Unit 7:
Economic Indicators
Chapters 9 and 14
The Theory of Production
Chapter 9
2
The Theory of Production
Of the four factors of production:
Land
Labor
Capital
Entrepreneurship
Which is usually the first to be changed due to
demand?
Because it is relatively easy for firms to change
the number of workers it employs whenever
demand changes, labor is often thought of as
being the VARIABLE factor of production.
3
Production
Production function: The bell-like figure that
shows how the total output changes when the
amount of a single variable input (usually labor)
changes while all other inputs are held constant.
The Production Period: focus on the short run
– a period so brief that only the amount of
variable input can be changed. Looking at
FIGURE 5.5, (pg. 128) the only input that has
changed is labor – no changes occur in the
amount of machinery, technology or land used.
Thus any change in output must be caused by a
change in the number of workers.
4
Production (Long Run)
5
LONG RUN: a period long enough for the
firm to adjust the quantities of ALL
productive resources, including capital.
For example, a firm that reduces its labor
force today may also have to close down
some factories later on.
TOTAL PRODUCT: total output produced
by the firm.
MARGINAL PRODUCT: The *EXTRA*
output or change in total product caused
by adding one more unit of variable input.
The Three Stages of Production
6
Increasing marginal returns. The marginal
product of each additional worker
increases. As more workers are added,
more cooperate with each other to make
better use of the equipment.
Decreasing Marginal Returns. Total
production keeps growing, but it does so
by smaller and smaller amounts. Also
known as diminishing returns.
Negative Marginal returns. If the firm hires
too many workers, they will all get in each
other’s way, causing output to fall.
Paper Airplane Activity
 You need to produce 150 paper airplanes in 15 minutes.
 The airplanes must look like airplanes (they cannot be
wads of paper) and they must fly a minimum of 12 feet.
 We will start with one worker and add another every
minute for 10 minutes, from 11-15 minutes we will add
2 workers per minute.
 Tell that “foreman” to count how many airplanes are
made every 1 minute.
REMEMBER YOUR GRADE DEPENDS
UPON HITTING THE QUOTA
7
The Costs of Production
Key Questions for Costs of Production
 What
 What
 What
 What
are
are
are
are
profits?
costs?
the different kinds of costs?
economies of scale?
9
What are Costs?
 Total revenue
 Amount a firm receives for the sale of
its output
 Total cost
 Market value of the inputs a firm uses
in production
 Profit
 Total revenue minus total cost
10
What are Costs?
 Costs as opportunity costs
 The cost of something is what you
give up to get it
 Firm’s cost of production
 Include all the opportunity costs of
making its output of goods and
services
11
Production and Costs
 Production function
 Relationship between
 Quantity of inputs used to make a
good
 And the quantity of output of that
good
 Gets flatter as production rises
 Marginal product
 Increase in output arising from an
additional unit of input
12
Production and Costs
 Diminishing marginal product
 Marginal product of an input declines
as the quantity of the input increases
 Total-cost curve
 Relationship between quantity
produced and total costs
 Gets steeper as the amount produced
rises
13
The Various Measures of Cost
 Fixed costs
 Do not vary with the quantity of
output produced
 Variable costs
 Vary with the quantity of output
produced
14
The Various Measures of Cost
 Average total cost (ATC)
 Total cost divided by the quantity of
output
 Marginal cost (MC)
 Increase in total cost
 Arising from an extra unit of
production
15
Costs in Short Run and in Long Run
 Many decisions are fixed in the short
run and variable in the long run.
