Chapter Introduction
Section 1: National Income
Accounting
Section 2: Correcting Statistics for
Inflation
Section 3: Aggregate Demand and
Supply
Section 4: Business Fluctuations
Section 5: Causes and Indicators
of Business Fluctuations
Visual Summary
Economists look at a variety of
factors to assess the growth and
performance of a nation’s
economy.
Economists use an array of tools
to evaluate the performance of
the American economy. In this
chapter, read to learn about GDP,
the consumer price index, and
other economic indicators.
Section Preview
In this section, you will learn how
economists calculate the overall success of
the nation’s economy.
Are you familiar with the way the
nation’s economy is measured?
A. Very familiar
B. Somewhat familiar
0%
C
A
0%
A. A
B. B
C.0%C
B
C. Not familiar
National Income Accounting, GDP,
and NDP
Gross domestic product is an estimate
of the total dollar value of all final
goods and services produced annually
within a country.
National Income Accounting, GDP,
and NDP (cont.)
• National income accounting is used to
measure the national economy’s
performance.
View: Measuring the National Economy
National Income Accounting, GDP,
and NDP (cont.)
• Five major statistics measure the national
economy:
– Gross domestic product
– Net domestic product
– National income
– Personal income
– Disposable income
National Income Accounting, GDP,
and NDP (cont.)
• Gross domestic product (GDP) is the
broadest measure of the economy’s size.
– Only new and final goods are counted.
National Income Accounting, GDP,
and NDP (cont.)
• To derive GDP, economists add the
expenditures made in four economic
categories:
– Consumer sector (C)—goods and
services bought directly by consumers.
– Investment sector (I)—business
purchases of items used to produce
other goods.
National Income Accounting, GDP,
and NDP (cont.)
– Government sector (G)—goods and
services bought by the government.
– Net exports (X)—difference between
what the nation sells and what it buys
from other countries.
View: Computing GDP
National Income Accounting, GDP,
and NDP (cont.)
• Net domestic product (NDP) takes GDP and
subtracts the total loss in value of capital
goods caused by depreciation.
Why do economists count only the value
of the final product when calculating the
GDP?
A. To avoid double
counting.
D. To account for depreciation.
0%
D
A
B
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C
D
C
0%
A
C. To avoid confusion
with the NDP.
A.
B.
0%
C.
D.
B
B. To find the correct
dollar value.
Measurements of Income
Disposable personal income is the total
income that people have left after taxes
are paid.
Measurements of Income (cont.)
• In gauging the value of the nation’s output,
economists also look at three
measurements dealing with income.
• National income (NI) or the total income
earned by everyone in the economy.
View: Elements of National Income
Measurements of Income (cont.)
• NI is the sum of the income resulting from
five different sources:
– Wages and salaries
– Income of self-employed individuals
– Rental income
– Corporate profits
– Interest on savings and other investments
Measurements of Income (cont.)
• Personal income (PI) is the total income
that individuals receive before personal
taxes are paid.
Measurements of Income (cont.)
• This number is derived from NI through a
two-step process:
– Several items, including corporate income
taxes and social security contributions
employees make, are subtracted.
– Government transfer payments such as
welfare and unemployment compensation
are added to NI.
Measurements of Income (cont.)
• Disposable personal income (DPI)
equals PI minus personal taxes. It
represents the actual amount of money
income people have available to spend.
Section Preview
In this section, you will learn what price
inflation is and how it is measured.
The Purchasing Power of Money
The nominal value of GDP must be
adjusted for changes in the purchasing
power of money to determine changes
in real output.
The Purchasing Power of Money (cont.)
• Economists need to take inflation into
account when thinking about GDP.
• When inflation occurs, the purchasing
power of the dollar goes down.
• Deflation also has an impact on the GDP,
although this has rarely happened in
modern times.
Can you think of any examples of
items that cost more now than they
did when you were younger?
A. A lot of examples
B. A couple of examples
0%
C
A
0%
B
C. No examples
A. A
B. B
C.0%C
Measures of Inflation
Inflation can be measured in several
ways by calculating changes in
different price indexes.
Measures of Inflation (cont.)
• The three most commonly used
measurements of inflation are:
– The consumer price index (CPI)
• About 80,000 specific goods and services
make up the market basket.
• The CPI is compiled monthly starting with
prices from a base year so there is a point
of comparison for current-day prices. (The
base year is really the average of prices
that existed for the three years, 1982-1984).
