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Gross Domestic Product
Aggregate output of an economy
How we measure growth in the economy
Measure of the market value of the output of final goods and services in the economy in a given period
How do we grow the economy?
the net investment needs to be postive (more gross investment than depreciation)
How to calculate GDP?
expenditures method: add up aggregate spending on all domestically produced goods and services in the economy (Y=C+I+G+(X-M)) *rent is counted as consumption
income method: add up the total factor income earned by households from firms in the economy, every dollar spent become a dollar of income for someone, total value of market income = total value of GDP (income = wages, profits, interest, rent)
value-add method: add total value of all final goods and services produced, used to avoid double counting by excluding intermediate goods
intermediate good
goods and services used as input to create a final good/service ex. leather in shoes
final good
final product counted in GDP
GDP v. GNP (Gross National Product)
GDP measures the market value of the output of final goods and services in the economy versus GNP which measures the market value of the output produced by residents and citizens of a country
Real GDP v. Nominal GDP
Real GDP is the value of final output produced adjusting for changing prices (accounts for inflation) (year t = nominal GDP in year t / price index) versus nominal GDP is the value of final output produced measured in the prices during that period of time (year t = 0)
price index
price level percentage change from a base of 100
purchasing power parity
the nominal exchange rate between two countries at which a given basket of goods would cost the same amount in each country (COLA) - exchange rates differ
What is counted in GDP?
investment spending
capital spending
domestically produced G&S
What is not counted in GDP?
spending on intermediate G&S
used goods
financial assets like stocks and bonds
import spending
black market economy
What are som shortcomings of GDP as a measure of economic growth?
Does not account for: externalities ex. environmental damages, quality changes ex. free software updates, intangibles ex. political freedom, and non-market activities ex. money laundering
does not show wealth distribution or accurately reflect the quality of life
labor force
all people 16 or older employed or actively seeking work (not included are those not employed or actively seeking work)
how to calculate labor force participation rate?
participation rate = (labor force / population 16 and older) x 100
way in which labor force increases?
aging of the younger population (out of school)
population increase
immigration
*growth expands PPC
unemployment
inability of people in labor force to find a job
how to calculate unemployment rate
unemployment rate = number of people unemployed / labor force
okuns law
1% more unemployment = 2% less output
how does the government measure unemployment?
US census bureau surveys 60,000 households every month
how do unemployment rates understate the labor market
it does not count discouraged workers
how do unemployment rates overstate the labor market?
it includes people in between jobs (frictional unemployment) or gig workers
discouraged worker
individuals who have given up on looking for work because they cannot find a job (not counted in unemployment rate)
underemployed
workers who want full-time jobs but are working part-time or below their capacity
federal minumum wage
$7.25 per hour
labor supply curve
shows number of workers willing and able to work in an occupation at different wages
labor demand curve
shows number of workers firms are willing to hire at different wages
unemployment graphically
when minimum wage (price floor) is above equilibrium = surplus of labor = people unemployed
seasonal unemployment
unemployment due to seasonal changes ex. summer job
frictional unemployment
brief unemployment due to people moving between jobs or entering the labor market ex. college student
structural unemployment
unemployment caused by mismatch in skills ex. new technology puts factory workers out of work
cyclical unemployment
unemployment due to lack of job vacancies ex. market crash, depression
what does not count as unemployment?
vacation, strike, parental leave
full employment
not 0% unemployment because always people moving in between jobs, will cause inflation if at 0% unemployment, stays at natural unemployment
0% unemployment
unachievable because there is always frictional and seasonal unemployment
what is the relationship between unemployment and inflation?
when low unemployment (below 4-6% - natural rate), workers will demand higher wages, prices then increase, people buying more, wage pressure, inflation
stagflation
when both unemployment rate and inflation are high
inflation
increase in average price level
causes of inflation
demand-pull inflation: consumers willing and able to buy more goods than economy can produce, producers raise prices, driven by high demand
cost-push inflation: producers raising output prices to cover high costs when production gets expensive
inflationary spiral
when demand-pull and cost-push cause each other to grow, goes round and round (consequence of inflation)
deflation
decrease in average price levels
macroeconomic effects of inflation
price of goods and services go up
can affect people if nominal income does not rise with the rate of inflation
affect wealth if assets are declining in real value
social tensions, loose faith in government
psychological affects: money illusion - the use of nominal dollars rather than real dollars to gauge income or wealth
consequences of deflation
avg price level falling
microeconomic effects of inflation
speculation
uncertainty makes it hard to make long term decisions (investments)
bracket creep: higher tax brackets = higher taxes but real income may not have increased
hyperinflation
200% inflation for at least one year
how do you measure inflation?
