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Economic Indicators

AP Macroeconomics - GDP/Inflation/Unemployment
by

Daniel Kim

on 20 October 2014

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Transcript of Economic Indicators

National Income Accounting
AP Macroeconomics
Macroeconomics!
Finally the good stuff!
S0 up until now, we've been covering the basics of economics. We laid the foundation, or the initial comprehension needed to get to the heavy lifting of Macroeconomics.
So it turns out that economists share a very similar job description as medical doctors. Economists have two major job functions
Diagnostics
Treatment
Economists use multiple measures to determine whether or not the economy is "healthy" or "sick" The way doctors use CAT scans and thermometers, economists use:
Gross Domestic Product
Inflation Rate
Unemployment Rate
}
And many more!
The Government and the FED use a combination of Fiscal and Monetary policies to either speed up or slow down economic activity
Don't worry we'll get to this craziness later!
So in regards to Diagnostics, the most important concepts are Economic Growth and Gross Domestic Product
GDP
=
aggregate output as the
DOLLAR VALUE
of all
FINAL
goods and services produced within the
BORDERS
of a given country during a given period of
TIME
Notice there are a ton of working parts to this definition
1st Part
Dollar Value
We need to understand that any measure of the economy is a MONETARY measure. Without a monetary measure, it would be impossible to accurately define the success and failure of an economy
Imagine Colonel Sanders here sold 500 Chicken Wings, and 100 Chicken Breasts on day one, and then sold 100 Wings and 500 Breasts on day two
Which day was more successful? Or have a larger Aggregate Output?
Next up:
Final Goods and Services
Once again if we're measuring every individual good and service produced in the United States, we need to ensure accuracy by counting goods and services once, and only once! This forces us to differentiate between two types of goods
Intermediate Goods
Final Goods
These are goods or services that are typically
used in the production of other goods or services
. These are often inputs in the production process of another good.
Let's say that we're calculating the total output of Apple for 2014. Let's postulate that Apple was able to sell 20 Million units of the iPhone 6!
iPhone 6 (No Contract) - $649
20,000,000 x $649
=
$12,980,000,000
Now the question is, do we also calculate the cost and sale of 20 million screens, batteries, computer chips, and everything else that goes into an iPhone 6?
NO
That would be considered "Multiple Counting" When calculating GDP we IGNORE intermediate goods completely.
are all Consumer and Capital goods/services that are produced for final users. The reason we completely ignore intermediate goods is because the
value of Final Goods

already includes the value of intermediate goods.
When given a good or service, try to imagine:
Is this good or service used in the production of OTHER goods and services? If the answer is YES, it is most likely an intermediate good.
Coffee Mug
Intermediate
Final
Or
Lumber
Bowtie
If Amy purchased a BRAND NEW Toyota in
2008 for