 Firms – greater flexibility in the longrun
 Long-run cost curves
 Differ from short-run cost curves
 Much flatter than short-run cost curves
 Short-run cost curves
 Lie on or above the long-run cost
curves
16
Costs in Short Run and in Long Run
 Economies of scale
 Long-run average total cost falls as the
quantity of output increases
 Increasing specialization
 Diseconomies of scale
 Long-run average total cost rises as the
quantity of output increases
 Increasing coordination problems
 Constant returns to scale
 Long-run average total cost stays the same
as the quantity of output changes
17
3
The many types of cost: A summary
Term
Definition
Explicit costs
Costs that require an outlay of money by the firm
Implicit costs
Costs that do not require an outlay of money by the
firm
Fixed costs
Variable costs
Costs that do not vary with the quantity of output
produced
Total cost
Costs that vary with the quantity of output produced
Average fixed cost
The market value of all the inputs that a firm uses in
production
Average variable
cost
Average total cost
Marginal cost
Fixed cost divided by the quantity of output
Variable cost divided by the quantity of output
Total cost divided by the quantity of output
The increase in total cost that arises from an extra
unit of production
18
Key Questions for Costs of Production
Review
 What
 What
 What
 What
are
are
are
are
profits?
costs?
the different kinds of costs?
economies of scale?
19
Production and Productivity
Chapter 9
Economic Stability
Chapter 14
Business Cycles
 Economic growth is something that is
beneficial to almost everyone
 We cannot take it for granted
 Business Cycles – regular ups and
downs of real GDP – interrupt economic
growth
 Business Fluctuations – the rise and fall
of real GDP over time in an irregular
manner – interrupt growth at other
times.
Slower Economic Growth
•
•
•
•
•
•
Slower economic growth always a matter
of concern
Businesses lose sales
Voters become unhappy
Investors get nervous
Stock market shows its disapproval
Because of this economists have
developed elaborate forecasting models
and statistical tools
The Phases of a Business Cycle
•
•
•
•
•
2 Phases of a business cycle
First Phase = Recession – a period
during which real GDP – declines for at
least two quarters in a row, or six
consecutive months
The recession begins when the economy
reaches a peak
The point where real GDP stops going up
It ends when the economy reaches a
trough – the turnaround point where real
GDP stops going down.
Phases of a Business Cycle
Second Phase
 As soon as the declining real GDP bottoms
out
 Expansion – a period of recovery from a
recession
 Expansion continues until the economy
reaches a new peak.
 When it does the current business cycle
ends and a new one begins
Trend Line
 Trend Line – The economy departs from,
and then returns to, its trend line as it
passes from through phases or recession
and expansion
 Or Growth path the economy would follow
if it were not interrupted by alternating
periods of recession and recovery
Depression
 If a recession is very severe – it may turn
into a depression – a state of economy
with large numbers of people out of work,
acute shortages, and excess capacity in
manufacturing plans
Causes of Business Cycles




Changes in Investment Spending
Innovation and Imitation
Monetary Policy Decisions
External Shocks
The Great Depression of the
1930s
•
•
•
•
•
•
•
•
•
•
1929 – 1933 GDP declined 50 %
$103 Billion - $55 Billion
Unemployment rose 800%
1.6 million to 12.8 million
25 % of the workforce
Wages fell from $.55 to $.05 per hour
Banks across the country failed
FDIC did not exist
Bank Holidays
Depression Script
Causes
1. Enormous gap between Rich and Poor
2.Easy Credit – buying on margin
3. Global Economic Conditions
4. High Tariffs
Causes of the Great
Depression
 Disparity in the distribution of income –
the Great Gatsby effect. America did not really
have a middle class. It was split up into the
very poor and the very rich.
 The poor could not stimulate the economy
with consumer spending, because they had
very little or no money to spend.
 The rich had the money, but didn’t use it in
ways to spark economic growth. They either
saved it in banks or used it to speculate on
the stock market.
Causes of the Great Depression
 Easy and Plentiful credit
 Many people borrowed heavily in the
1920s – more than they could afford
to pay back. High interests rates and
business fluctuations also impacted
this.
Causes of the Great Depression
 Global Economic Conditions:
 Europe was still recovering from a massive war
(WWI). A good deal of farmable land had been
decimated by trench warfare.
 During the 1920s, banks, businesses and public
institutions made tons of loans to foreign companies,
interests and nations to help support business and
international trade.
 When the Depression began, these companies called
in their debts. This left these foreign interests broke.
As a result, they didn’t have any money to buy
American goods. This led to American job losses.
 High American tariffs made foreign good too
expensive for Americans to buy.
