Do Now.

1
Do Now.

• In December 1975 the government of Portugala
  provisional government in the process of
  establishing a democracyfeared that it was
  facing an economic crisis. Business owners,
  alarmed by the rise of leftist political parties,
  issued dire warnings about plunging production.
  Newspapers speculated that the economy had shrunk
  10 to 15 since the 1974 revolution that had
  overthrown the countrys long-standing
  dictatorship.
• In the face of these reports of economic
  collapse, some Portuguese were pronouncing
  democracy itself a failure. Others declared that
  capitalism was the culprit, demanding that the
  government seize control of the nations
  factories and force them to produce more. But how
  bad was the situation, really? Speculate on why
  Portugal was having so many problems.

2
AP Macroeconomics MR. Graham
Unit Three Measurement of Economic Performance
3
Module 10 The Circular Flow and
Gross Domestic Product
3
4
National Income Accounting

• Measures the flows of income and expenditures in
  the economy over time.
• Serves the same purpose for the economy as a
  whole as does the income statement of a firm.
• The most simplified representation of the
  macroeconomy and national income accounting is
  the Circular-Flow Model.

5
The Circular-Flow Diagram

• The model involves the following principles
• There are two groups of decision-makers in a
  private economy households and businesses
• In every economic exchange, the seller receives
  exactly the same amount that the buyer spends
• Goods and services flow in one direction and
  money payments flow in the other

6
The Circular-Flow Diagram

• Product Markets
• Households are on the demand side, purchasing
  goods and services.
• Businesses are on the supply side,
  offering products for sale.
• Interaction of this demand and supply determines
  the price of each product.

7
The Circular-Flow Diagram

• Product Markets
• Businesses provide final goods and services to
  households

8
The Circular-Flow Diagram

• Product Markets
• who in turn pay for them with money.

9
The Circular-Flow Diagram

• Factor Markets
• Households are on the supply side, providing
  resources directly (workers) or indirectly
  (ownership of corporations, land, etc.)
• Businesses are on the demand side, purchasing
  resources in order to produce goods and services.
• Interaction of this supply and demand determines
  the price of each resource, which in turn is
  income for the owner of that resource.

10
The Circular-Flow Diagram

• Factor Markets
• Households sell resources to businesses

11
The Circular-Flow Diagram

• Factor Markets
• who in turn pay for them with wages, rent,
  interest, and profits (i.e. Total Income).

12
The Circular-Flow Diagram
13
The Circular-Flow Diagram

• Question
• Why must the total dollar value of income and
  output money be identical to each other?
• Answer
• Every transaction simultaneously involves
  expenditure and receipt.

If value of output is greater than value of
input, difference is profit. Profitfor both
households and firmsis always the residual item
that completes the circular flow.
14
(Expanded) Circular-Flow Diagram
15
Do Now.

• Explain the Circular Flow Model
• Define GDP
• Explain how GDP is calculated

16
Gross Domestic Product (GDP)

• The most commonly presented statistic of national
  income accounting is the GDP.
• Represents the total market value of all
  final goods and services produced within a
  country in one year.
• The GDP at the end of FY12 15.85 trillion.

17
Gross Domestic Product (GDP)

• Represents the total market value
• We compute the value of production, not just
  production.

Simply Adding Production
January January January February February February
Cappuccinos Lattes Scones Cappuccinos Lattes Scones
25 25 50 30 30 40
Adding the Value of Production
January Quantity Prices Value
Cappuccinos 25 3.00 75
Lattes 25 2.50 62.50
Scones 50 1.50 75
Totals 100 212.50
February Quantity Prices Value
Cappuccinos 30 3.00 90
Lattes 30 2.50 75
Scones 40 1.50 60
Totals 100 225.00
18
Gross Domestic Product (GDP)

• of all final goods and services
• It avoids double or multiple counting by
  eliminating any intermediate goods(goods used up
  entirely in the production of final goods).

