AP Macroeconomics-Unit-2

UNIT 2: Economic Indicators and the Business Cycle

• Economic Indicators: Key statistics that provide information about the economic performance and health of a country. These indicators can be leading, lagging, or coincident, influencing business decisions and policy-making.

• Business Cycle: The fluctuations in economic activity characterized by periods of expansion and contraction, typically measured by changes in real GDP.

• Understanding the circular flow of the macroeconomy

  • Firms provide goods and services to households through the product market. Households pay firms for these goods and services

  • The income firms pay to households includes: wages, income, rent, and profits (AKA W.I.R.P.)

GROSS DOMESTIC PRODUCT (GDP)

• Definition: GDP is the total monetary value of all final goods and services produced within a country over a specific period.

Approaches to Calculate GDP

• Expenditures Approach:

  • Calculates GDP by summing all spending by households, businesses, and governments in the economy.

  • Represents how much is spent rather than produced.

  • Formula: GDP=C+I+G+Xn

    Where:

    • C = Consumption: total spending by households on goods and services

    • I = Investment: spending on capital goods by businesses

    • G = Government Spending: total government expenditures on goods and services

    • Xn = Net Exports: exports minus imports.

• Income Approach:

  • Calculates GDP by adding total income earned, including national income, sales taxes, depreciation, and net foreign factor income.

  • WIRP= Wealth, Income, Rent, and Profit: these components represent the various sources of income that contribute to the overall calculation of GDP.

• Value-Added Approach:

  • Calculates GDP as gross value of output minus value of intermediate consumption.

What is Not Included in GDP

• Non-New Sales:

  • GDP excludes sales of used goods (e.g. selling an old coat).

  • Does not account for financial transactions such as sale of stocks that do not produce new goods.

• Final vs. Intermediate Goods:

  • Only final goods count towards GDP to avoid counting goods produced in the process (e.g., prices of flour used to make cupcakes are excluded).

Illegal Activities in GDP

• Illegal economic activities (black market and drug deals) are not counted in GDP as these transactions often go unrecorded.

CIRCULAR FLOW MODEL

• Represents economic transactions and flow of money:

  • Factor Market: Households sell labor; businesses buy factors of production.

  • Product Market: Businesses sell products; households buy finished goods from markets.

  • The circular flow model goes:

  • Households provide factors of production to businesses in the factor market, receiving wages in return.

  • Businesses use these factors to produce goods and services, which they then sell in the product market to households.

  • Households use their income from wages to purchase these goods and services, creating a continuous cycle of economic activity.

UNEMPLOYMENT

• Definition: Unemployment refers to individuals who are capable of working and actively seeking employment but unable to find a job.

• Eligibility: To be counted as unemployed, individuals must be of working age and not have disabilities preventing work.

Types of Unemployment

1. Frictional Unemployment:

   • Temporary unemployment experienced while transitioning between jobs (e.g., quitting one job to find another).

2. Structural Unemployment:

   • Occurs due to technological advancements leading to job loss (e.g., machines replacing human labor).

3. Seasonal Unemployment:

   • Results from seasonal work; for example, a lobster fisherman being unemployed in winter.

Calculate Unemployment Rate

• Formula:

  • Unemployment Rate = (Number of Unemployed / Labor Force) x 100

  • Labor Force includes employed and actively seeking unemployed individuals.

CONSUMER PRICE INDEX (CPI)

• Definition: CPI tracks the price change of a fixed basket of goods over time, reflecting inflation and cost of living changes.

Inflation

• Definition: Inflation refers to a general increase in prices, leading to a decrease in purchasing power (fewer goods can be bought at higher prices).

GDP DEFLATOR

• Definition: A measure capturing the change in prices for all final goods in a specific period.

Inflation and Deflation

• Inflation: The overall increase in the price level in the economy. After the price level increases, a dollar will buy less than it would before. If people anticipate inflation, they will build that expectation into their decisions; for example, workers will demand higher wages to keep their purchasing power the same if prices are expected to rise.

• Deflation: The opposite of inflation, characterized by an overall decrease in the price level.

• In the case of unanticipated inflation, people do not adjust their decisions accordingly, leading to mixed effects: some individuals may benefit while others may suffer. In inflationary contexts, borrowers typically gain since they repay loans with less valuable dollars, while lenders lose as the real value of the money they receive decreases.

REAL VS. NOMINAL GDP

• Nominal GDP:

  • Measures the market value of final goods/services at current prices, without adjusting for inflation.

• Real GDP:

  • Measures the market value adjusted for inflation, providing a more accurate economic performance over time.

Measuring Short-Run Economic Growth

Fluctuations in output are measured by increases or decreases in the quantity of goods and services produced in the economy over time. The GDP is the dollar value of all final goods and services produced in an economy in a stated period. Final goods are goods intended for consumers, such as gasoline.

Price Index

• A price index is used to measure price changes in the economy. Price indices combine the prices of a bundle of goods and services and track changes in the price of that bundle over time.

• Consumer Price Index (CPI): The most familiar price index, it measures the changes in the price bundle of goods and services commonly bought by consumers. The CPI is based on a market basket of more than 200 categories of goods and services, weighted according to how much the average consumer spends on them.

• Producer Price Index (PPI): Measures the average change over time in the selling prices received by domestic producers for their output.

• GDP Deflator: The most inclusive index that measures the change in prices for all final goods and services produced within a country.

• CPI Formula: CPI = (cost of the market basket in current year prices / cost of market basket in base year prices) x 100.

Percent Change Formula: Percent Change = ((New Value - Old Value) / Old Value) x 100.

Formulas:

• GDP Expenditure Approach:GDP = C + I + G + Xnwhere Xn = Exports - Imports

• Consumer Price Index (CPI):CPI = (Current Market Value / Base Year Market Basket) x 100

• Inflation Rate:Percent change = ((New Value - Old Value) / Old Value) x 100(CPI in base year is always 100)

• Market Basket:Market Basket = Quantity x Price

• Real Interest Rate:Real Interest = Nominal Interest - Inflation Rate

• Real GDP:Real GDP = (Nominal GDP / Price Index) x 100

• Real GDP per Capita:Real GDP per Capita = Real GDP / Population

• GDP Deflator:GDP Deflator = (Nominal GDP / Real GDP) x 100

• Nominal GDP:Nominal GDP = (Real GDP x GDP Deflator) / 100

• Unemployment Rate:Unemployment Rate = (Number Unemployed in Labor Force / Labor Force) x 100

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

• Labor Force:Labor Force = Employed + Unemployed

• GDP Gap:GDP Gap = Amount by which actual GDP falls short of potential GDP due to unemployment.