Economics - Chapter 13: Measuring the Economy's Performance

Faces on Dollar Bills

$1: George Washington

$5: Abraham Lincoln

$10: Alexander Hamilton

$20: Andrew Jackson

$50: Ulysses S. Grant

$100: Benjamin Franklin

$2: Thomas Jefferson

$500: William McKinley

national income accounting

the measurement of the national economy’s performance; measure of the amount of goods and services produced yearly by the nation and the amount of income people have to spend

Elements of National Income

1. wages and salaries paid to employees

2. income of self-employed individuals, included farmers and owners of sole-proprietorships and partnerships

3. rental incomes of property owners

4. corporate profits

5. interests on savings and investments

gross domestic product (GDP)

the broadest measure of the economy’s size; total dollar value of all the final goods and services produced in the nation during a single year; includes all products in 4 sectors: consumer goods and services, investment goods and services, government goods and services, and net exports; GDP = C + I + G + X

net domestic product (NDP)

a measure of the economy that subtracts depreciation from GDP; NDP = GDP - depreciation

national income (NI)

a measure of the total amount of income earned by everyone in the economy; wages and salaries, income of self-employed individuals, rental income, corporate profit, interest on savings and other investments; NI = NDP - indirect business taxes

personal income (PI)

a measure of the total income that individuals receive before personal taxes are paid; PI = NI - (corporate taxes + reinvested profits + employer social security contributions) + transfer payments (welfare, unemployment, social security, Medicaid)

disposable income (DI)

a measure of the income remaining for people to spend or save after all taxes have been paid; DI = PI - personal taxes

Purchasing Power of Money

• the nominal value of GDP must be adjusted for changes in the purchasing power of money to determine changes in real output

• economists take inflation into account when thinking about GDP

• when inflation occurs, the purchasing power of money goes down

• deflation also has an impact on GDP, although this has rarely happened in modern times

• a dollar’s purchasing power is the real goods and services it can buy

nominal GDP

GDP evaluated at current market price; will include all of the changes in market price that have occurred during the current year due to inflation or deflation

inflation

a prolonged rise in the general price level of goods and services; skews GDP

deflation

a prolonged decline in the general price level; rarely occurs

Measures of Inflation

• inflation can be measured in different ways by calculating changes in different price indexes

• Consumer Price Index, Producer Price Index, GDP Price Deflator

Consumer Price Index (CPI)

the measure of the change in price over time of a specific group of goods and services used by the average household; measure the percent increase every 3 years over the base year; market basket: the specific group of goods and services analyzed (approx. 90,000)

Producer Price Index (PPI)

the measure of the change in price over time that the U.S. producers have charged for their goods and services; often an indicator if the CPI will rise

GDP Price Deflator

a price index that removes the effect of inflation from the GDP so that the overall economy in 1 year can be compared to another; real GDP: new figure that is compared to a base year GDP

aggregate demand

the total quantity of all goods and services in the entire economy demanded by all people; related to the price level since it is the the average of all the prices as measured by a price index; aggregate demand curve: a graphed line showing the relationship between the aggregate quantity demanded and the average of all prices as measured by the implicit GDP Price Deflator

aggregate supply

the real domestic output of producers based on the rise and fall of the price level; aggregate supply curve: a graphed line showing the relationship between the aggregate quantity supplied and the average of all prices as measured by the implicit GDP Price Deflator

equilibrium price

where the aggregate demand curve intersects the aggregate supply curve

business fluctuations

the ups and downs in an economy

business cycle

changes in the level of total output measured by real GDP:

1. growth

2. peak/boom

3. contraction/recession

4. trough

5. expansion/recovery

peak/boom

a period of prosperity

contraction

business activity slows down

recession

any period of at least two quarters (6 months) during which real GDP does not grow

trough

where the downward direction of the economy levels off

expansion/recovery

the increase in total economic activity following a trough

Ups and Downs of Business

• US has experienced business expansions and recessions of varying severity and frequency throughout its history

• stock market crash in October of 1929 was the largest drop in business and led to the Great Depression; economy slowly rose and reached a boom period due to mobilization for WWII

• the 1980s also started off with a small recession, but recovered within two years (except for stock market crash in 1987)

• economy experienced more trouble during the dot-com meltdown in March of 2001 and the terrorist attacks of 9/11/01

Causes and Indicators of Business Fluctuations

Business Investments, Government Activity, External Factors, Psychological Factors, Economic Indicators

Business Investments

• business decisions are key to business fluctuations

• like capital investments: increase or cut back

• like innovations: inventions and new production techniques

Government Activity

• the changing of policies by the federal government are a reason for business cycles

• like government policies on taxing and spending and government control over the money supply in the economy

External Factors

• wars impact the economy

• like the availability of raw materials (ex. oil)

Psychological Factors

• prospects of peace in an area can improve the economy

• like the discovery of new oil reserves

• like war (ex. terrorist attacks)

Economic Indicators

• economists try to predict what will happen in the economy in the coming months and years

• economic indicators: the statistics that measure variables in the economy, such as stock prices or the dollar amounts of loans to be repaid

Types of Indicators

• leading indicators: statistics that point to what will happen in the economy; lead to an overall change in the business activity, up or down

• coincident indicators: usually change at the same time as changes in the overall business activity; lead to a contraction in the economy

• lagging indicators: seem to lag behind overall business activity; give economists clues as to the duration of the phases of the business cycle