Unit 2 - Measures of Economic Performance

GDP, unemployment, and inflation

product market

product market

place where goods and services produced by businesses are sold to households

resource (factor) market

place where resources (land, labor, etc.) are sold to businesses

Gross Domestic Product (GDP)

the dollar value of all final goods and services produced within a country’s boarders in one year

intermediate goods

goods used in the production of final goods and services

NOT included in GDP

1. intermediate goods

2. nonproduction transactions (stocks, welfare, etc.)

3. nonmarket (illegal) activities

Expenditures approach

adding all the spending

expenditures approach equation

GDP (y) = C + I + G + (X - M)

4 components of GDP using the income approach

• labor income/wages (w)

• rental income (r)

• interest income (i)

• profit (π)

Income approach

adding all the resulted income

income approach equation

GDP (y) = w + π + r + i

4 components of GDP using the expenditures approach

• consumer spending (C)

• investments (I)

• government spending (G)

• net exports (X-M)

investment (I)

when businesses buy capital (machines, resources, etc.)

inventory

good produced and held in storage in anticipation of later sales (counted the year they’re produced)

government (G)

public sector (NOT welfare, subsidies, SS, or interest payments on national debt)

% change in GDP (equation)

(Year 2 - Year 1 / Year 1) x 100

inflation

a rising general level of prices

nominal GDP

GDP measured in current prices; doesn’t account for inflation from year-to-year

real GDP

GDP expressed in constant, unchanging dollars; adjusts for inflation (good to determine econ. growth)

real GDP per capita (equation); good determiner of standard of living

rGDP / population

labor force

employed + unemployed

unemployment rate (equation)

(# unemployed / # in labor force) x 100

labor force participation rate (equation)

(labor force / population ≥ 16) x 100

frictional unemployment

temporarily unemployed or between jobs (ex: seasonal workers)

structural unemployment

skills are made obsolete (ex: replaced by robots)

cyclical unemployment

results from economic downturns and is the only one that government has control over

Natural Rate of Unemployment (NRU)

frictional and structural unemployment together; unavoidable

Okun’s Law

when unemployment rises 1% above the national rate, GDP falls around 2%

problems with unemployment rate

it can misdiagnose the actual unemployment rate because of:

1. discouraged workers (understated)

2. part-time workers (understated)

3. race/age inequalities

4. illegal labor

what does inflation do

lowers the purchasing power of money

how is inflation measured

the gov. tracks prices of the same goods and services each year (called a market basket)

inflation rate

% change in prices in one year

deflation

general fall in prices (ex The Great Depression)

disinflation

bringing inflation rates down, but not into the negative (ex lowered from 5% → 2%)

people hurt by unanticipated inflation

savers, people with fixed incomes, and lenders (at fixed interest rates)

people helped by unanticipated inflation

borrowers and businesses where the price of products increase faster than the price of resources

nominal wage

wage measured by dollars rather than purchasing power

real wage

wage adjusted for inflation (wage-inflation)

3 costs of inflation

1. menu costs

2. shoe leather cost

3. unit of account cost

menu costs

real cost of changing listed prices

shoe leather cost

increased costs of transactions

unit of account cost

currency is no longer reliable as a way of measuring value

consumer price index (CPI)

most commonly used measurement of inflation for consumers

CPI equation (will NOT be a %)

(current year price of market basket / price of market basket in base year) x 100

problems with CPI

1. substitution bias (CPI may be higher than what customers are really paying)

2. new products (CPI measures prices but not the increase in choices)

3. product quality (CPI may suggest that prices stay the same though the economic well being has improved significantly)

GDP deflator

measures the prices of all goods produced (whereas CPI only measures prices of goods and services bought by consumers)

GDP deflator equation

(nominal GDP / real GDP) x 100

• quantity is constant

• price changes

CPI

• price is constant

• quantity changes

GDP deflator