View: Selected Consumer Prices
Measures of Inflation (cont.)
– The producer price index (PPI)
• PPI usually increases before the CPI. PPI is
mainly from mining, manufacturing and
agriculture industries.
– The GDP price deflator
• When the price deflator is applied to GDP
in any year, the new figure is called real
GDP.
View: Nominal and Real GDP Over Time
Section Preview
In this section, you will learn how the laws
of supply and demand apply to the
economy as a whole.
Aggregate Demand and Supply
Aggregate demand and aggregate
supply curves plot the price level
versus total output.
Aggregate Demand and Supply (cont.)
• When we look at demand and supply in
the economy as a whole, we are looking at
aggregates.
• Aggregate demand is the total of all
planned expenditures in the entire
economy.
– This is related to price level, the average
of all prices as measured by a price
index.
View: Aggregate Demand and Supply
Aggregate Demand and Supply (cont.)
• An aggregate demand curve is a
graphed line showing the relationship
between the aggregate quantity demanded
and the average of all prices as measured
by the implicit GDP price deflator.
Aggregate Demand and Supply (cont.)
• There are two reasons for the inverse
relationship of the aggregate demand
curve:
– Inflation causes the purchasing power
of cash to go down, and deflation
causes it to go up.
Aggregate Demand and Supply (cont.)
– When the price level goes down in the
U.S., our goods become relatively better
deals for foreigners who want to buy
them.
• Aggregate supply looks at the real
domestic output of producers based on the
rise and fall of the price level.
– Producers offer more real domestic
output as the price level increases, and
less as the price falls.
Aggregate Demand and Supply (cont.)
• Aggregate supply curve is a graphed line
showing the relationship between the
aggregate quantity supplied and the
average of all prices as measured by the
implicit GDP price deflator.
• The equilibrium price level is determined
where the aggregate demand curve
crosses the aggregate supply curve, or
at the GDP price deflator.
View: Equilibrium Price Level
If something pushes out the
aggregate demand curve faster than
the aggregate supply curve, what will
the equilibrium price level do?
A. Rise
D
0%
A
D. Shift left
C
C. Shift right
A. A
B. B
C. C
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D. D
B
B. Fall
Section Preview
In this section, you will learn about the
forces that cause fluctuations, or “ups and
downs,” in the American economy.
Can you give some examples from
history of times that the economy
was doing well or badly?
A. A lot of examples
B. A couple of examples
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C
A
0%
A. A
B. B
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C. C
B
C. No examples
Model of the Business Cycle
Business cycles are characterized by
periods of expansion and contraction
in economic activity.
Model of the Business Cycle (cont.)
• Business fluctuations are common and
some individuals associate them with the
business cycle.
View: Model of a Business Cycle
Model of the Business Cycle (cont.)
• The business cycle usually follows the
following pattern:
– Peak/boom
– Contraction
– Recession
– Depression
– Trough
– Expansion/recovery
Can you think of some reasons why
the economy experiences a business
cycle?
A. Many reasons
B. Some reasons
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C
A
0%
A. A
B. B
0%
C. C
B
C. No reasons
Ups and Downs of Business
Throughout its history, the United
States has experienced business
expansions and recessions of varying
severity and frequency.
Ups and Downs of Business (cont.)
• The stock market crash in October 1929
was the largest drop in the business cycle,
and led to the Great Depression.
– The economy slowly began to rise
again, reaching a boom period after
World War II.
View: Business Activity
Ups and Downs of Business (cont.)
• The 1980s also started off with a small
recession, but recovered within 2 years
(except for the stock market crash of
1987).
• The economy experienced more trouble
during the dot-com meltdown of March
2001 and the September 11 terrorist
attacks.
What do you think is the main reason
that terrorist attack may cause
weakness in the economy?
A. It shakes consumer
confidence.
B. It disrupts supply.
C. It disrupts demand.
0%
A
A. A
B. B
0%
C. C
B
0%
C
Section Preview
In this section, you will learn how
economists explain and predict changes or
fluctuations in the economy.
Can you think of some factors that
work together to cause business
fluctuations?
A. Many factors
B. Some factors
0%
C
A
0%
A. A
B. B
0%
C. C
B
C. No factors
Causes of Business Fluctuations
Business cycles can be caused by
changes in business investment,
government policies, and the
availability of key commodities, or by
psychological factors.
Causes of Business Fluctuations (cont.)
