Do Now.
• In December 1975 the government of Portugal—a provisional government
in the process of establishing a democracy—feared that it was facing an
economic crisis. Business owners, alarmed by the rise of leftist political
parties, issued dire warnings about plunging production. Newspapers
speculated that the economy had shrunk 10 to 15% since the 1974
revolution that had overthrown the country’s long-standing dictatorship.
• In the face of these reports of economic collapse, some Portuguese were
pronouncing democracy itself a failure. Others declared that capitalism
was the culprit, demanding that the government seize control of the
nation’s factories and force them to produce more. But how bad was the
situation, really? Speculate on why Portugal was having so many
problems.
AP Macroeconomics
MR. Graham
Unit Three
Measurement of Economic Performance
Module 10:
The Circular Flow and
Gross Domestic Product
3
National Income Accounting
• Measures the flows of income and
expenditures in the economy over time.
• Serves the same purpose for the economy as a
whole as does the income statement of a firm.
• The most simplified representation of the
macroeconomy and national income
accounting is the Circular-Flow Model.
The Circular-Flow Diagram
• The model involves the following principles:
– There are two groups of decision-makers in a
private economy: households and businesses
– In every economic exchange, the seller receives
exactly the same amount that the buyer spends
– Goods and services flow in one direction and
money payments flow in the other
The Circular-Flow Diagram
• Product Markets
– Households are on the demand side,
purchasing goods and services.
– Businesses are on the supply side,
offering products for sale.
– Interaction of this demand and supply
determines the price of each product.
The Circular-Flow Diagram
• Product Markets
– Businesses provide final goods and services to
households…
The Circular-Flow Diagram
• Product Markets
– …who in turn pay for them with money.
The Circular-Flow Diagram
• Factor Markets
– Households are on the supply side, providing
resources directly (workers) or indirectly
(ownership of corporations, land, etc.)
– Businesses are on the demand side, purchasing
resources in order to produce goods and services.
– Interaction of this supply and demand determines
the price of each resource, which in turn is
income for the owner of that resource.
The Circular-Flow Diagram
• Factor Markets
– Households “sell” resources to businesses…
The Circular-Flow Diagram
• Factor Markets
– …who in turn pay for them with wages, rent,
interest, and profits (i.e. Total Income).
The Circular-Flow Diagram
The Circular-Flow Diagram
• Question
– Why must the total dollar
value of income and
output money be
identical to each other?
• Answer
– Every transaction
simultaneously involves
expenditure and receipt.
If $ value of output is greater than $ value of input,
difference is profit. “Profit”—for both households and firms—
is always the residual item that completes the circular flow.
(Expanded) Circular-Flow Diagram
Gross Domestic Product (GDP)
• The most commonly presented statistic of
national income accounting is the GDP.
• Represents the total market value of all
final goods and services produced within a
country in one year.
• The GDP at the end of FY12 = $15.85 trillion.
Gross Domestic Product (GDP)
• Represents the total market value…
– We compute the value of production, not just production.
Simply Adding Production
January
February
# Cappuccinos
# Lattes
# Scones
# Cappuccinos
# Lattes
# Scones
25
25
50
30
30
40
Adding the Value of Production
January
Quantity
Prices
Value
February
Quantity
Prices
Value
Cappuccinos
25
$3.00
$75
Cappuccinos
30
$3.00
$90
Lattes
25
$2.50
$62.50
Lattes
30
$2.50
$75
Scones
50
$1.50
$75
Scones
40
$1.50
$60
Totals
100
$212.50
Totals
100
$225.00
Gross Domestic Product (GDP)
• …of all final goods and services…
– It avoids double or multiple counting by eliminating
any intermediate goods (goods used up entirely in
the production of final goods).
Transaction
Cost
1 lb. of tomatoes from Grower to Processor
$.50
Bottle of ketchup from Processor to Grocer
$1.50
Grocer sells ketchup to consumer
$3.00
Total $ Spent
$5.00
• At each stage, value is added to the final product, the
bottle of ketchup; we only count the final price ($3)
Gross Domestic Product (GDP)
• …produced within a country…
– If a good was produced in America, it doesn’t matter
where it was consumed, or where the actual
company was headquartered.
– Ex: General Motors has a factory producing trucks in
South Africa. The value of these trucks is counted in
South Africa’s GDP.
Gross Domestic Product (GDP)
• …in one year.
– GDP sums the dollar value of what has been
produced in the economy over the year, not what
was actually sold.
– Ex: A Honda Civic produced in Kentucky in 2012, but
not sold until January 2013, is counted in 2012
production and 2012 GDP.
