Unit 2: Economic Indicators and The Business Cycle 💵

Circular flow of economic activity

A model that shows how households and firms circulate resources, goods, and incomes through the economy.

Closed economy

A model that assumes there is no foreign sector (imports and exports).

Consumers

People who buy goods/services in an economy.

Firms

Businesses that produce goods and supply them to the product market.

Product market

The market where firms sell goods and services to households.

Factor market

The market where factors of production, such as labor and capital, are bought and sold.

Gross Domestic Product (GDP)

The market value of the final goods and services produced within a nation in a given period.

Aggregate spending

The sum of all spending from four sectors of the economy, represented as GDP = C + I + G + (X – M).

Consumer spending (C)

Spending done by customers.

Investment spending (I)

Current spending to increase output or productivity later.

Government spending (G)

Purchases made by the government for final goods and services.

Net exports (X-M)

Exports (X) minus imports (M).

Aggregate income (AI)

The sum of all income earned by suppliers of resources in the economy.

Value-added approach

A method of calculating GDP that considers all stages of production of a final good.

Illegal activities

Transactions concerning illegal activities such as drug trafficking, that are not included in GDP.

Unpaid work

Volunteering and caregiving activities that are not counted in GDP.

Transfer payments

Payments like social security benefits that do not represent the production of goods and services.

Intermediate goods

Goods used in the production of final goods, not counted for final consumption.

Depreciation

Wear and tear on capital goods that is not included in GDP.

Measuring Economic Growth

GDP is used to measure and compare the economic performance of different countries over time.

Comparing Living Standards

GDP per capita measures average income per person in a country to compare living standards.

Assessing Business Cycles

GDP helps identify periods of economic expansion and contraction.

Formulating Economic Policies

Governments use GDP data to inform decisions about fiscal and monetary policies.

Attracting Foreign Investment

Countries with higher GDPs are generally more attractive to foreign investors.

Population (Limitations of GDP)

Different populations producing similar amounts can give an inaccurate picture of GDP.

Inequality (Limitations of GDP)

Same GDP figures can mask unequal distribution of income.

Environment (Limitations of GDP)

Environmental health is not reflected in GDP measurements.

Shadow economy (Limitations of GDP)

Economic activities not counted in GDP, often related to the black market.

Employed

A person who has worked for pay at least one hour per week.

Unemployed

A person not working but actively seeking work.

Labor force

The sum of all individuals 16 years and older who are either employed or unemployed.

Out of the labor force

Individuals who have chosen not to seek employment.

Labor force participation rate (LFPR)

The ratio of the size of the labor force to the size of the population 16 years and older.

Unemployment rate

The percentage of the labor force that is unemployed.

Discouraged workers

Citizens who drop out of the labor force after being unable to find work.

Frictional unemployment

Unemployment occurring when someone new enters the labor market or switches jobs.

Seasonal unemployment

Unemployment that is periodic and predictable, following the calendar cycle.

Structural unemployment

Unemployment resulting from fundamental changes in the economy that leave some job skills in demand.

Cyclical unemployment

Unemployment that rises and falls with the business cycle.

Full employment

When there is no cyclical unemployment in the economy.

Natural rate of unemployment

The unemployment rate associated with full employment, typically between 4 to 6 percent.

Consumer Price Index (CPI)

The price index that measures the average price level of items in a base year market basket.

Deflation

The general decrease in prices.

Inflation

The general increase in prices.

Disinflation

A decrease in the rate of inflation.

Inflation rate

The percentage change in aggregate price level across the economy over a year.

Market basket

A collection of goods and services used to represent what is consumed in the economy.

Difference between CPI and GDP Deflator

CPI measures consumer goods inflation, while GDP deflator includes all items that make up domestic products.

Nominal income

Income measured in current dollars, unadjusted for inflation.

Real income

Income measured in base year dollars, adjusted for inflation.

Consumer substitute (Difficulties with CPI)

Changes in consumer preferences not reflected in the base year market basket.

Goods evolve (Difficulties with CPI)

Emergence and extinction of products can make the market basket irrelevant.

Quality differences (Difficulties with CPI)

Price increases due to quality improvements obscure actual inflation.

Expected inflation

Inflation that is predictable, allowing individuals to plan accordingly.

Unexpected inflation

Inflation that occurs without warning, impacting different groups differently.

Menu costs

Costs incurred by firms from changing prices due to inflation.

Shoe-leather costs

Time and effort spent by people to counteract inflation effects.

Loss of purchasing power

The decrease in value of money over time due to inflation.

Wealth distribution

The transfer of real wealth from one socioeconomic group to another due to inflation.

Nominal GDP

The value of current production at current prices.

Real GDP

The value of current production using prices from a fixed reference year.

Base year

The year that serves as a reference point for constructing a price index.

Price index

A measure of the average price level in a market basket for a given year compared to the base year.

Business cycle

The periodic rise and fall in economic activity measured by changes in real GDP.

Expansion

A period where real GDP is growing.

Peak

The highest point of a business cycle where expansion ends.

Contraction

A period where real GDP is falling.

Recession

Defined informally as two consecutive quarters of falling real GDP.

Depression

A prolonged, deep contraction in the business cycle.

Trough

The lowest point in a business cycle where contraction stops.