Download Unit 3: Measuring Economic Performance

Unit 3: Measuring Economic
Performance
Chapters 6-7
Revisit the Circular Flow Diagram
• On board
• What is “Income”?
– Rent, profits to the entrepreneur, interest, wages
Measuring Economic Activity
• Three primary ways to measure
– Gross Domestic Product
– Unemployment
– Inflation
National Income Accounting
• Measures the economy’s overall performance
• Why measure?
– Assess the health of the economy by comparing
production to previous dates
– Track long-run course of the economy
– Formulate policies that will improve economy
Gross Domestic Product
• Gross Domestic Product (GDP)
– Measure of aggregate output
– Total market value of all final goods and services
produced by either citizen or foreign supplied
resources within the country
– Includes everything made in the US for final use
– It is a monetary measure ($ value)
GDP cont.
• What is included?
– All final goods produced within the country
– Goods purchased for final use by consumers, not
for resale or further processing
GDP cont.
• What is not included?
– Intermediate goods
• Goods purchased for resale or further processing or
manufacturing
• Why exclude these?
– Nonproduction transactions
• Financial transactions
– Public transfer payments
» Welfare, unemployment, social security, subsidies
– Private transfer payments
» Birthday money from family
– Stock market transactions
• Secondhand sales
GDP cont.
• What else is not included?
– Stuff made by American companies in other
countries
– Illegal activities
– Non-market activities
• Doing things yourself
GDP cont.
• How do you find the GDP value?
• 2 ways
– Expenditure VS Income Approach
– Expenditure Approach (Super Easy)
• Based on what people spend to purchase on the
Product Market of the Circular Flow Diagram
• C + Ig + G + Xn
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C = Personal Consumption Expenditures
Ig = Gross Private Domestic Investment
G = Government Purchases
Xn = Net Exports
GDP cont.
– C = Personal consumption expenditure
• All households expenditures
• Largest portion
– Ig = Gross Private Domestic Investment
• All final purchases of machinery, equipment, and tools
by business enterprises
• All construction (houses, factories, warehouses, and
stores)
• Changes in business inventories
– Negative and Positive
GDP cont.
• G = Government Purchases
– Includes all government expenditures on final
goods and services and purchases of resources,
including labor
• In other words…all government spending except
transfer payments
• G/S the government consumes to provide public
services
• “Social or Public Capital” like schools and roads
• Xn = Net Exports
– Exports (X) – Imports (M)
GDP cont.
• Income Approach (Super Complicated)
– Add the following to get National Income (All
income earned through the use of Americanowned resources)
– Based on the income generated from purchasing
FOP on the Factor Market of the circular flow
diagram
GDP cont.
• Income Approach = Expenditure Approach
– All income earned is “spent” as either
expenditures or savings
• Because expenditures equal income, if GDP
rises income must also. (VERY IMPORTANT
CONCEPT)
Real VS Nominal
• Nominal values change with prices and real
values are adjusted for price changes
– Why would this be an important difference?
• Use price indices to adjust nominal values to
create real values
– A price index tells you what $100 worth of goods
in a previous year would cost today.
• Price Index = (current prices/base year prices)x100
• Real GDP = (nominal GDP/price index in hundredths)
GDP cont.
• Shortcomings
– Nonmarket activities
• Leads to understated number
– Leisure time or job satisfaction
• Adds to well-being but cannot be measured
– Product quality
– Underground economy
• Also includes cash-only jobs not reported on taxes
– Environment
– Distribution of income
– Noneconomic sources of well-being
• Reductions in crime, civility, drug or alcohol abuse
GDP and the Business Cycle
Economic Growth
• Growth occurs when…
– Increase in real GDP
– Increase in real GDP per Capita
• GDP/population
• Tells more about living standards
• Growth leads to…
– Rise in real wages
– Decreases of the burden of scarcity
Growth cont.
• Rule of 70
– 70 divided by annual % growth rate tells us how
long it will take to double GDP
• Sources of growth
– What shifts PPC?
• Increases in resources
• Increasing productivity
– Real output per input
– 2/3 of US growth comes from this
Growth cont.
• Again, what are the limitations of growth
information?
– What are the limitations of GDP?
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Improved products
Added leisure
Environment
Gains in well-being
Business Cycle and Growth
• What causes the business cycle?
– Really controversial
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Innovations
Changes in productivity
Monetary phenomenon
Changes in spending
Government interference
• Who is affected most/least?
