises from the fluctuations of the business cycle. Increases during a recession and decreases during an expansion. The ONLY ONE DIRECTLY related to the BUSINESS CYCLE. EXAMPLE: Ford lays off employees because sales have plummeted over the pass two quarters. How is Unemployment Measured? 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. How is Unemployment Measured? Based on the answers to the survey questions, the BLS places each adult into one of three categories: 1) Employed 2) Unemployed 3) Not in the labor force Unemployment Rate According to the Bureau of Labor Statistics: • An Unemployed Worker is: One who is 16 years or older (but not retired), not currently employed, AND is actively seeking employment. •People are Not in the Labor Force if they are: not actively seeking (wealthy or lazy), under 16, in the military, institutionalized (prison), retired, or in school. Natural Rate of Unemployment The Natural Rate of Unemployment is unemployment that will not go away. It is the amount of unemployment that the economy normally experiences, even in the good times. So, how do we know what is a healthy unemployment rate? According to the Bureau of Labor Statistics: in-between 4% and 5% How does the Government help the Unemployed? 1) UNEMPLOYMENT INSURANCE is a government program that partially protects workers’ incomes when they become unemployed. Offers partial payment of former wages for a limited time to those who are laid off. NOT ENTITLED TO THIS IF YOU GET FIRED. 2) Government-Run Employment Agencies: give out information about job vacancies in order to match workers and jobs more quickly. Problems with the Unemployment Rate: It does not measure: 1) Those that are UNDEREMPLOYED: Their skills are above the job they have. EXAMPLE: Someone with a Ph.D working at McDonalds 2) Those that are falsely reporting that they are not seeking employment (or get paid under the table) only to get WELFARE. Summary Gross Domestic Product (GDP) …measures an economy’s total expenditure on newly produced goods and services @ their market value. Does not count products made overseas. Does not count used goods. Does not count depreciation. Indirectly counts transfer payments. Summary GDP is divided among four components of expenditure: 1. Consumption (only market prices) 2. Investment (net only, no depreciation) 3. Government Purchases (no Trans Pay) 4. Net Exports (Ex - Im) Y = C + I + G + (X-N) Consumer Price Index is the tool we use to measure inflation and reduce Nominal GDP to Real GDP by using CPI.