UNIT 2 Macroeconomics GDP, Employment + Inflation

Purpose of macroeconomics

1.) Measure the health of the whole economy

2.) Guide government policies to fix problems

3 major economic goals

1.) Promote economic growth

2.) Limit unemployment

3.) Keep prices stable (limit inflation)

GDP

Dollar value of all final goods and services produced within a country’s borders in one year.

Purpose of GDP

• Compare to previous years (growth)

• Compare policy changes (new policy efficiency)

• Compare to other countries (competition)

Formula for: % change in GDP

(year 2 - year 1) / year 1 × 100

Not included in GDP

• Intermediate goods

• Nonproduction transactions

• Nonmarket activities (illegal)

How to calculate GDP

1.) Expenditure approach - adds up all spending on final goods

2.) Income approach - adds up all income on selling final goods

Components of GDP

• Consumption (household/consumer spending)

• Investment (business spending)

• Government purchases (gov. spending)

• Net exports (exports - imports)

Transfer payment

Payment not made in exchange for goods and services.

Issue with GDP

Doesn’t account for inflation, GDP can be rising with the country being worse off. (Prices raising with inflation)

Nominal GDP

Measured in current prices, doesn’t account for inflation year to year.

Real GDP

Constant or unchanging dollars, adjusts for inflation, best measure of economic growth.

(nominal GDP/GDP deflator) x 100

GDP Deflator

Measure of the price level ratio of Nominal GDP:Real GDP. Shows the rise in prices rather than a rise in quantities produced.

(nominal GDP/real GDP) x 100

Reasons for fluctuation of the economy

• Retailer and producers send misleading info. about consumer demand

• Advances in technology, productivity, or resources

• Outside influences (wars, supply shocks, panic)

Characteristics of economic expansion

1.) Less unemployment

2.) Increase in Real GDP

3.) Rapid job growth

4.) Increasing interest rates

5.) Increasing prices

6.) Fewer social problems

Characteristics of economic recession

1.) Increasing unemployment

2.) Decrease in Real GDP

3.) Reduced job growth

4.) Lower interest rates

5.) Decreasing prices

6.) More social problems

Economic growth defined

Increase in real GDP over time, along with an increase in real GDP per capita over time.

What does economic growth provide to society?

• Better goods and services

• Increased wages and standard of living

• Allows more leisure time

• Economy can better meet the wants of society

Business cycles connection to PPC

Can show on both:

• Full employment

• Unemployment

• Inflation

Shifters of PPC that affect GDP

• Changes in quantity/quality of resources

• Changes in technology

• Changes in trade

Unemployment rate

Percent of people in the labor force who want a job but are not working.

Labor force

People who are willing and able to work. Includes employed and unemployed.

3 forms of unemployment

1.) Frictional Unemployment

2.) Structural Unemployment

3.) Cyclical Unemployment

Frictional Unemployment

Individuals who are qualified workers with transferable skills but are not currently working.

Ex: High school/College graduates, people who were fired and are looking for a better job

Seasonal unemployment

Type of frictional unemployment due to time of year and type of job.

Structural Unemployment

Changes in the structure of the labor force making some skills obsolete. Workers do not have transferable skills and jobs will not come back. Permanent loss of jobs is “creative destruction”.

Ex: VCR repairmen, carriage makers

Technological unemployment

Type of structural unemployment where automation and machinery replace workers causing unemployment.

Cyclical unemployment

Results from economic downturns. As demand for goods and services falls, demand for labor falls and workers are laid off.

Natural rate of unemployment

Consists of frictional and structural unemployment because they are unavoidable. Should be 4-6% unemployment. Country is at full rate of employment if there is only the NRU.

Okun’s law

When unemployment is 1% above the natural rate, GDP will falls by about 2%

Issues with the unemployment rate

Can misdiagnose actual unemployment rate due to:

• Discouraged job seekers

• Part-time workers

• Race/age inequalities

• Illegal labor

Inflation

• Rising general level of prices

• Reduces purchasing power of money

• Each dollar of income will buy fewer goods than before

Measure of inflation

• Government tracks the prices of the same goods and services each year

• “Market Basket” is made up of ~300 commonly purchased goods

• Inflation rate % change in prices in 1 year

Those hurt by inflation

• Lenders: people who lend money at fixed rates

• People with fixed incomes

• Savers

Those helped by inflation

• Borrowers: people who borrow money at fixed rates

• Businesses where the price of the product increases faster than the price of resources

Cost-of-living-adjustment

Negotiated wages that rise with inflation.

Consumer price index (CPI)

Most commonly used measurement of inflation for consumers.

price of market basket / price of market basket in base year x 100

Issues with CPI

1.) Substitution bias

2.) New products (newest consumer prices not included by market basket)

3.) Product quality (ignores improvements and declines)

Substitution bias

As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket.

CPI vs. GDP deflator

CPI - Measures prices of only consumption

GDP deflator - Measures everything (government, investment, consumption, and exports)