market baskets: economist track prices of typical consumer goods
inflation rate = ((price index in year 1 - price index in year 0)/price index in year 0)x100
price indexes: (cost of market basket in given year / cost of market basket in base year) x 100
real interest rate
nominal - inflation
inflation rate
((consumer price index in year 1 - consumer price index in year 0)/consumer price index in year 0)x100
what are the economic cost of unstable prices?
shoe-leather costs: everyone is running around with their money because loosing value if in savings
menu costs: restaurants keep changing menu prices due to unstable prices, have to pay for printing new menus
unit-of-account costs: money becomes unreliable unit of measurement
what indicates aggregate price level?
consumer price index
producer price index
GDP deflator
employment cost index
import/export price indicators
what are limitations of consumer price index?
avg bundle of goods isn’t necessarily what avg consumers purchase
consumer habit change
people substitute goods when prices change
CPI
consumer price index: measures price level of consumer goods
PPI
production price index: measures price level of production goods (includes material, intermediate goods, and final goods) - more accurate in measuring
what can the government do to control inflation?
price stability
allow some unemployment
What can happen when there is low inflation?
high unemployment
slower economic growth
more demand from people anticipating inflation
What are some measures to reduce the effects of inflation?
COLAs: cost of living adjustments, auto adjusts nominal income to rate of inflation
ARMs: adjustable rate mortgages, protects banks
business cycle
peak - max gdp
recession - gdp declines
trough - gdp minimizes
recovery - gdp increases
*the business cycle is unpredictable
What causes economic recovery?
stimulating aggregate demand or supply
printing more money
lowering interest rates
tax relief/subsidies
stimulus check
what causes recession?
supply shocks ex. covid restricting resources
demand shocks ex. gov stimulus everyone buying stuff
aggregate demand
total quantity of output (real GDP) demanded at alternative price levels
why does the aggregate demand curve slope downward?
people will buy more goods and services at lower price levels and vice cersa
real-balances effect
real value of money measure by how many goods/services dollars can buy us, therefore more money = more output
foreign-trade effect
as price levels rise, americans substitute away from american products, use cheaper foreign ones
interest-rate effect
at lower price levels, money is cheaper because interest rates go down at lower price levels
aggregate supply
total quantity of output (real GDP) producers are willing and able to supply at alternative prices
why is the aggregate supply curve sloping upward?
suppliers will bring more goods and services to the market at higher prices and vice versa
profit-effect
when price levels decline, profits drop, producers are stick with fixed costs ex. rent output will increase when price level rises
cost effect
costs are minimal at low rates of output but economy approaches capacity so suppliers raise prices to keep pace w costs
What causes shifts in aggregate demand?
changes in wealth, expectations, size of existing stock of physical capital, fiscal policy (congress, state, and local), monetary policy (the fed)
what causes shifts in aggregate supply?
changes in commodity prices, nominal wages, and productivity
the fed
the central bank of the united states
What are the results from shifts in aggregate demand and supply
AD shift left = recession, reduces output and price levels
AD shift right = recovery
AS shift left = stagflation, reduced GDP and raises prices, too much = overheat
AS shift right = lower inflation, reduces prices of key inputs
supply side theories
failure to achieve full employment may result from unwillingness of producers to provide more goods and services at current prices
solution = use tax incentives, deregulation, etc.
keynesian theory
deficiency in spending depresses economy
inadequate aggregate demand would lead to unemployment
increasing money supply or lowering interest rates could move AD curve to the right
recessionary gap
between theoretical LRAS and current equilibrium
bottom of business cycle
not achieving natural output
real GDP is less than GDP at full employment
inflationary gap
peak in business cycle
inflationary flashpoint
aggregate demand stimulated to inflation, at the start of the inflationary spiral where inflation accelerates faster than output
why is the LRAS curve vertical?
natural rate of output does not change with market structure, tech, demographics, etc.
institutional infrastructure of economy is fixed (neoclassical)
natural rate is immune to short-run fluctuations in AD
shifts in AD in long run do not change quantity of output demanded, in the long run costs will catch up with prices, workers will demand higher wages, interest rates go up, etc.
classical economists
laissez-faire - let market mechanism, invisible hand do its thing, assumes nothing goes wrong
Say’s law
whatever is produced will be sold, unsold goods and unemployed labor only last until prices and wages are adjusted - supply creates its own demand
keynesian economics
market-driven economies are unstable and take gov intervention to stimulate demand
gov should spend money they don’t have (debt) to stimulate projects, more jobs, more economic activity, more supply, leads to more demand, out of great depression
keynesian multiplier
extra government spending can trigger private spending and investment
monetarist economist
amt of money the fed prints is what circles around the economy
concerned w reducing taxes and regulations to reach full productive capacity
stimulate or cool AD
inflation winners
stockholders, owners of appreciating assets, fixed rate debt holders, gov with public sector debt
inflation losers
bondholders, renters, savers, some debt holders (ARMs), people with fixed income, banks with fix-interest loans, politicians