Transaction Cost
1 lb. of tomatoes from Grower to Processor .50
Bottle of ketchup from Processor to Grocer 1.50
Grocer sells ketchup to consumer 3.00
Total Spent 5.00

• At each stage, value is added to the final
  product, the bottle of ketchup we only count the
  final price (3)

19
Gross Domestic Product (GDP)

• produced within a country
• If a good was produced in America, it doesnt
  matter where it was consumed, or where the actual
  company was headquartered.
• Ex General Motors has a factory producing trucks
  in South Africa. The value of these trucks is
  counted in South Africas GDP.

20
Gross Domestic Product (GDP)

• in one year.
• GDP sums the dollar value of what has been
  produced in the economy over the year, not what
  was actually sold.
• Ex A Honda Civic produced in Kentucky in 2012,
  but not sold until January 2013, is counted in
  2012 production and 2012 GDP.

21
Gross Domestic Product (GDP)

• 3 Ways for Calculating GDP
• Survey firms and add up the total value of their
  production of final goods and services.
• Sum the total factor income earned by households
  from firms in the economy.
• Add up aggregate spending on domestically
  produced final goods and services in the economy.

22
Calculating GDP
3
2
1
23
Calculating GDP

• Sum the total factor income earned by households
  from firms in the economy.
• Adding up all components of national income,
  including wages, interest, rent, and profits.
• Income Approach

24
Calculating GDP
2
25
Calculating GDP

• Add up aggregate spending on domestically
  produced final goods and services in economy.
• Adding up the dollar value of all final goods and
  services purchased by consumers, businesses,
  government, and buyers from outside the country.
• Expenditure Approach

26
Calculating GDP
3
27
The Components of GDP

• GDP C I G X
• Consumption (C) Households purchases of final
  goods and services during the year
• Durable Consumer Goods
• Nondurable Consumer Goods
• Services

28
The Components of GDP

• GDP C I G X
• Gross Private Domestic Investment (I) Domestic
  spending on
• additions to inventories,
• new capital goods (factories, machines)

29
The Components of GDP

• GDP C I G X
• Government Expenditures (G) consumption and
  investment for all government branches
• State, local, and federal
• Includes all direct purchases of resources (i.e.
  labor)

30
The Components of GDP

• GDP C I G X
• Net Exports (X) the value of exports less the
  value of imports

Net exports (X) Total exports Total imports
31
The Components of GDP

• Presenting the expenditure approach
• Where
• C consumption expenditures
• I investment expenditures
• G government expenditures
• X net exports

GDP C I G X
32
Comparing the Methods (1 and 2)
33
Comparing the Methods (2 and 3)
GDP and National Income, 2011
34
Comparing the Methods (2 and 3)
GDP and National Income, 2011
35
GDP Whats In and Whats Out?

• Exclusions from the GDP calculation
• Intermediate goods and services
• Inputs
• Used goods
• Transfer Payments
• Financial assets (i.e. stocks and bonds)
• Foreign-produced goods and services

36
Should it be counted?

1. A painter purchases new brushes for his business?
2. The services of an accountant?
3. A purchase of a used automobile?
4. A Social Security check paid to a retired worker?
5. The sale of a new home?
6. An increase in business inventories?
7. The governments purchase of a new fighter jet?
8. Unemployment paid to a laid-off worker?

37
Module 11 Interpreting Real Gross Domestic
Product
37
38
What GDP Tells Us

• Provides us with a scale against which to compare
  our current economy with
• economic performance of other
  years
• economic performance of other
  countries

• Be carefulpart of the increase in the value of
  GDP over time represents increases in the prices
  of goods and services rather than an increase in
  output.

39
Calculating Nominal GDP

• Nominal GDP GDP calculated at existing prices.

• Has the value of sales increased from year 1 to
  year 2?
• What is the Nominal GDP growth rate?

Year 2 Year 1
Growth Rate
?- 1
8-39
40
Calculating Real GDP

• Real GDP Nominal GDP adjusted for inflation.

• Does this increase in the dollar value of GDP
  overstate the real growth in the economy?
• How much would GDP have gone up if prices had
  not changed (i.e. Year 1 prices)?

