Macro Ex. 2 - Feb 13 recording Ch 18

Preparation for Exam 2

• Upcoming Exam 2 will cover Chapters 9, 18, and 19.

• Chapter 18 is being discussed today.

• Highlights indicate which material is on the test.

Business Cycle

• Definition: Refers to the fluctuations in economic activity over time, typically including periods of expansion and contraction.

• Graph Overview:

  • Expansion: Period of economic growth.

  • Peak: The highest point before a downturn.

  • Recession: Decline in economic activity.

  • Trough: Lowest point before recovery.

• Historical Trends: Periods of expansion tend to be longer than recessions in the U.S.

Economic Growth

• Definition: The ability of an economy to produce increasing quantities of goods and services.

• Related Factors: Production possibilities frontier, including land, labor, capital, and technology advancements.

Inflation

• Definition: The rate at which the general level of prices for goods and services rises, eroding purchasing power.

• Impact on Economy:

  • High inflation rates affect consumers and businesses.

Gross Domestic Product (GDP)

• Definition: The market value of all final goods and services produced in a country during a specific period, typically one year.

• Key Components of the Definition:

  • Final Goods and Services: Goods created for final consumption, not intermediate goods.

  • Example: Tires can be classified as either intermediate (when used in the assembly of a vehicle) or final (when sold to consumers to replace worn ones).

  • Importance of Avoiding Double Counting: Counting intermediate goods in GDP can inflate the measure of production if counted again in final goods.

Measuring GDP

• Production Focus: Only production within the borders of the U.S. counts towards GDP, regardless of the ownership of the company.

• Examples:

  • Ford cars manufactured in Michigan contribute to GDP.

  • Honda vehicles produced in Michigan also count toward GDP.

  • Ford cars made in China do not count.

• Components of GDP Calculation:

  • GDP = C + I + G + NX

  • C: Consumption

  • I: Investment

  • G: Government Purchases

  • NX: Net Exports (Exports - Imports)

Components of GDP Explained

• Consumption (C): Household spending on goods and services, excluding new houses (which falls under investment).

  • Includes expenditures on nondurable goods (food, clothing) and services (education, health care).

• Investment (I): Spending on capital goods that will be used for future production. Includes purchases of new factories and machinery.

• Government Purchases (G): Spending by the government on goods and services.

  • Excludes transfer payments (welfare, unemployment benefits) as they do not reflect production.

• Net Exports (NX): The difference between what a country sells to other nations and what it buys.

  • Can be positive (trade surplus) or negative (trade deficit).

Shortcomings of GDP

• Household Production: Activities performed within the home (like childcare or cooking) are often not included in GDP, leading to an underestimate of economic activity.

• Illegal Activities: Underground economy is unaccounted for in GDP measurements.

• Neglect of Social Factors: GDP does not take into account the distribution of income, leisure time, pollution, and other social issues that affect well-being.

Real GDP vs. Nominal GDP

• Nominal GDP: Measures the value of all finished goods and services produced in a country at current prices, unadjusted for inflation.

• Real GDP: Adjusted for inflation, providing a more accurate reflection of an economy's size and how it's growing over time.

  • Example: Base year prices are used to calculate real GDP in subsequent years.

Calculation Example of GDP

• Nominal GDP Calculation: Multiply quantities sold by current year prices.

• Real GDP Calculation: Multiply the same quantities sold by base year prices.

• Practical Application: Important to understand how changes in production and prices affect economic measures.