Module 10
The Circular
Flow and Gross
Domestic Product
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How economists use aggregate measures to
track the performance of the economy
• The circular flow diagram of the economy
• What gross domestic product, or GDP, is and
the three ways of calculating it
The National Accounts
• National Income and
Product Accounts
• Reliability
The Simple Circular-Flow Diagram
The Expanded Circular-Flow
Diagram
Gross Domestic Product
• Final goods and services
• Intermediate goods and services
• GDP
• Value of all goods and services produced (value added
approach)
• Aggregate Spending (C + I + G + XN)
• Total Factor Income
The Components of GDP
What's Included
Not Included
Intermediate goods and services
Inputs
Domestically produced final goods and
services, including capital goods, new
construction of structures, and changes to
inventories
Used goods
Stocks & Bonds
Foreign produced goods & services
Module
11
Interpreting
Real Gross
Domestic Product
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The difference between real GDP and
nominal GDP
• Why real GDP is the appropriate measure of
real economic activity
What GDP Tells Us
• Economic Size
• Comparison
Relative size of country indicates
relative size of Gross Domestic
Product
Real GDP: A Measure of Aggergate
Output
• Inflation’s effect on GDP
• Aggregate Output
Calculating Real GDP
Year
Tons of
Corn
Price per
Ton
Tons of
Soybeans
Price
per Ton
Nominal Real GDP
GDP
Base Year
= 2007
2007
100
$100
80
$50
(100*$10
0) +
(80*$50)
= $14,000
2008
110
$110
80
$100
(110*$11 (110*$10
0) +
0) + (80*
(80*$50)
$50) =
= $20,100 $15,000
$14,000
What Real GDP Doesn’t Measure
• Real GDP v. GDP per capita
• Living Standards
• Limitations of Real GDP per capita
12
Module
The Meaning
and Calculation
of Unemployment
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How unemployment is measured
• How the unemployment rate is calculated
• The significance of the unemployment rate
for the economy
• The relationship between the
unemployment rate and economic growth
Defining and Measuring
Unemployment
•Employed
•Unemployed
•Labor Force
•Labor Force Participation Rate
•Unemployment Rate
The Significance of the
Unemployment Rate
• Indicator of employment opportunity
• Overstating the true level of unemployment
• Understating the true level of unemployment
• discouraged workers
• marginally attached workers
• underemployed
The Significance of the
Unemployment Rate
Growth and Unemployment
• Recessions and unemployment
• Economic expansions and unemployment
• Except
• Relationship between economic growth and unemployment
Module
13
The Meaning
and Calculation
of Unemployment
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The three different types of unemployment
and their causes
• The factors that determine the natural rate
of unemployment
Job Creation and Job Destruction
•4.5 million jobs destroyed in a ‘good’ month
•Structural changes in the economy
Frictional Unemployment
• Job Search
• Frictional Unemployment
• Duration
• periods of low unemployment
• periods of high unemployment
Structural Unemployment
• Persistent Surplus
• Structural Unemployment
• Minimum Wages
• Labor Unions
• Efficiency Wages
• Side Effects of Public Policy
Structural Unemployment
The Natural Rate of
Unemployment
• Natural Rate of Unemployment
Natural unemployment = Frictional unemployment + Structural
unemployment
• Cyclical Unemployment
Actual unemployment = Natural unemployment + Cyclical unemployment
Changes in the Natural Rate of
Unemployment
• Natural rate of unemployment changes
• Changes in Labor Force Characteristics
• Changes in Labor Market Institutions
• Changes in Government Policies
14
Module
Inflation:
An Overview
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The economic costs of inflation
• How inflation creates winners and losers
• Why policy makers try to maintain a stable
rate of inflation
• The difference between real and nominal
values of income, wages, and interest rates
• The problems of deflation and disinflation
The Level of Prices Doesn’t
Matter...
•Misconception
•It’s all relative
•Real Wage
•Real Income
...But the Rate of Change of Prices
Does
• Inflation Rate
Inflation rate =
Price level in year 2 - Price level in year 1
Price level in year 1
•Shoe-Leather Costs
•Hyperinflation
•Menu Costs
•Unit-of-Account Costs
X 100
Winners and Losers from Inflation
• Nominal contracts
• Nominal interest rate v. real interest rate
Inflation is Easy; Disinflation is
Hard
• Disinflation
• The cost of disinflation
• Policy response to inflation
15
Module
The Measurement
and Calculation
of Inflation
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How the inflation rate is measured
• What a price index is and how it is
calculated
• The importance of the consumer price index
and other price indexes
Price Indexes and the Aggregate Price
Level
• Aggregate Price
Level
Market Baskets and Price Indexes
•Market Basket
Market Baskets and Price Indexes
•Price Index
Price Index in given year =
Inflation Rate =
Cost of market basket in a given year
Cost of market basket in base year
Price index in year 2 - Price index in year 1
Price index in year 1
X 100
X 100
The Consumer Price Index
•Consumer Price Index (CPI)
•What is it?
Other Price Measures
• Producer Price Index (PPI)
• GDP deflator
• Coincidence of inflation measures