Gross Domestic Product (GDP)
• 3 Ways for Calculating GDP
1. Survey firms and add up the total value of their
production of final goods and services.
2. Sum the total factor income earned by households
from firms in the economy.
3. Add up aggregate spending on domestically
produced final goods and services in the economy.
Calculating GDP
3
2
1
Calculating GDP
2. Sum the total factor income earned by
households from firms in the economy.
• Adding up all components of national income,
including wages, interest, rent, and profits.
• “Income Approach”
Calculating GDP
2
Calculating GDP
3. Add up aggregate spending on domestically
produced final goods and services in economy.
– Adding up the dollar value of all final goods and
services purchased by consumers, businesses,
government, and buyers from outside the country.
– “Expenditure Approach”
Calculating GDP
3
The Components of GDP
• GDP = C + I + G + X
• Consumption (C): Households’ purchases of final
goods and services during the year
– Durable Consumer Goods
– Nondurable Consumer Goods
– Services
The Components of GDP
• GDP = C + I + G + X
• Gross Private Domestic Investment (I):
Domestic spending on:
– additions to inventories,
– new capital goods (factories, machines)
The Components of GDP
• GDP = C + I + G + X
• Government Expenditures (G): consumption
and investment for all government branches
– State, local, and federal
– Includes all direct purchases of resources (i.e. labor)
The Components of GDP
• GDP = C + I + G + X
• Net Exports (X): the value of exports less the
value of imports
Net exports (X) = Total exports – Total imports
The Components of GDP
• Presenting the expenditure approach
– Where
• C = consumption expenditures
• I = investment expenditures
• G = government expenditures
• X = net exports
GDP = C + I + G + X
Answer the following…
1. Define GDP
2. List some things that are included in the
calculation of GDP
3. List some things that are not
4. Explain why national income accounting is
important
5. What are the 3 methods for calculating GDP?
Comparing the Methods (1 and 2)
Comparing the Methods (2 and 3)
GDP and National Income, 2011
Comparing the Methods (2 and 3)
GDP and National Income, 2011
GDP: What’s In and What’s Out?
• Exclusions from the GDP calculation…
– Intermediate goods and services
– Inputs
– Used goods
– Transfer Payments
– Financial assets (i.e. stocks and bonds)
– Foreign-produced goods and services
Should it be counted?
1. A painter purchases new brushes for his business?
2. The services of an accountant?
3. A purchase of a used automobile?
4. A Social Security check paid to a retired worker?
5. The sale of a new home?
6. An increase in business inventories?
7. The government’s purchase of a new fighter jet?
8. Unemployment paid to a laid-off worker?
Do Now:
• http://www.reffonomics.com/textbook2/macr
oeconomics2/introtomacro/gdp.swf
• http://www.youtube.com/watch?v=lBDT2w5
Wl84
• http://www.learner.org/series/econusa/unit1
5/
Module 11:
Interpreting Real Gross Domestic Product
38
What GDP Tells Us
•
Provides us with a scale
against which to compare our
current economy with
• economic performance
of other years
• economic performance
of other countries
 Be careful…part of the increase in the value of GDP over
time represents increases in the prices of goods and
services rather than an increase in output.
Calculating Nominal GDP
• Nominal GDP: GDP calculated at existing prices.
•
Has the value of sales increased from year 1 to year 2?
•
What is the Nominal GDP growth rate?
Growth Rate =
Year 2
-1
Year 1
8-40
Calculating Real GDP
• Real GDP: Nominal GDP adjusted for inflation.
•
Does this increase in the dollar value of GDP
overstate the real growth in the economy?
•
How much would GDP have gone up if prices had
not changed (i.e. “Year 1” prices)?
8-41
Calculating Real GDP
Nominal GDP
Real GDP =
x 100
Price Index*
*Price Index: measured by the GDP deflator
Year
Nominal GDP
(billions)
Price Index
(base year
2005 = 100)
1980
$2,915
49.59
1985
$4,319
62.14
1990
$5,846
73.24
1995
$7,543
82.20
2000
$10,130
89.49
2005
$12,740
100
2010
$14,740
111.84
Real GDP
(billions)
8-42
Real GDP
• Between 1997 and 2007, Venezuela’s GDP grew by
an average of 28% annually—is Venezuela
experiencing an economic miracle?
7-43
Economic Growth
• Typically measured by Real GDP growth rate:
Growth Rate =
Year 2
Year 1
-1
2010: $13,180 billion
2012: $13,660 billion
8-44
Per Capita Real GDP
• Other things equal, a country with a larger
population will have higher GDP simply
because there are more people working.