Recovery and Legislation
Social Security Act of 1935
Minimum Wage
Unemployment Benefits/Programs
SEC – Securities and Exchange
Commission
 (Companies required to give full
disclosure of financial statements)
 FDIC




Great Recession of the 2000s
 Why?
 How were we able to avoid another Great
Depression?
 Huge Government Bail Outs -
GDP and CPI
Starter
 GROSS DOMESTIC PRODUCT – THE
MEASURE OF NATIONAL OUTPUT.
 In 2009, the United States GDP measured
$14.26 Trillion. (CIA world Factbook)
 (GDP Per Capita of 46,400 – down
from $48,000 in 2008)
 China’s GDP in 2009 was $4.8 Trillion (but
their currency is considered undervalued. In
U.S. dollars, it is $8.789T
 (GDP Per Capita of $6,600)
 Why is China’s Per Capita so much lower than
the that of the U.S. when the total difference
is less than $9 trillion?
GDP
 GDP - is the market value of all final
goods and services produced within a
country in a given period of time.
Quick Group Activity
 You have 30 seconds to get into groups
of two.
 You will have 5 minutes to list, in order
from #1 to #10 the top 10 individual
national economies in the world.
 Cell phones / books prohibited
 Each group must write their top 10 on
the board.
Answers (CIA World Factbook)










1 United States 14,430,000
2 Japan 5,108,000
3 People's Republic of China 4,814,000
4 Germany 3,273,000
5 France 2,666,000
6 United Kingdom 2,198,000
7 Italy 2,090,000
8 Brazil 1,499,000
9 Spain 1,466,000
10 Canada 1,335,000
What’s Excluded from GDP?

Intermediate goods:
 Products used to make other products already counted
in GDP. Or something that is already part of the product.
 EXAMPLES:



Factory Tires on a new car.
Processors on a computer.
Sugar used in the process of baking brownies.
 QUESTION: Do aftermarket tires and upgrades count
in GDP? Should they?



Secondhand sales
 Sales of used goods.

Re-sold Houses, Used Cars, used CDS.

Mowing the lawn, cooking your meals, cleaning your clothes.
Nonmarket Transactions:
 Things you do yourself:
Underground activity:
 Illegal: Drugs, Prostitution (except in Nevada),
gambling, counterfeiting.
 Legal: Bake sales, flea markets, garage sales
Figuring the Underground
Economy
Country
Size of shadow economy in percent of GDP,
average over 1990-93[25]
Nigeria and Egypt
68-76%
Tunisia and Morocco
39-45%
Guatemala, Mexico, Peru and Panama
40-60%
Chile, Costa Rica, Venezuela, Brazil, Paraguay and
Colombia
25-35%
Thailand
70%
Philippines, Sri Lanka and Malaysia
38-50%
Hong Kong and Singapore
13%
Hungary, Bulgaria and Poland
20-28%
Romania, Slovakia and Czech Republic
7-16%
Georgia, Azerbaijan, Ukraine and Belarus
28-43%
Russia, Lithuania, Latvia and Estonia
20-27%
Greece, Italy, Spain, Portugal and Belgium
24-30%
Sweden, Norway, Denmark, Ireland, France, The
Netherlands, Germany and Great Britain
13-23%
Japan, United States, Austria and Switzerland
8-10%
Analysis
 At 8%: The U.S. Underground Economy is
$1.168 Trillion (12th largest in the world)
 At 10%: $1.426 (10th Largest in the
world)
 Question: Why would some nations have
higher rates of Underground Economies?
Real GDP
 To evaluate GDP over time – to see if an economy
experienced growth or loss, you need to find a
common starting point – a BASE year.
 GDP can be measured used current dollars,
or in the dollars for the base year.
 BASE YEAR: IS REAL GDP.
 CURRENT GDP – based upon prices that existed in
those years.
Limits to GDP
 GDP tells nothing about the following:
 the composition of output (What
companies and products make up the
economy)
 or the impact of production on quality of
life. (For example, are 10,000 new
homes going to force the extinction of a
rare bird species)
 Despite its limitations, GDP is still the best
measure of overall economic health.
