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Macroeconomic Measurements Full Employment Act - 1946 Ensure economic stability Maintain low unemployment Keep prices stable Promote economic growth How do we measure progress? Macroeconomic Goals Inflation: 3 percent Unemployment: 4 percent Economic growth: 4 percent Bureau of Labor Statistics BLS Chart for latest unemployment. Unemployment Rate 2011 to 2012 GDP 1007 to 2012 Q3 GDP Growth to March, 2013 Now- was that a bad recession???? Gross Domestic Product (GDP) The dollar (market) value of all final goods and services produced within the nation’s borders in one year. total production total expenditures total income Transactions Not Included in GDP Transfer payments Entitlement programs Transfers in kind Cash payments Unreported income Legal and illegal Work for which no money changed hands Production within household Sale of used goods Basic Circular Flow This shows the interactions between households (income earners and resource owners) and businesses (resource buyers) Figure 8-1. Basic Circular Flow Business Sales Revenues Product market Business firms Business Costs Consumer Spending Consumers in Households Resource market Income Expenditures The components of total spending are: – Consumption spending I – Investment spending G – Government spending C X – Exports From which we subtract M – Imports to get NX = Net exports (exports – imports) C – Consumption spending Three kinds: durable goods non-durable goods services Determining factors: income expectations about the future I – Investment spending Three kinds: new or replacement capital goods inventory changes new housing construction Determining factors: interest rates expected return on investment expectations about the future G – Government spending Three kinds: Federal state local Determining factors: Politics - goals unexpected external events X – Exports and M - Imports Exports - Determining factors: income of foreign customers comparative advantage of American goods Imports – Determining factors: income of American customers comparative advantage of foreign goods Macro Equilibrium Total spending = total output = total income No unexpected changes in inventories Full-employment equilibrium is the goal: total spending = total production at the economy’s capacity to produce Total Income = Total Spending For every transaction, when someone spends money, it is income to someone else Macro Equilibrium Equilibrium with high unemployment: total spending is less than the economy’s capacity to produce recession underperforming economy idle labor and capital goods Macro Equilibrium Equilibrium with low unemployment: total spending is greater than the economy’s capacity to produce inflation overheated economy shortages of labor and capital goods Leakages Leakages – funds leaving the circular flow Households do not spend all of their income on American goods The following leak out of the circular flow: saving (S) taxes (T) imports (M) Injections Injections – funds entering the circular flow Not all American made products are bought by US households. The following are injected into the circular flow: investment spending (I) government spending (G) exports (X) Basic Circular Flow Business Revenues (GDP) I + G + X Product market Business firms Business Costs Consumer Spending (C) Consumers in Households Resource market Income (Y) S + T + M Leakages and Injections For equilibrium: leakages = injections S + T + M = I + G + X It is not necessary that S = I and T = G and M = X to have equilibrium Recessions Usually caused by a decrease in total spending Spending < production Inventories rise Investment spending falls Unemployment rises Income falls Tax collections fall and transfer payments rise Recessions Real GDP decreases To be called a recession, real GDP must decrease two quarters (six months) in a row. Recessions Possible causes: Decreases in injections (I, G, X) Increases in leakages (S, T, M) Result: injections < leakages spending < production ultimately reach an equilibrium in an underperforming economy Real GDP Terminology: “nominal” means ‘as measured’ – current $ or rate “real” means with ‘the effects of inflation removed’ Is the Growth of GDP real or inflated? This is the real test!!!!!!! Was there actual increase in production and services or did the prices just skew the GDP statistics when C+I+G was added? Have to correct GDP for price changes so we can measure actual production. CPI tells the consumer if they have to spend more dollars to get that loaf of bread… but other measures have to be evaluated. Still another way to test the health of the U.S. economy The GDP Deflator…. The broadest price index and covers all output including consumer goods, investment goods and government services. (C+I+G) The GDP deflator isn’t a pure measure of price change. Its value reflects both price changes AND market responses to those price changes as reflected in new expenditure patterns. The GDP deflator typically registers a lower inflation rate than CPI and the government watchdogs use this barometer more readily than current CPI Historical Record Graph 20 Inflation 16 A 12 8 4 B 0 4 8 Deflation 12 1920 1930 1940 1950 1960 1970 1980 1990 2000 Real GDP A change in Nominal GDP can include changes in both prices and quantities. Economic growth wants to consider only the change in quantities Remember – GDP measures production. Thus, the change in prices must be removed from the data. Convert Nominal GDP to Real GDP GDP Deflator GDP Deflator = Nominal GDP x 100 Real GDP Real GDP = Nominal GDP x 100 GDP deflator Nominal GDP is GDP measured at current prices Real GDP is GDP measured at base year prices Year Price of good Quantity (base GDP Real GDP 1 $10 100 $1,000 $1,000 2 $12 