Unit 2: Economic Indicators and the Business Cycle

GDP

Gross Domestic Product; most important measurement of economic growth.

Measures national income or total output value of a country’s goals or products

Two ways to measure GDP

Expenditure Approach: C+G+I+X_n - Consumer spending+government spending+investment+net exports (exports-imports)

Income Approach: WIRP - Wages+Interest+Rent+Profit

Circular flow

Basic economic model of an entire economy between the product and factor markets.

Firms are the suppliers of the products and buyers of the factor market

Households are the suppliers of the factor market and buyers of the products

Leakage from circular flow

savings, taxes, imports; non-consumption uses of money

When a good is produced, which steps are calculated into GDP?

Only final output, no intermediates are considered

Factors NOT included in GDP calculation

other years, transfer payments (welfare, social security, unemployment, food stamps), stocks/finance instruments, any non-market transactions (black-market), value of social aspects, anything foreign (even if it is a US company on foreign soil)

Unemployment rate

#unemployed/total labor force x100

Types of Unemployment

Frictional: temporarily in between jobs or entering the labor market; usually short and voluntary

Structural: workers skills are no longer in demand due to changing economy, technology, or globalization (seasonal too)

Cyclical: workers whose skills would normally be in demand lose their jobs because of economic downturn/recession

Natural Rate of Unemployment

Usually 3 to 5%. ONLY includes frictional and structural

Consumer Price Index

measures the general change sin price over a variety of goods; the changes in income to maintain the same standard of living

Inflation rate

rate of change of CPI between two points, calculated by

CPI₂-CPI₁/(CPI₁) x 100

Real interest rates

nominal interest rate- inflation rate

real means inflation-adjusted

Nominal GDP

how much spent on a country’s output per year in terms of that year’s prices. Can change when a price changes.

Real GDP

measures output from a base year, IGNORING price and adjusting for inflation.

If there is inflation, Real < Nominal

Real GDP formula

Nominal/GDP deflator price index x100

Phases of the business cycle

Expansion: GDP increasing

Peak: maximum GDP

Recession: GDP decreasing

Trough: Minimum GDP

What happens when GDP increases?

Supply/Demand and PPC curves shift outward, employment increases

How to find output gaps in business cycle graph

Expansion - Recession

Labor Force Participation Rate (LFPR)

#employed+unemployed/eligible adult population x100

Misconception about full employment

NOT 100% employment, just means country has maximum amount of employment, which is the 3-5% unemployment number

Inflation is good for ____ and bad for ____

businesses, bad for consumers

Also bad for country’s international competitiveness (foreign countries benefit)

Biggest part of GDP

Consumption

Greatest GDP factor for economic growth

Investment

Classical Theory vs Keynesian Economics

Classical is Adam Smith, laissez faire, invisible hand of market (supply and demand) determines price

Keynesian is deficit spending, government pumps money into economy and cuts taxes to raise Demand to the level of Supply

Milton Friedmen was anti-Keynesian, advocating for monetary policy (lower interest rates, decrease government spending)

Private vs Public Sector

Private = Firms+Households

Public = government

Subsidies are…

transfer payments

What does the circular flow model aim to illustrate

total expenditure and total income

expenditure means spending

total spending = total income

What is exchanged with the government?

Public goods (infrastructure), taxes, transfer payments, government spending for the product/factor markets

Examples of Factor Payments

Interest, Wages, Rent

How to real interest rate

Real rate = nominal - inflation rate

What causes cyclical unemployment?

Decreeases in consumption/any factor of GDP in a recession

Full employment happens when

The only unemployment is structural and frictional

macro basket

Consumer price index; fixed set of goods and services that economists, politicians, and financial analysts use to track price changes and inflation

An economy with an unemployment rate below its natural rate of unemployment would tend to suffer from what?

Inflation

Are subsidies counted in GDP?

Yes, its gov spending

How to calculate labor force

unemployed + employed

Which of the following formulas would be used to calculate nominal GDP? (Assume that the current year is different from the base year.)

current year prices • current year quantity

Leaving one job for another is an example of…

employment, the time in between the two jobs IS frictional unemployment

The business cycle depicts the…

changes in output and employment in the short-run.

Why does real GDP equal nominal GDP divided by CPI for the given year?

Because one must factor out any price changes in the value of the economy to enable true (or real) GDP comparisons.

A part time worker is…

employed and may understate the level of unemployment

Potential GDP

Linear slope line that represents predicted GDP with no cycling in business cycle

Expansion and contraction

Same as GDP increase and decreaserefers to the phases of the business cycle where the economy grows and shrinks.

What does the government do to interest rates when there is inflation? How does this affect GDP?

Raises them, which reduces C and I

If GDP deflator increases above 100, how does this affect a borrower with a fixed interest rate?

Benefits them because they are paying back a loan with money that is worth less so they are essentially losing less worth as a whole in the loan This means the real value of their debt decreases, making it cheaper in terms of purchasing power.

If price index is 50 in base year and 55 in the next, what is inflation rate?

55-50/50 = 5%

Who loses from inflation?

Loaners at fixed rates, people with fixed income, savers

Who benefits from inflation?

Borrowers, businesses wwhere product prices increase father than resource prices

Goal rate of unemployment and inflation

3-5%, 2%

What are discouraged workers and are they included in the labor force?

People who have given up looking for a job? NO they are not, because you must be actively seeking work to be unemployedand therefore counted in the labor force.

What happens to the unemployment rate when full-time workers involuntarily become part-time workers?

Nothing, they are still considered employed, overstates their value

What does a PPC of capital goods vs consumer goods look like?

BOWED OUT because these goods are NOT interchangeable

Output gap

Difference between actual and potential GDP (can be recessionary or expansionary gap

When is unemployment at the natural rate on the business cycle?

When the actual and potential GDP are equal

CPI only measures inflation in…

the consumer sector