8-40
41
Calculating Real GDP
Nominal GDP Price Index
Real GDP
?x 100
Price Index measured by the GDP deflator
Year Nominal GDP (billions) Price Index (base year 2005 100) Real GDP (billions)
1980 2,915 49.59
1985 4,319 62.14
1990 5,846 73.24
1995 7,543 82.20
2000 10,130 89.49
2005 12,740 100
2010 14,740 111.84
8-41
42
Real GDP

• Between 1997 and 2007, Venezuelas GDP grew by an
  average of 28 annuallyis Venezuela experiencing
  an economic miracle?

7-42
43
Economic Growth

• Typically measured by Real GDP growth rate

Year 2 Year 1
2010 13,180 billion 2012 13,660 billion
Growth Rate
?- 1
8-43
44
Per Capita Real GDP

• Other things equal, a country with a larger
  population will have higher GDP simply because
  there are more people working.
• Per capita real GDP
• Adjusting for population growth

8-44
45
Comparing GDP Internationally

• Purchasing Power Parity Adjustment in exchange
  rate conversions that takes into account
  differences in the true cost of living across
  countries

46
Module 12 The Meaning and Calculation
of Unemployment
46
47
The Unemployment Rate

• It is another important variable, in addition to
  GDP and inflation, on which macroeconomics
  focuses.

7-47
48
Defining and Measuring Unemployment

• Unemployed
• Actively looking for work but arent currently
  employed.
• Labor Force
• Number of employed plus the number of unemployed.
• Currently 155.5 million people (February 2013)

Labor Force Employed Unemployed
7-48
49
The Unemployment Rate

• Unemployment Rate
• The percentage of the labor force that is
  unemployed.

Unemployed Labor Force
Unemployment Rate
?x 100
7-49
50
Categories of Individuals Without Work

• Job loser An individual whose employment was
  involuntarily terminated or who was laid off
  (4060)
• Reentrant An individual who has worked a
  full-time job before but left the labor force and
  has now reentered it looking for a job (20-30)
• Job leaver An individual who voluntarily quit
  (10-15)
• New entrant An individual who has never worked a
  full-time job for two weeks or longer (10-15)

7-50
51
Duration of Unemployment

• More than 1/3 of job seekers find work within 1
  month.
• Approximately 2/3 find employment within 2
  months.
• About 1/6 are still unemployed after 6 months.
• Current average duration of unemployment is 37
  weeks.

52
Problems with the Unemployment Rate

• It can overstate the true level of unemployment.
• It is healthy and normal for a confident
  job-seeker to take his time before accepting a
  position.

7-52
53
Problems with the Unemployment Rate

• It can understate the true level of unemployment.
• Excludes discouraged workers
• individuals who have stopped looking for a job
  because they are convinced they will not find a
  suitable one.
• Excludes marginally attached workers
• individuals who have stopped looking for a job
  during the measured period.
• Excludes underemployed workers
• individuals working beneath their skill level or
  only able to find part-time jobs.

7-53
54
Problems with the Unemployment Rate

• It can understate the true level of unemployment.

7-54
55
Problems with the Unemployment Rate

• It varies greatly among demographic groups.

7-55
56
Growth and Unemployment

• The unemployment rate remains the most closely
  watched and highly publicized labor statistic.

7-56
57
Growth and Unemployment

• There is a generally strong negative relationship
  between growth in the economy and the rate of
  unemployment.

7-57
58
Module 13 The Causes and Categories
of Unemployment
58
59
Categories of Unemployment

• Frictional Unemployment
• Results from workers moving from one job to
  another seeking appropriate offers
• Includes people who have decided to leave one job
  to look for another
• Includes new entrants and re-entrants into the
  labor force
• This takes time, so they remain temporarily
  unemployed
• Regarded by economists as a normal part of a
  healthy and changing economy

7-59
60
Frictional Unemployment

• During periods of high unemployment (i.e. 2012),
  a smaller share of unemployment is frictional.