– Least
• Non-durable good producers
– Most
• Durable good producers and capital good producers
Enemies of the Economy
• Inflation and unemployment
– Usually don’t occur at the same time
– High rates are either have negative effects on the
economy
• Therefore, societies want to avoid both
Unemployment
• Civilian Labor Force (CLF)
– Men and women 16 and up not in the military, prison, or
otherwise institutionalized who are working or actively
looking for a job.
• Who does this not include? (IMPORTANT!!!)
– The number of people in the CLF is determined by the
Bureau of Labor Statistics (BLS)
Unemployment cont.
• Unemployment rate
– % of Civilian Labor Force without a job
– Calculation?
• On board
– They also determine the unemployment rate
• Current Rate?
– http://www.bls.gov/cps/
– Limitations
• Part-time employment
• Underemployed
• Discouraged workers
Unemployment cont.
• 4 types of unemployment
– Frictional
• Not necessarily bad
• Labor market is not perfect and it takes time to match jobs to
workers
• Usually short term
– Structural
• Replaced by machines, changes in demand for products,
movement of businesses
• Longer term
– Cyclical
• Downturn in economy
– Seasonal
• Seasonal demand for employees
Unemployment cont.
• Is zero unemployment desirable?
– Why or why not?
• Full Employment rate of unemployment or natural rate of
unemployment (NRU)
– Economy is at potential output
– Long-run equilibrium rate of unemployment
– Job seekers=job vacancies
– There is only frictional unemployment
– Economy can be above potential output temporarily
– NRU can change over time
– In the 1980s it was around 6%
– Today between 4-5%
– Changes in population
– Welfare laws
– Internet job sites
Unemployment cont.
• GDP gap
– Gap between PPC and point inside the curve due
to unemployment
• GDP Gap = actual GDP – potential GDP
– Okun’s Law
• For every 1% actual unemployment exceeds NRU, a
negative GDP gap of about 2% occurs
• We can use this to find how much loss of wealth
unemployment causes
Unemployment cont.
• Unequal burdens
– Low skilled or less educated
– Teenagers
– AA and Hispanics
• Costs of unemployment
– Loss of wealth (GDP)
– Social costs
• Poverty, racial and ethnic tensions, loss of hope and morale,
sociopolitical unrest, family disintegration, loss of skills
– Long term unemployed
Inflation
• What is inflation?
– Rise in the general level of prices
• Real income is declining
• Does NOT mean all prices are rising
– Inflation is monetary phenomenon!!!
– Hyperinflation
• Caused by inflating away government deficits/debt
– Deflation
Inflation cont.
• How is it measured?
– Consumer Price Index (CPI)
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Official price index used to measure inflation in the US
“market basket” of 300 consumer goods and services
Compiled by the BLS
CPI = [(Price of most recent “basket”) / (Price estimate of same
basket in 1982-1984)] X 100
– Inflation Rate = [(year 2 – year 1) / (year 1)] X 100
– Weakness? Only 300 goods…
– Does not account for the face that you can substitute goods
– GDP Deflator
• Uses GDP instead of “market basket”
• (Nominal / Real) X 100
Inflation cont.
• Types
– Demand Pull
• Too much money chasing too few goods
• Loans increasing at a rapid rate
– Cost Push
• Increasing in factor of production costs
• Per-unit production costs rise
– Per-unit cost = (total input cost) / unit of output
• Supply shocks
• Leads to increases in unemployment and inflation at the
same time (stagflation)
– Hard to know which is causing inflation
Effects of Inflation
• Nominal and real income changes
– Real income = (nominal income) / (price index in
hundredths)
– Doesn’t necessarily change real income for
everyone
• Anticipated VS Unanticipated Inflation
– If we expect it we can plan for it
Effects cont.
• Who is hurt?
– Almost everyone, but in particular…
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People on fixed incomes
Savers
Creditors
People who hold cash (non-interest bearing accounts)
People who are shifted into higher tax brackets
• Who is helped or unaffected?
– Flexible-income receivers
• People who receive Cost-of-Living Adjustments
– Borrowers AKA Debtors
• Governments
Effects cont.
• Planning for inflation
– Real VS Nominal Interest rates
• Real is true cost to borrow the money
• Nominal is real plus the extra cost of due to inflation
– Nominal = Real + Expected Rate of Inflation
• Effects on output
– Cost-push reduces output
– Demand-pull
• Harder to know. Some say…
– Costs associated with changing prices (menu costs)
– Distinguishing between real and nominal interest rates
– Costs of getting cash