$20,000
, and sold it to her brother in
2010 for

$12,000
what was the total GDP contribution for 2010?
Answer is Zero
The GDP contribution of the car was already calculated into 2008's GDP. No need to count it again!
These goods DO NOT COUNT when calculating GDP!
GDP also excludes Non-production Transactions
It's important to note that GDP counts
PRODUCTION
, not Sales. Whether or not a good or service was purchased is irrelevant; what matters is if it was produced! Later on
inventories
will play a large role in calculating GDP
Windows
Intermediate
Final
Or
Intermediate
Final
Or
Intermediate
Final
Or
There are two types of Non-production Transactions
Financial Transactions
Secondhand Sales
While there is a monetary value associated with financial transactions, these transactions DO NOT generate Final Goods. Turns out there are two types of financial Transactions!
Transfer Payments
Stock Market Transactions
a monetary payments that the government makes directly to households. These would include:
Welfare
Social Security
Veteran's Payments
None of these payments contribute to production value
Selling Stocks and Bonds doesn't actually create anything. It's just moving money from one party to another
The Services on the other hand that stock brokers provide ARE included in GDP!!!
or used goods contribute nothing to current production and thus are excluded in GDP!
The final two parts to GDP are relatively simple!
Borders
Time
Production MUST be done
WITHIN the United States!
If an American company produces goods/services in China, those g/s will count towards
China's GDP!!
Domestic Production
GDP is an
Annual measurement
. The U.S. Department of Commerce's Bureau of Economic Analysis calculates and reports GDP
So to Recap:
Included in GDP:
Final Goods and Services
Production, not Sales
Domestic Production
Excluded in GDP:
Intermediate Goods
Non-production Transactions
Financial Transactions
Transfer Payments
Stock Market Transactions
Secondhand Sales
International Production
The last thing we DO NOT count towards GDP are
Non-Market Activities
These are any economic forces that are operating OUTSIDE of a traditional market. Examples would be
illegal goods and services
like the black market drug trade or under the table labor
Non-Market Activities
Now there are two ways of calculating GDP:
Expenditure Approach
Income Approach
Otherwise known as the Output Approach
The Expenditure Approach is a way of looking at GDP as the
aggregate of all the money spent buying it
. All goods and services produced in the nation are bought by four entities:
Households
Businesses
Government
Other Countries
=
C + I + G + Xn
Consumers
Also known as "
Personal Consumption Expenditures
"
This is any expenditures by households. These expenditures can also be split into a few categories:
Durable Goods (1yr)
Nondurable Goods (>1yr)
Consumer Services
Cars
Refrigerators
TV's
Bread
Toothpaste
Lotion
Lawyers
Doctors
Hair Cuts
Car Mechanics
This stuff lasts a while
This stuff doesn't
(C)
Investment
Also known as "
Gross Private Domestic Investment
"
These are any investments made by businesses.
(I)
All final purchases of machinery, equipment, and tools by businesses
All construction - new factories, warehouses, stores, and even Residential construction
Inventories - Considered unsold goods that businesses hold.
Inventories are a tough one to understand!
Changes in inventories will either increase or decrease GDP.
So let's say the U.S. increased their inventories by $20 Billion dollars in 2010. That means that there was
$20 Billion MORE PRODUCTION
than
SALES
in 2010. That's why production is more important than sales when calculating GDP!
Government
(G)
Government spending can be divided into two part:
Expenditures for
goods and services
by providing public services
Expenditures for
publicly owned capital
like schools and highways
Does NOT INCLUDE transfer payments!! These are just a redistribution of tax revenue!
Net Exports
(X )
n
International trade affects GDP! Net exports is the total income earned from
selling to other countries
, subtracted by the total
spent on foreign goods and service
s
.
This can be a positive or negative number, depending their trade behavior. The United States imports far more than it exports which is called a
Trade Deficit
. The other way would be called a
Trade Surplus
BUY
>
Sell
Because all expenditures should equal incomes in an economy, the Expenditure and Income Approaches should be equal
The Income Approach measures GDP by recording the
income of households
in the resource market. It's the payment for providing the four factors of production minus taxes and depreciation
Wages
Interest
Rent
Profits
=
W + I + R + P