7-60
61
Categories of Unemployment

• Structural Unemployment
• Results from a poor match of workers abilities
  and skills with current requirements of employers
• Caused by technological advances and shifts in
  consumers tastes
• Caused by a decline or disappearance of natural
  resources in a region
• Caused by a seasonal pattern of work in specific
  industries (a.k.a. Seasonal Unemployment)

7-61
62
Categories of Unemployment

• Structural Unemployment
• Results when there are more people seeking jobs
  in a labor market than there are jobs available
  at the current wage rate.

• Occurs when the wage rate is, for some reason,
  persistently above equilibrium.

7-62
63
Categories of Unemployment

• Cyclical Unemployment
• Results from business recessions and economic
  downturns that occur when aggregate (total)
  demand is insufficient to create full employment
• When sales decline, producers tend to reduce
  output and lay off workers
• Harms the economy more than any other type of
  unemployment.

7-63
64
Cyclical Unemployment

• Is it Structural, Frictional and Cyclical
  Unemployment?

7-64
65
The Natural Rate of Unemployment

• When cyclical unemployment is zero, the
  unemployment rate is called the natural rate of
  unemployment, because it reflects unemployment
  that arises from natural features of a market
  society.
• When seasonally adjusted

Natural rate of unemployment

Frictional unemployment
Structural unemployment
Actual rate of unemployment

Natural unemployment Cyclical
unemployment
66
The Natural Rate of Unemployment

• Full Employment
• The natural rate of unemployment is considered to
  reflect the economy at full employment
• This is an arbitrary level of unemployment that
  corresponds to normal friction in the labor
  market
• For the U.S. economy, the rate is around 5

67
The Natural Rate of Unemployment

• In Macroeconomics, we will often refer to
  Full Employment, which is exhibited by the
  vertical LRAS in the graph to the right.

68
Changes in the
Natural Rate of Unemployment

• Changes in Labor Force Characteristics
• In general, unemployment rates tend to be lower
  for an older population and a male population.

69
Changes in the
Natural Rate of Unemployment

• Changes in Labor Market Institutions
• New unions can increase structural unemployment.
• Temporary employment agencies and job-placement
  websites can decrease frictional unemployment.

70
Changes in the
Natural Rate of Unemployment

• Changes in Government Policies
• A high minimum wage can increase structural
  unemployment.
• Generous unemployment benefits can increase both
  structural and frictional unemployment.
• Job training and employment subsidies may
  decrease structural and frictional unemployment.

71
Module 14 Inflation An Overview
71
72
Inflation and Deflation

• Inflation
• The situation in which the average of all prices
  of goods and services in an economy is rising.
• Deflation
• The situation in which the average of all prices
  of goods and services in an economy is falling.

73
The Level of Prices Doesn't Matter

• If the level of prices was rising/falling,
  so would wages and incomes in general.

74
But the Rate of Change of Prices Does
75
But the Rate of Change of Prices Does

• Inflation Rate
• The percentage increase in the overall level of
  prices per year.

Price Level in Year 2 Price Level in Year 1
Inflation Rate
?- 1
7-75
76
"Costs" of Inflation

• Shoe-Leather Costs
• A high inflation rate discourages people from
  holding money, because the purchasing power of
  the cash in your wallet and the funds in your
  bank account steadily erodes as the overall level
  of prices rise.
• The search for ways to reduce the money they
  hold comes at considerable cost

77
"Costs" of Inflation

• Menu Costs
• A high inflation rate forces firms to change
  prices more often than they would if the price
  level was more or less stable.
• The changing of a listed price has a real cost.

78
"Costs" of Inflation

• Unit-of-Account Costs
• The role of the dollar as a basis for contracts
  and calculation is called the unit-of-account
  role of money
• A high inflation rate causes a dollar next year
  to be worth less than a dollar this year.
• This effect reduces the quality of economic
  decisions and the economy as a whole makes less
  efficient use of its resources

79
Inflation and Deflation in U.S. History
80
Winners and Losers from Inflation

• The value of money is typically talked about in
  terms of purchasing power
• Represents real goods and services that it can
  buy
• Inflation is decline in purchasing power of money

81
Winners and Losers from Inflation

• Purchasing Power
• Nominal value price expressed in todays dollars
• Real value value expressed in purchasing power,
  adjusted for inflation
• For example, a 100 bill from your grandparents
  this year will have a nominal value of 100 next
  year but a real value of less, assuming a
  decrease in the purchasing power after a year of
  inflation

82
Winners and Losers from Inflation

• Anticipated vs. Unanticipated Inflation
• To determine who is hurt by inflation we
  distinguish between the two types.
• The effects of inflation on individuals depend
  upon which type of inflation exists.