• Economists link fluctuations to four main
forces:
– Business investment—when businesses
anticipate an economic downturn, they
may cut back on capital investment,
which could lead to a recession—or vice
versa.
• Innovations can also help the economy
Causes of Business Fluctuations (cont.)
– Government activity—the government
affects business activity in two ways:
• Through its policies on taxing and spending.
• Through its control over the supply of money
available in the economy.
– External factors—wars and the
availability of raw materials may also
have an effect.
Causes of Business Fluctuations (cont.)
– Psychological factors—factors, such as
the terrorist attacks in 2001, can cause
fluctuations in business.
Which force do you think is the
strongest?
A. Business investment
B. Government activity
C. External factors
D. Psychological factors
0%
A
A.
B.
0%
C.
D.
B
A
B
0%
C
D
C
0%
D
Economic Indicators
Some economists use leading,
coincident, and lagging indicators to
assess the current state of the
economy and to predict its future
course.
Economic Indicators (cont.)
• Economists study a number of economic
indicators to learn about the state of the
economy.
– The U.S. Department of Commerce,
along with a private company called the
Conference Board, compiles these
statistics once a month.
View: Major Economic Indicators
Economic Indicators (cont.)
• Economic indicators include:
– Leading indicators
– Coincident indicators
– Lagging indicators
A nation’s gross domestic product (GDP)
is the total dollar value of all final goods and
services produced annually.
GDP figures must be adjusted for inflation,
which can be measured in several ways.
The price level of the overall economy is
determined by the interaction of aggregate
demand and aggregate supply.
Economic Concepts
Transparencies
Transparency 13 Gross Domestic
Product
Transparency 14 Aggregate Supply
Transparency 15 Aggregate Demand
Select a transparency to view.
national income accounting:
measurement of the national
economy’s performance, dealing with
the overall economy’s output and
income
gross domestic product (GDP):
total dollar value of all final goods and
services produced in a nation in a
single year
net exports: difference between what
the nation sells to other countries and
what it buys from other countries
depreciation: loss of value because
of wear and tear to durable goods
and capital goods
net domestic product (NDP): value
of the nation’s total output (GDP)
minus the total value lost through
depreciation on equipment
national income (NI): total income
earned by everyone in the economy
personal income (PI): total income
that individuals receive before
personal taxes are paid
transfer payments: welfare and
other supplementary payments that a
state or the federal government
makes to individuals
disposable personal income (DPI):
income remaining for people to spend
or save after all taxes have been paid
inflation: prolonged rise in the
general price level of final goods and
services
purchasing power: the real goods
and services that money can buy;
determines the value of money
deflation: prolonged decline in the
general price level of goods and
services
consumer price index (CPI): a
statistical measure of the average of
prices of a specified set of goods and
services purchased by typical
consumers in city areas
market basket: representative group
of goods and services used to
compile the consumer price index
base year: year used as a point of
comparison for other years in a series
of statistics
producer price index (PPI):
measure of the change in price over
time that U.S. producers charge for
their goods and services
GDP price deflator: price index that
removes the effect of inflation from
GDP so that the overall economy in
one year can be compared to another
year
real GDP: GDP that has been
adjusted for inflation by applying the
price deflator
aggregates: summation of all the
individual parts in the economy
aggregate demand: the total of all
planned expenditures in the entire
economy
aggregate demand curve: a
graphed line showing the relationship
between the aggregate quantity
demanded and the average of all
prices as measured by the implicit
GDP price deflator
aggregate supply: real domestic
output of producers based on the rise
and fall of the price level
aggregate supply curve: a graphed
line showing the relationship between
the aggregate quantity supplied and
the average of all prices as measured
by the implicit GDP price deflator
business fluctuations: ups and
downs in an economy
business cycle: irregular changes in
the level of total output measured by
real GDP
peak/boom: period of prosperity in a
business cycle in which economic
activity is at its highest point
contraction: part of the business
cycle during which economic activity
is slowing down
recession: part of the business cycle
in which the nation’s output (real
GDP) declines for at least six months
depression: major slowdown of
economic activity
trough: lowest part of the business
cycle in which the downward spiral of
the economy levels off
expansion/recovery: part of the
business cycle in which economic
activity slowly increases
innovation: transforming an
invention into something useful to
humans
economic indicators: statistics that
measure variables in the economy
leading indicators: statistics that
point to what will happen in the
economy
coincident indicators: economic
indicators that usually change at the
same time as changes in overall
business activity
lagging indicators: indicators that
seem to lag behind changes in overall
business activity
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