 QUESTION: What does an increase in GDP
indicate?
 The output-expenditure model:
GDP = C + I + G + (X – M)
 Net export on goods and services is written
as (X – M).
CPI and the Cost of Living
The Consumer Price Index
 Consumer price index (CPI)
 Measure of the overall cost of goods &
services bought by a typical consumer
 How the consumer price index is
calculated
1. Fix the basket
2. Find the prices
3. Compute the basket’s cost
50
The Consumer Price Index
 How the consumer price index is
calculated
4. Chose a base year and compute the CPI
 Price of basket of goods & services in current
year Divided by price of basket in base year
Times 100
5. Compute the inflation rate
 Percentage change in the price index from the
preceding period
CPI in year 2 - CPI in year 1
Inflation rate in year 2 
100
CPI in year 1
51
1
The typical basket of goods and services
This figure shows how the
typical consumer divides
spending among various
categories of goods and
services. The Bureau of
Labor Statistics calls each
percentage the “relative
importance” of the category.
52
The Consumer Price Index
 Problems in measuring the cost of living
 Substitution bias
 Introduction of new goods
 Unmeasured quality change
53
“The Warning”
 http://www.pbs.org/wgbh/pages/fr
ontline/warning/view/?utm_campai
gn=viewpage&utm_medium=grid&ut
m_source=grid
Unemployment
What is the unemployment
rate of the United States?
Michigan?
US & Michigan Facts
USA: 6.3%
Michigan: 7.4% (went from 8th worst in
2013 to 7th worst in 2014)
Detroit-Livonia-Warren: 8.3%
Flint Area:9%
Natural Rate of Unemployment: 5-6%
How do we compare to the rest
of the world?
World Facts
Nigeria – (worst in Africa) 95%
Nauru (worst in Oceana) 90%
Nepal (worst in Asia) 46%
Bosnia/Herzegovina (between E/W Europe)
44.3%
Haiti (worst in Caribbean) 40.6
Yemen (worst in Middle East) 35%
Greece (worst in W. Europe) 27.9%
Columbia (worst in S./Central America)
9.5%
True Unemployment
How do we figure it out?
Census Bureau surveys about 50,000
Americans per month, in 200 counties,
across all 50 states to gain a sample
number they hope reflects the entire
nation.
They are looking for the people who are
officially unemployed per the definition
of the US government.
What is that?
Unemployment
“People available for work who made a
specific effort to find a job during the past
month”
In addition, they have to have worked for
less than one hour for par or profit a week.
You have to have worked at a family
business without pay for less than 15
hours a week.
 Also, you have to be over the age of 15 and not a
dependent.
All this data is turned over to the BLS and
published once per month
Unemployment Rate
To figure this out, we take the total
number of people unemployed and divide it
by the total workforce.
Group Work!
Get into groups of three
and write down what you
think are the limitations
of this system. What
does this rate miss?
Understatement
3 major reasons that this
reported number is too low.
1.Frustrated or discouraged
workers
2.Underemployment
3.People who do not want/care
about traditional employment
Overstatement?
What might not be taken
into account, that would
lower the unemployment
rate?
Types of Unemployment
Much like Econ teachers, not all types of
unemployment are created equal.
What causes lead to unemployment make
a difference to the BLS on why you are
unemployed.
Bob
Bob is a salesmen who has left his job
at GM and has three weeks before he
starts his job at Kroger. 
What type of unemployment is this?
Frictional
Short-term unemployed
Little amount of hardship from their
unemployment.
Young workers
There will always be frictional
unemployment
Bob 2
Bob worked really hard on the line at Ford,
but now is out of a job due to the rise in
sales from BMW. 
What type of unemployment is this?
Structural Unemployment
This occurs when a fundamental change in
the economy reduces the demand for
workers and their skills.
Michigan: Cars
Congress decision to close some
military bases
New skills forced on old workers
Bob 3
Bob got laid off from work because his
company’s sales were down 
What type of unemployment is this?
