Unit 3: Measuring Economic Performance

1. Unit 3: Measuring Economic Performance Chapters 6-7

2. Revisit the Circular Flow Diagram • On board • What is “Income”? • Rent, profits to the entrepreneur, interest, wages

3. Measuring Economic Activity • Three primary ways to measure • Gross Domestic Product • Unemployment • Inflation

4. 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

5. 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 minus what we import • It is a monetary measure ($ value)

6. GDP cont. • What is included? • All final goods (not for resale or further processing) produced within the country

7. 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

8. GDP cont. • What else is not included? • Stuff made by American companies in other countries • Illegal activities • Non-market activities • Doing things yourself

9. 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 • C = Personal Consumption Expenditures • Ig = Gross Private Domestic Investment • G = Government Purchases • Xn = Net Exports

10. 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 • A Note on Net Investment • Investment - Depreciation

11. 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)

12. GDP cont. • Income Approach (Super Complicated) • Based on the income generated from households selling FOP on the Factor Market of the circular flow diagram

13. 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)

14. Real VS Nominal • Nominal • Total dollar value of all goods/services in a given year • Change with prices • Real • Total dollar value of all goods/services in a given year, calculated using the prices of a selected base year • Adjusted for price changes • Why would this be an important difference?

15. Real VS Nominal • 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 (called base year) would cost today. • Price Index = (current prices/base year prices)x100 • Examples: CPI, PPI • Base Year PI = 100 • Why? • Real GDP = (nominal GDP/price index)x100

16. 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

17. GDP cont. • https://fred.stlouisfed.org/series/GDPC1

18. GDP and the Business Cycle

19. 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

20. 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

21. Growth cont. • Again, what are the limitations of growth information? • What are the limitations of GDP? • Improved products • Added leisure • Environment • Gains in well-being

22. Business Cycle and Growth • What causes the business cycle? • Really controversial • 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

23. 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

24. 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)

25. Unemployment cont. • Unemployment rate • % of Civilian Labor Force without a job • Calculation? • Unemployment Rate VS Labor Force Participation Rate • They also determine the unemployment rate • Current Rate? • http://www.bls.gov/cps/ • Limitations • Part-time employment • Underemployed • Discouraged workers • Cash Jobs (Underground Economy)

26. 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

27. 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 • Equal to the sum of structural and frictional unemployment • No cyclical 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

28. 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

29. 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

30. 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

31. Inflation cont. • How is it measured? • Consumer Price Index (CPI) • 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

32. 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

33. Effects of Inflation • Nominal and real income changes • Real income = (nominal income/price index) x 100 • Doesn’t necessarily change real income for everyone • Anticipated VS Unanticipated Inflation • If we expect it we can plan for it

34. Effects cont. • Who is hurt? • Almost everyone, but in particular… • 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

35. Effects cont. • Planning for inflation • Real VS Nominal Interest rates • Real is true cost to borrow the money adjusted for the rate of inflation • Real = Nominal – Inflation Rate • Nominal is real plus the extra cost of due to inflation • Nominal = Real + Inflation Rate • 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