Economics Unit 3

Measuring Economic Growth: Circular Flow Model

• Households - provide resources (like human labor), earn income

• Businesses - provide products, earn profit

Measuring Economic Growth: The Business Cycle

• Periods of expansion, recession, and depression

• Relationship between GDP, CPI and unemployment

Gross Domestic Product (GDP)

the value of all final goods and services produced within a nation in a year

What does not count in our GDP?

Intermediate goods, double counting, non market transactions, underground economy

Intermediate goods

goods used to produce final goods - DONT COUNT

Double counting

items sold more than once in a production year

Nonmarket transaction

unpaid labor

Underground economy

illegal activity or under the table practices

What is used to calculate GDP

Consumer spending, investment spending, government spending, net exports

Consumer spending

money spent by households (consumers)

Investment spending

Money spend by businesses

Government spending 

money spent by the government 

Net exports

Gross exports minus gross imports

Calculating GDP

Consumer + Imports + Government + (exports - imports)

Consumer price index (CPI)

A measure of the average of the prices paid by consumers for a fixed market basket of consumer goods and services.

Calculating CPI

(Cost of CPI basket at current price/ Cost of CPI basket at base period price) * 100

Real

Adjusting the value of money for inflation

Nominal

The actual amount of money, the actual dollar amount

Nominal Income

the amount you are actually making

Real Income

the amount you are actually making taking into consideration inflation

Nominal Income vs Real Income Formula

Nominal Income/ CPI in hundredths = real income

Nominal GDP

States GDP in terms of the current value of goods and services

Real GDP

States GDP corrected for changes in price year to year (taking out inflation)

Nominal GDP vs Real GDP Formula

Nominal GDP/ CPI in hundredths = real GDP

Calculating Unemployment rate

= Unemployed/Labor Force

Formula for Labor Force

= Unemployed (over 16) + employed (over 16)

Employed

People who work for pay at least one hour a week

Unemployed

People who are out of work, but looking for work

Out of labor force

people who are not seeking employment

discouraged workers

• people who are out of work and have given up looking for work

• These people are no longer considered unemployed, therefore not part of labor force

Natural rate of unemployment

• There will always be workers switching jobs, working seasonally or being replaced by technology. The unemployment rate can never be zero

  • Considered full employment when unemployment rate is around 4% to 6%

What is considered full employment?

• Nearly everyone who wants a job can find one

• lowest sustainable unemployment rate 

Types of unemployment

Frictional, Structural, Seasonal, Cyclical

Frictional

When someone is unemployed short term either voluntarily or involuntarily - finishing college, fired - least troublesome

Structural

When the economy changes to create job loss for a skill no longer in demand - technology replaces

Seasonal

Unemployment for jobs that have a particular season during the calendar year - lifeguard - doesn’t affect published employment rate

Cyclical

Jobs are lost and gained as the business cycle improves and worsens - company downsizes - last as long as it takes to get through the recession

The circular flow model is

A tool that economists use to understand how market economies operate

Product market

The market where goods and services are bought and sold

Factor (Resource) Market

The market for the factor of production (Land, Labor, Capital and entrepreneurial ability)

the resource that almost every household provides to businesses is

Labor

The business cycle is

the periodic rise and fall in economic activity

What is an extended period of high unemployment and limited business activity called?

Depression

Would economic growth lead to an increase in real GDP or a decrease in real GDP?

Increase

A contraction lasting two or more quarters is called?

Recession

Are jobs easier to find during economic expansion or economic contraction?

economic expansion

People considered to be unemployed are

actively looking

What unemployment rate is considered full employment?

4% - 6%

What is treason why cloth made in the US would NOT be counted as part of the nation’s GDP for that year (cloth is used to make clothes)?

Intermediate goods

Difference between GDP and GNP

GDP - US only, GNP - Everywhere

What type of spending would the purchase of chicken, socks and dentist visits be classified as?

Consumer Spending

Cars produced but not sold, new capital (machines) purchased, and buying of stocks/bonds in a given year would be classified as which type of spending?

Investment spending

How do you find the value of net exports?

Export - Import

If consumption increases by 800 billion and imports increases by 800 billion, then GDP will do what?

Doesn’t change

How is real GDP different than just GDP?

Real GDP adjust for inflation

What is the best measure of a nation’s economic growth?

GDP

A sustained rise in the level of prices or a sustained fall in buying power is known as?

inflation

What does inflation do to the value of the dollar?

brings it down

If the current year CPI is 125, then the amount of inflation since the base year has risen what percent? (hint, what is always the base year CPI))

25%

Your income increases 82000(2011) to 90000 (2012). The CPI from 2011 to 2012 is 110. Did you gain or lose buying power?

Calculate real income - lost buying power

Relationship between CPI, UE and GDP

High GDP = Low UE and vice vera

CPI high = inflation

Explain how the circular flow model works

• Households provide resources (mainly Human Resources) to businesses in order to earn income

• Businesses purchase these resources, from households to produce goods and services

• Businesses produce goods/services consumers want in order to make a profit

• Households ultimately use their income to purchase goods/services they want