Cyclical Unemployment
Business cycles.
Recessions
Expansions
Bob 4
Bob picks apples, but now it is December
and there are no apples to pick 
What type of unemployment is this?
Seasonal Unemployment
Results from the changes in the weather or
changes in demand for certain products.
Cutting grass
Picking fruit
Comerica Park Peanut Vendor
Bob 5
Bob studied hard at ITT Tech to become a
VCR repair. He now has no job, since most
of you do not even know how to use a
VCR… 
What type of unemployment is this?
Technological Unemployment
Technological improvement makes jobs
obsolete.
Full Employment
What is it?
How does it relate to unemployment?
Poverty and Distribution of
Income
Poverty
 About 1 in 8 people in the USA lives in
poverty –
 some of them are what is called the
“working poor” – those who do not earn
enough to feed and care for their families
even though they are employed.
 The poverty threshold varies based on age
and size of family.
 Individuals and families that fall below the
poverty threshold are considered to be living
in poverty.
 For example, for a four-person family unit
with two children, the 2009 poverty
threshold is $21,756.
Poverty
 Poverty thresholds are used to
create poverty guidelines. These
guidelines are used to determine
what assistance an individual or
family is eligible for (things like
Food Stamps and Head Start).
2011 HHS Poverty
Guidelines
Persons
in Family
48 Contiguous
States and D.C.
Alaska
Hawaii
1
$10,890
$13,600
$12,540
2
14,710
18,380
16,930
3
18,530
23,160
21,320
4
22,350
27,940
25,710
5
26,170
32,720
30,100
6
29,990
37,500
34,490
7
33,810
42,280
38,880
8
37,630
47,060
43,270
3,820
4,780
4,390
For each additional
person, add
What causes incomes to be
unequal?
 Education – more you have the higher your
income tends to be
 Wealth – when people or households are
organized from most to least wealth – the
top 1/5 control over 75 % of the country’s
wealth. The bottom 2/5th (40% of the
country) control less than 2%.
 Ask – how does having wealth to start with
assure that you will keep it?
 Better education
 Ability to invest to make money even without a
job
What causes incomes to be
unequal?
 Tax Law changes – the changes in taxes have
benefited everyone – but not equally. Those
who are in the wealthiest have benefited the
most from tax law changes
 Decline of Unions – union jobs are fewer and
non-union, non-professional work is the
lowest paying job market.
 Changing family structure – the increase in
single parent households has worked to
decrease the average American income.
What causes incomes to be
unequal?
 More Service Jobs (sales clerk, waitress, etc.)
have replaced the unskilled manufacturing
jobs (factory workers) – these service jobs
are lower paying.
 Monopoly Power – some groups have been
able to limit the number of people able to
work in their field and therefore kept wages
for that group very high. Doctors for
example – only a certain number of
certifications are allowed by the AMA.
 Discrimination – while illegal – it would be
foolish to think this doesn’t keep wages for
women and minorities lower than wages for
white males.
What do we do about poverty?
 Income assistance – direct payments to
families that meet the criteria
 General assistance – non-cash assistance
such as:
 Food stamps – coupons that can be
redeemed for food at most stores that
sell food
 Medicaid – medical insurance for the
poor, disabled and visually impaired
 Social Service Programs – varies widely from
state to state but can include foster care,
family planning, job training, etc.
 Tax Credits – a credit on your federal
income tax that relieves some of the
burden of individual income tax
payments taken out of your payroll
check. May result in a tax refund
(transfer payment).
 Enterprise zones – tax credits given
to businesses to locate in depressed
areas. (There are enterprise zones in
Detroit)
What do we do about poverty?
 Workfare – working a government job
(sanitation, highway clean-up) to earn your
assistance. Sometimes businesses are given
special tax incentives to hire people from off
the welfare roles which works well for both
employer and employee.
 Negative income Tax – not currently used but
would eliminate welfare programs. People
who qualified would pay NO income tax and
would get funds from the government if they
fell below a certain poverty limit.
 Bottom line – even with a growing
economy and government assistance
we have done little to reduce poverty.