• Per capita real GDP
– Adjusting for population growth
Real GDP
Per capita real GDP =
Population
8-45
Comparing GDP Internationally
 Purchasing Power Parity: Adjustment in exchange
rate conversions that takes into account differences
in the true cost of living across countries
Links
• http://www.reffonomics.com/textbook2/macr
oeconomics2/inflation/realnominal.swf
Do Now.
• http://www.youtube.com/w
atch?v=lBDT2w5Wl84
• http://www.learner.org/seri
es/econusa/unit15/
• What is the difference
between real GDP and
nominal GDP
• Define labor force
• Define unemployment
• What is the current
unemployment rate?
• What is a “healthy”
unemployment rate for a
country to have?
Module 12:
The Meaning and Calculation
of Unemployment
49
The Unemployment Rate
 It is another important variable, in addition to GDP and
inflation, on which macroeconomics focuses.
7-50
Defining and Measuring Unemployment
• Unemployed
– Actively looking for work but aren’t currently
employed.
• Labor Force
– Number of employed plus the number of
unemployed.
– Currently 155.5 million people (February 2013)
Labor Force = Employed + Unemployed
7-51
The Unemployment Rate
• Unemployment Rate
– The percentage of the labor force that is unemployed.
Unemployed
Unemployment Rate =
Labor Force
x 100
7-52
Categories of Individuals Without Work
 Job loser: An individual whose employment was
involuntarily terminated or who was laid off (40–60%)
 Reentrant: An individual who has worked a full-time
job before but left the labor force and has now
reentered it looking for a job (20-30%)
 Job leaver: An individual who voluntarily quit (10-15%)
 New entrant: An individual who has never worked a
full-time job for two weeks or longer (10-15%)
7-53
Duration of Unemployment
• More than 1/3 of job seekers find work within 1 month.
• Approximately 2/3 find employment within 2 months.
• About 1/6 are still unemployed after 6 months.
• Current average duration of unemployment is 37 weeks.
Problems with the Unemployment Rate
•
It can overstate the true level of unemployment.
•
It is healthy and normal for a confident job-seeker to
take his time before accepting a position.
7-55
Problems with the Unemployment Rate
•
It can understate the true level of unemployment.
•
Excludes discouraged workers
• individuals who have stopped looking for a job because
they are convinced they will not find a suitable one.
•
Excludes marginally attached workers
• individuals who have stopped looking for a job during
the measured period.
•
Excludes underemployed workers
• individuals working beneath their skill level or only able
to find part-time jobs.
7-56
Problems with the Unemployment Rate
 It can understate the true level of unemployment.
7-57
Problems with the Unemployment Rate
 It varies greatly among demographic groups.
7-58
Growth and Unemployment
 The unemployment rate remains the most closely
watched and highly publicized labor statistic.
7-59
Growth and Unemployment
 There is a generally strong negative relationship between
growth in the economy and the rate of unemployment.
7-60
Module 13:
The Causes and Categories
of Unemployment
61
Categories of Unemployment
• Frictional Unemployment
– Results from workers moving from one job to
another seeking appropriate offers
• Includes people who have decided to leave one job to
look for another
• Includes new entrants and re-entrants into the labor
force
• This takes time, so they remain temporarily
unemployed
– Regarded by economists as a normal part of a
healthy and changing economy
7-62
Frictional Unemployment
•
During periods of high unemployment (i.e. 2012), a
smaller share of unemployment is frictional.
7-63
Categories of Unemployment
• Structural Unemployment
– Results from a poor match of workers’ abilities
and skills with current requirements of employers
• Caused by technological advances and shifts in
consumers’ tastes
• Caused by a decline or disappearance of natural
resources in a region
• Caused by a seasonal pattern of work in specific
industries (a.k.a. “Seasonal Unemployment)
7-64
Categories of Unemployment
• Structural Unemployment
– Results when there are more people seeking jobs in
a labor market than there are jobs available
at the current wage rate.
– Occurs when the
wage rate is, for
some reason,
persistently above
equilibrium.
7-65
Categories of Unemployment
• Cyclical Unemployment
– Results from business recessions and economic
downturns that occur when aggregate (total)
demand is insufficient to create full employment
• When sales decline, producers tend to reduce output
and lay off workers
– Harms the economy more than any other type of
unemployment.
7-66
Cyclical Unemployment
•
Is it “Structural, Frictional and Cyclical Unemployment?”