Wages
(W)
This is payment households receive for providing their labor to the resource market. Wages make up the largest component of national income
$7.8 Trillion!
Interest
(i)
Is the money firms pay to purchase capital like tools and machines. Firms typically borrow money from banks who charge firms interest.
Rent
(R)
Rent is the payment households receive
in exchange for use of their land
. This includes monthly payments tenants make to landlords, as well as firms renting factories or office space
Is it better to rent or to own?
Profits
(P)
Basically payments entrepreneurs seek after their work in the resource market. These are typically after taxes.
While GDP is the best we've got, it isn't perfect and there are some drawbacks to using GDP as a measure of economic health
Natural Disasters and other catastrophes technically increase GDP and are considered positive gains on GDP
GDP counts unpleasant goods and services like divorce lawyers, funeral costs, illness, and security equipment. Society would do better with less of these goods and services.
Because GDP is a monetary value, it is affected by changes in national price level. As a result we must adjust for inflation to get an accurate measure of economic growth
GDP DEFLATOR
It'll be difficult to compare market values of GDP from year to year when the
value of money itself changes
due to inflation or deflation. We'll use the GDP Deflator to ADJUST for inflation!
GDP Deflator
=
Nominal GDP
Real GDP
x
100
Another method to calculate changes in GDP is the
Consumer Price Index
While the GDP Deflator looks at all the goods and services produced in the economy, the CPI takes into account a stable
"Basket of Goods"
that a typical urban family would purchase.
The Bureau of Labor Statistics basically tracks
80,000 goods and services
that consumers typically purchase. They calculate the total prices of all the goods and services each year to
track changes in price over time
.
CPI
=
Market Basket in the year you're looking for
Market Basket of the Base Year
X
100
Unemployment Rate
Unemployment occurs when an individual who is
willing and able
to work is unable to find a job, despite actively looking for one.
It sucks because:
That individual COULD BE paying taxes
That individual COULD BE contributing to GDP growth and potential output!
4
So there are
Types of Unemployment
We can divide the US Population into
3
Groups
People under the age of 16 and/or institutionalized individuals
In regards to Unemployment
Individuals not in the labor force - Potential workers who are not employed, and are
NOT SEEKING
employment. Composed of Retirees, full-time students, or homemakers
71.8 Million People
78.7 Million People
Finally we've got the
Labor Force
which consists of individuals who are willing and able to work. We can further split this group into the
employed
and the
unemployed
.
146 Million People
Unemployment Rate
=
Unemployed
Labor Force
x
100
Frictional
Structural
Seasonal
Cyclical
Frictional Unemployment
This type of unemployment is
typically voluntary
. It's composed of college graduates who have just entered the labor force, workers who are in-between jobs, or people who have just been fired or laid off.
It's called frictional because it implies that the economy
does not operate perfectly and instantaneously
(w/o Friction) in matching workers and jobs
Structural Unemployment
This type of unemployment is results when the skills of workers do not match the needs of employers anymore!
This is "good" unemployment because it
forces individuals with outdated skills to develop new ones
better suited for society's needs
Structural Unemployment can be serious if the individuals are unable to retrain themselves, gain additional education, or relocating
Seasonal Unemployment
This type of unemployment is a result of the change in seasons. Lifeguards, Mall Santas, Easter Bunnies, Carnival Workers, and Migrant farmers. There is nothing we can do to keep this from happening.
Cyclical Unemployment
This type of unemployment is very serious and is caused by a
decline in total spending
. It typically begins during a recession. If the demand for goods and services falls, firms must cut costs by laying off workers. The 25% unemployment rate during the
Great Depression
in 1933 reflected mainly Cyclical Unemployment
Full Employment?
Most would think that full employment would occur when the unemployment rate is 0%. But that is actually impossible. It is impossible to prevent ALL employment, which brings us to the
Natural Rate of Unemployment (NRU)
Frictional
Structural
Seasonal
}
Inevitable
=
NRU = 5%
GDP Gap
The cost of unemployment is high. The sacrifice in output caused by unemployment is called the GDP Gap.
GDP Gap
=
Actual GDP
-
Potential GDP
The GDP Gap could have either a
positive
or
negative value
contingent on whether or not the unemployment rate is above or below the NRU.
A Negative GDP Gap -
Unemployment is ABOVE the NRU
A Positive GDP Gap -
Unemployment is BELOW the NRU
Basically, the higher the unemployment rate, the larger the GDP Gap
An economist by the name of
Arthur Okun
was the first to quantify the relationship between the unemployment rate and the GDP Gap!
This basically states that for every
1% point of actual unemployment
that exceeds the NRU,
(cyclical unemployment),
a
negative GDP Gap of about
2% will occur
Notice we have an inverse relationship between changes in the unemployment rate, and GDP growth!
As GDP, and Unemployment are measures of an economy's health, we can now turn to
Inflation
as a subtler measure of stability.
Inflation
Is just the
rise in the general level of prices
. Inflation basically decreases the
purchasing power
of consumers, as each dollar of income will buy fewer goods and services as before.
We'll use CPI as a measure of Inflation!
CPI was
206
in 2012
CPI was
214
in 2013
The Rate of Inflation
=
CPI2 - CPI1
x
100
Now there are two types of Inflation!
Demand Pull
Cost-Push
CPI1
For example:
214 - 206
206
x
100
=
3.88%
This is when
total demand exceeds total supply
, which causes the demand curve to shift to the right which causes prices to rise! Remember this stuff?
(y)
Price
Level
rGDP
AS
(x)
AD
AD1
PL1
Qe1
PL2
Qe2
This rise in the price level is considered
Demand-Pull Inflation
because it was a change in DEMAND that caused the increase!
This is when
wages or other input prices increase
which increases the marginal cost of production. This shifts the supply curve to the left, causing the price to increase
(y)
Price
rGDP
AS
(x)
AD
AS1
PL1
PL2
Qe1
Qe2
This rise in the price level is considered
Cost-Push Inflation
because it was a change in SUPPLY that caused the increase!
Everything in Moderation!
Now a little bit of inflation can be a good thing...
Higher prices can lead to increased profits, which would expand production
Firms will then want to hire additional workers
Higher employment rates means more money in the economy which will increase demand, thus increasing GDP
But if prices inflate too quickly.....
Consumers won't be able to purchase as many goods and services
Demand for most goods will fall, and inventories will build due to a lack of sale
Firms will then lay off workers and unemployment will rise which takes money out of the economy and GDP will fall
Now as a review, here's what economist want out of the US Economy:
GDP Growth = 2-3% a year
Unemployment Rate = 4-6%
Inflation Rate = 2-3% a year
Now the last thing we'll cover is using
changes in price level (inflation/deflation)
to calculate
Real and Nominal Income
This is quantified by the
Fisher Equation
:
% Real Income
=
% Nominal Income
% Price Level
-
Let's say Sarah is currently working at Coldstone Creamery slingin ice cream to kids in C-ville...
Let's say she's such a hard worker that her boss, Chad decides to give her a
14% raise
!
Sarah
But at the same time,
inflation is currently at 5%
Her "REAL" raise is....
% Real Income
=
% Nominal Income
% Price Level
-
% Nominal Income
=
14%
Raise
% Price Level
=
5%
Inflation
% Real Income
=
9%
"Real" Raise
Full transcript