120 12x120 10 x 120 = $1,440 = $1,200 3 $14 140 14 x 140 10 x 140 = $1,960 = $1,400 GDP Growth Rates Growth economy – increases 3% or more Stagnant economy – grows less than 3% Declining economy – growth is negative Business Cycle The long run trend in economic growth is positive, 3 to 3.5 percent per year Short run, there are periods of greater growth and of decline this variation is called the business cycle Business Cycle Four phases: peak recession/contraction trough recovery/expansion/prosperity Figure 8-3. A Stylized Business Cycle real GDP peak prosperity (“boom” times) recession peak long-run trend of real GDP recovery recession trough time Peak economic activity at its highest unemployment is low income is at its highest tax collections are high transfer payments are low danger of inflation Recession/Contraction economic activity slows inventory levels rise unexpectedly sales fall off production decreases unemployment rises incomes fall tax collections fall and transfer payments rise Trough economic activity is at its lowest unemployment is high incomes are at their lowest tax collections are low and transfer payments are high Recovery/Expansion/Prosperity economic activity increases sales rise production rises unemployment falls income rises tax collections rise and transfer payments fall when real GDP increases beyond the previous peak, prosperity sets in in the late stages, inflation may become a problem Inflation A rising general/average level of prices Measured monthly similar to the GDP deflator Special basket of goods urban consumers buy Consumer Price Index (CPI) Inflation then is the %change in the CPI from year to year How to measure rate of inflation Measuring the Rate of Inflation Market Basket Representative bundle of goods and services Base Year The point of reference for comparison of prices in other years Macroeconomic Measures - Prices Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year. (82-84) Computing the Consumer Price Index Consumer Price Index (CPI) By observing the extent of price increases, we can calculate the inflation rate. n The inflation rate is the annual percentage rate of increase in the average price level. Percentage change in prices = Current year - later year later year x100 In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006? Click below for answer. 3.22 % Changes in Prices Here’s a little hint if you forget…C-L/L CPI determined Calculates the inflation rate Market basket of goods and services (same each year.) Bureau of Labor Statistics determines cost in 85 cities by shopping 184 items. 19,000 stores visited and 60,000 landlords,renters and homeowners surveyed each month Statistics released each month.(3.15- .7%) Yearly average compiled. CPI expressed in base year ’82-84 Constructing the CPI The base period is the time period used for comparative analysis — the basis of indexing, for example, of price changes. Shopping for CPI CPI is constructed by identifying a typical bundle of goods that the average consumer buys. This bundle stays the same each year. The base year is changed periodically. The base year used is ’82-’84 and prior to that it was ’63.The price level in the base period is designated as 100. The market basket (bundle) can be changed if BLS research shows that the “average” consumer no longer is purchasing that good or service. Each item in the bundle is weighted percent-wise in the market basket figures. The Market Basket Transportation 19.0% Housing 32.6% Food 13.6% Insurance and pensions 9.3% Clothing 4.7% Entertainment 5.1% Miscellaneous 10.5% Health care 5.3% Inflation’s Harmful Effects Purchasing power falls Redistribution of income and wealth Savings rate tends to fall Businesses plan only in very short time horizons Interest rates rise – business investment falls Bottom Line CPI is designed to measure the impact of price changes on the cost of a typical bundle of goods purchased by households(remember, market basket and only for urban purchasers.) GDP deflator is a broader price index and is designed to measure the change in the average price of the market basket of goods included in GDP (in addition to consumer goods it includes capital goods, & g & s by government.) CPI measures money income of consumers in relation to rising prices (only consumer goods.) GDP deflator measures economy wide inflation- more g & s included in measurement. Types of Inflation Monetary supply rapidly increases – ‘too many dollars chasing too few goods and services’ Money Demand-pull Total spending exceeds production of goods and services Cost-push in production – may be caused by rising production costs/external shocks Decrease Unemployment Definitions: labor force = those at least 16 years old who are working or are actively seeking work Labor Force = # E + # UE Employed (#E) = those in the labor force who are working Unemployed (#UE) = those in the labor force who are not working but are actively seeking work Unemployment Unemployment rate = # unemployed / labor force x 100 Types: seasonal cyclical frictional structural Full Employment No cyclical unemployment exists. Only frictional and structural unemployment exists. Full employment exists when the unemployment rate is 4 to 6 percent. Occurs at or near the peak of the business cycle. Macroeconomic Measurements Study Questions 1. What is Gross Domestic Product (GDP)? 2. Why must Nominal GDP be corrected for inflation? 3. How is economic growth calculated? 4. What is the difference between growth, stagnation, and decline? Study Questions 5. What are the phases of the business cycle? 6. What are the three types of inflation? 7. What are the four types of unemployment? 8. Which is the one of most concern to policy makers? 9. What is the full employment goal?