7-67
The Natural Rate of Unemployment
• When cyclical unemployment is zero, the
unemployment rate is called the natural rate
of unemployment, because it reflects
unemployment that arises from natural
features of a market society.
• When seasonally adjusted…
Natural rate of unemployment =
Frictional unemployment + Structural unemployment
Actual rate of unemployment =
Natural unemployment + Cyclical unemployment
The Natural Rate of Unemployment
• “Full Employment”
– The natural rate of unemployment is considered to
reflect the economy at full employment
– This is an arbitrary level of unemployment that
corresponds to “normal” friction in the
labor market
– For the U.S. economy, the rate is around 5%
The Natural Rate of Unemployment
• In Macroeconomics,
we will often refer to
“Full Employment,”
which is exhibited by
the vertical LRAS in the
graph to the right.
Changes in the
Natural Rate of Unemployment
• Changes in Labor Force Characteristics
– In general, unemployment rates tend to be lower for
an older population and a male population.
Changes in the
Natural Rate of Unemployment
• Changes in Labor Market Institutions
– New unions can increase structural unemployment.
– Temporary employment agencies and job-placement
websites can decrease frictional unemployment.
Changes in the
Natural Rate of Unemployment
• Changes in Government Policies
– A high minimum wage can increase structural
unemployment.
– Generous unemployment benefits can increase both
structural and frictional unemployment.
– Job training and employment subsidies may
decrease structural and frictional unemployment.
Do Now.
• http://www.criticalcommons.org/Members/G
hent/clips/the%20revenge.mp4
• http://www.criticalcommons.org/Members/g
dmateer/clips/parks_and_rec_budget_final.m
4v
Module 14:
Inflation: An Overview
75
Inflation and Deflation
• Inflation
– The situation in which the average of all prices of
goods and services in an economy is rising.
• Deflation
– The situation in which the average of all prices of
goods and services in an economy is falling.
The Level of Prices Doesn't Matter…
• If the level of prices was rising/falling,
so would wages and incomes in general.
…But the Rate of Change of Prices Does
…But the Rate of Change of Prices Does
• Inflation Rate
– The percentage increase in the overall level of
prices per year.
Inflation Rate =
Price Level in Year 2
Price Level in Year 1
-1
7-79
"Costs" of Inflation
• Shoe-Leather Costs
– A high inflation rate discourages people from
holding money, because the purchasing power of
the cash in your wallet and the funds in your
bank account steadily erodes as the overall level
of prices rise.
– The “search” for ways to reduce the money they
hold comes at considerable cost
"Costs" of Inflation
• Menu Costs
– A high inflation rate forces firms to change prices
more often than they would if the price level was
more or less stable.
– The changing of a listed price has a “real” cost.
"Costs" of Inflation
• Unit-of-Account Costs
– The role of the dollar as a basis for contracts and
calculation is called the “unit-of-account” role of
money;
– A high inflation rate causes a dollar next year to
be worth less than a dollar this year.
– This effect reduces the quality of economic
decisions and the economy as a whole makes less
efficient use of its resources
Inflation and Deflation in U.S. History
Winners and Losers from Inflation
• The value of money is typically talked about in
terms of purchasing power
– Represents real goods and services that it can buy
– Inflation is decline in purchasing power of money
Winners and Losers from Inflation
• Purchasing Power
– Nominal value: price expressed in today’s dollars
– Real value: value expressed in purchasing power,
adjusted for inflation
– For example, a $100 bill from your grandparents
this year will have a nominal value of $100 next
year but a real value of less, assuming a decrease
in the purchasing power after a year of inflation
Winners and Losers from Inflation
• Anticipated vs. Unanticipated Inflation
– To determine who is hurt by inflation we
distinguish between the two types.
– The effects of inflation on individuals depend
upon which type of inflation exists.
Winners and Losers from Inflation
• Unanticipated Inflation
– Inflation at a rate that comes as a surprise, either
higher or lower than rate anticipated
• Anticipated Inflation
– The inflation rate that we believe will occur
regardless of whether it is higher or lower than
the actual rate
• Some of the problems caused by inflation arise
when it is unanticipated…
Winners and Losers from Inflation
• Economists summarize the effect of inflation
on borrowers and lenders by distinguishing
between nominal and real interest rates.
