Unit 2 lecture slides - APMAC

\Unit 2 Slides

2.1 Circular Flow

Circular Flow Diagram

• Illustrates the movement of money and resources through the economy.

• Firms/Businesses: Buy factors of production to produce goods and services.

• Households: Sell factors of production and purchase goods and services.

• The role of governments, banks, and foreign trade adds complexity. These institutions can inject or remove money and products from the economy.

Key Components of Circular Flow

• Goods and Services: Produced by businesses, purchased by households.

• Households: Supply labor and other factors of production; receive income.

• Product Market: Where goods and services are exchanged.

• Resource/Factor Market: Where factors of production (land, labor, capital, entrepreneurship) are traded with firms for wages, rent, interest, and profits.

Leakages and Injections

• Leakages: Remove money from the economy:

  • Savings

  • Taxes

  • Imports

• Injections: Add money to the economy:

  • Bank loans

  • Investments

  • Government spending

  • Exports

2.2 GDP

Gross Domestic Product (GDP)

• Defined as the total value of all final goods and services produced within a country in a specific time.

• Increase in GDP: Indicates a healthy economy.

• Decrease in GDP: May signal a recession (two consecutive quarters of decline).

Measuring GDP

• Expenditure Approach: Also Called the Demand Approach. Summarizes consumption, investment, government spending, and net exports.

• Income Approach: Total income earned through factors of production (Wages, Rent, Interest, Profits).

• Value-Added Approach: Adding value at each production step.

Components of GDP

• Personal Consumption (C): Household expenditures, constitutes 2/3 of the U.S. economy. Must be market transactions.

• Government Purchases (G): Includes purchases by local, state, and federal levels; excludes transfer payments.

• Investment (I): Defined as purchasing capital, influenced by interest rates.

• Net Exports (XN): Calculated as exports minus imports, where:

  • Negative indicates a trade deficit,

  • Positive indicates a trade surplus.

2.3 Unemployment

Labor Force Counted:

• Individuals over 16 who are employed or actively seeking work.

Not Counted:

• Under 16, military, incarcerated, discouraged workers, etc.

Unemployment Rate Calculation Formula:

• (Unemployed/Labor Force) x 100

• Labor Force Participation Rate = (Labor Force/Total Population) x 100.

Types of Unemployment

• Frictional: Temporary transitions between jobs.

• Structural: Mismatch of skills to job market needs.

• Seasonal: Jobs available only during certain times of the year.

• Cyclical: Related to the economic cycle (e.g., layoffs in recession).

2.4 Inflation

CPI and Inflation

• Consumer Price Index (CPI): Measure of average price changes in a fixed basket of consumer goods.

  • Used to assess price changes associated with the cost of living.

  • Often used to adjust income eligibility levels for government assistance.

Inflation Rate Calculation:

• Annual percentage change in CPI, reflecting how much prices for goods and services have increased.

Types of Inflation

• Demand-pull Inflation: Increase in consumer demand leads to increased prices, often occurring in an expanding economy.

• Cost-push Inflation: Rising production costs (e.g., wages, raw materials) push prices higher. Factors such as supply chain disruptions can contribute.

2.5 Real vs Nominal GDP

• Nominal GDP: Unadjusted for inflation, reflecting current prices. Useful for basic comparisons, but not accurate for economic analysis over time.

• Real GDP: Adjusted for inflation, giving a more accurate portrayal of economic growth and living standards over time.

2.6 Business Cycle

Understanding the Phases:

• Peak: Highest GDP, lowest unemployment. Economy is operating at full capacity, often leading to inflation due to demand exceeding supply.

• Contraction: GDP decreases, unemployment rises. Consumer spending slows down, leading to a reduction in production and layoffs.

• Trough: Lowest GDP, highest unemployment. This phase can lead to economic recovery if consumer confidence and spending begin to rise.

• Expansion: GDP increases, unemployment decreases. Economic activity improves, production ramps up, and job growth occurs. This is typically marked by increased consumer spending and investment.

2.7 Economic Indicators

• Leading Indicators: Predict future economic activity (e.g., stock market performance, new orders for durable goods).

• Lagging Indicators: Confirm trends that are already in place (e.g., unemployment rate, corporate profits).

• Coincident Indicators: Occur simultaneously with economic trends and help to identify current economic conditions (e.g., GDP, industrial production).