– Nominal Rate of Interest
• The market rate of interest expressed in today’s dollars
– Real Rate of Interest
• The nominal interest rate adjusted for inflation
(i.e. minus the inflation rate)
•
•
Real interest rate—subtract the inflation rate from the nominal interest rate
Ex. if nominal is 8 and inflation rate is 5 the real interest rate is 3%
Winners and Losers from Inflation
• Inflation affects people differently
• When inflation is higher than anticipated…
– Creditors lose
– Debtors gain
– Creditors lose because the debtor is charged an
interest rate that does not cover the actual
inflation rate
– Loans are based on contracts. Dollars you pay to
the bank are actually less valuable over time
Winners and Losers from Inflation
• When inflation is lower than anticipated…
– Debtors lose
– Creditors gain
– Debtors lose because they are charged an
interest rate that is higher than the actual
inflation rate
– Creditors are paid back in more “valuable”
dollars over the course of the loan
Protecting Against Inflation
• Banks attempt to protect themselves by raising nominal
interest rates to reflect anticipated inflation (i.e. ARMs)
• Workers attempt to protect themselves with Cost of Living
Adjustments (COLAs)
– Clauses in contracts that allow for increases in specified
nominal values to take account of changes in the cost of living
• Individuals attempt to protect themselves by placing their
savings into interest-bearing accounts
– Often pay nominal rates of interest that reflect
anticipated inflation
The “Cost” of Disinflation
• Bringing the inflation rate down—a process
called disinflation—is very difficult and costly
The Misery Index Since the Early 1960s
Do Now.
• What is the purpose of a price index?
• What is the difference between anticipated
and unanticipated inflation?
• If inflation is higher than anticipated who
loses and who gains?
• Explain the concept of purchasing power.
Module 15:
The Measurement and Calculation
of Inflation
95
Price Indexes
• Aggregate Price Level
– Just as macroeconomists find it useful to have a
single number to represent the overall level of
output (GDP), they also find it useful to have a single
number to represent the overall level of prices.
– Much more difficult to measure!
Measuring Inflation
• Price Index
– The cost of today’s market basket of goods
expressed as a percentage of the cost of the
same market basket during a base year
Cost today of market basket
Price index =
 100
Cost of market basket in base year
Calculating the Cost of a Market Basket
• In the above table there are only three goods in the “market basket”.
The quantities in the basket remain the same between the pre-frost and
post-frost periods—a fixed-quantity price index is easiest to compute.
Calculating the Cost of a Market Basket
Price index =
Price index pre-frost:
 100
Price index =
 100
Price index post-frost:
• How much has the average price of “citrus” risen as a
consequence of the frost?
Recall…
• The “price level” mentioned in our inflation rate
formula from Module 14 is simply a price index value.
Inflation Rate =
Inflation Rate =
•
Price index in year 2
Price index in year 1
184.2
100
-1
- 1 = .842 or 84.2%
Typically, a news report that cites “the inflation rate”
is referring to annual change in consumer price index.
7-100
Price Indexes
• Consumer Price Index (CPI)
• Producer Price Index (PPI)
• GDP deflator
Price Indexes
• Consumer Price Index (CPI)
– A measure of the average change over time in the
price of a fixed groups of products
– Most commonly used inflation indicator
– Calculated and reported by the Bureau of Labor
Statistics (BLS) each month
• BLS selects a base year against which to measure change
• Selects a representative sample of commonly purchased
consumer goods (market basket)
Consumer Price Index (CPI)
Consumer Price Index (CPI)
Price Indexes
• Producer Price Index (PPI)
– A measure of the average change over time in the
costs of production
• Increasing costs of production lead to a decrease in supply
• Decreasing supply leads to increasing prices
– Used as a short-run leading indicator (before CPI)
– There are PPIs for selected types of products as well as
for production stages or particular industries:
• Food materials
• Intermediate goods
• Finished goods
Price Indexes
• GDP Deflator
– A price index measuring the changes in prices of all
new goods and services produced in the economy
– Unlike CPI and PPIs, the GDP deflator is not based on
a fixed market basket
– Broadest measure of prices; reflects both price
changes and the public’s market responses to
those price changes (i.e. new expenditure patterns)
– Very small statistical difference from CPI
Price Indexes
Appendix:
Unit Three
Review of Formulas
108
Real GDP
Nominal GDP
Real GDP =
Price level*
x 100
*Price level: measured by the GDP deflator
8-109
Per Capita Real GDP
Real GDP
Per capita real GDP =
Population
8-110
Economic Growth Rate
RGDP in year 2 – RGDP in year 1
Growth Rate =
x 100
RGDP in year 1
7-111
Unemployment Rate
Unemployed
Unemployment Rate =
Labor Force
x 100
7-112
Price Index
Cost today of market basket
Price index =
 100
Cost of market basket in base year
Inflation Rate
Price index in year 2 – Price index in year 1
Inflation Rate =
Price index in year 1
x 100
7-114