83
Winners and Losers from Inflation

• Unanticipated Inflation
• Inflation at a rate that comes as a surprise,
  either higher or lower than rate anticipated
• Anticipated Inflation
• The inflation rate that we believe will occur
  regardless of whether it is higher or lower than
  the actual rate
• Some of the problems caused by inflation arise
  when it is unanticipated

84
Winners and Losers from Inflation

• Economists summarize the effect of inflation on
  borrowers and lenders by distinguishing between
  nominal and real interest rates.
• Nominal Rate of Interest
• The market rate of interest expressed in todays
  dollars
• Real Rate of Interest
• The nominal interest rate adjusted for inflation
  (i.e. minus the inflation rate)

85
Winners and Losers from Inflation

• Inflation affects people differently
• When inflation is higher than anticipated
• Creditors lose
• Debtors gain
• Creditors lose because the debtor is charged an
  interest rate that does not cover the actual
  inflation rate

86
Winners and Losers from Inflation

• When inflation is lower than anticipated
• Debtors lose
• Creditors gain
• Debtors lose because they are charged an interest
  rate that is higher than the actual inflation
  rate
• Creditors are paid back in more valuable
  dollars over the course of the loan

87
Protecting Against Inflation

• Banks attempt to protect themselves by raising
  nominal interest rates to reflect anticipated
  inflation (i.e. ARMs)
• Workers attempt to protect themselves with Cost
  of Living Adjustments (COLAs)
• Clauses in contracts that allow for increases in
  specified nominal values to take account of
  changes in the cost of living
• Individuals attempt to protect themselves by
  placing their savings into interest-bearing
  accounts
• Often pay nominal rates of interest that reflect
  anticipated inflation

88
The Cost of Disinflation

• Bringing the inflation rate downa process called
  disinflationis very difficult and costly

89
The Misery Index Since the Early 1960s
90
Module 15 The Measurement and Calculation
of Inflation
90
91
Price Indexes

• Aggregate Price Level
• Just as macroeconomists find it useful to have a
  single number to represent the overall level of
  output (GDP), they also find it useful to have a
  single number to represent the overall level of
  prices.
• Much more difficult to measure!

92
Measuring Inflation

• Price Index
• The cost of todays market basket of goods
  expressed as a percentage of the cost of the same
  market basket during a base year

93
Calculating the Cost of a Market Basket

• In the above table there are only three goods in
  the market basket. The quantities in the
  basket remain the same between the pre-frost and
  post-frost periodsa fixed-quantity price index
  is easiest to compute.

94
Calculating the Cost of a Market Basket
Price index pre-frost Price index
post-frost

• How much has the average price of citrus risen
  as a consequence of the frost?

95
Recall

• The price level mentioned in our inflation rate
  formula from Module 14 is simply a price index
  value.

Price index in year 2 Price index in year 1
Inflation Rate
?- 1
187.2 100
Inflation Rate
?- 1
? .872
?or 87.2

• Typically, a news report that cites the
  inflation rate is referring to annual change in
  consumer price index.

7-95
96
Price Indexes

• Consumer Price Index (CPI)
• Producer Price Index (PPI)
• GDP deflator

97
Price Indexes

• Consumer Price Index (CPI)
• A measure of the average change over time in the
  price of a fixed groups of products
• Most commonly used inflation indicator
• Calculated and reported by the Bureau of Labor
  Statistics (BLS) each month
• BLS selects a base year against which to measure
  change
• Selects a representative sample of commonly
  purchased consumer goods (market basket)

98
Consumer Price Index (CPI)
99
Consumer Price Index (CPI)
100
Price Indexes

• Producer Price Index (PPI)
• A measure of the average change over time in the
  costs of production
• Increasing costs of production lead to a decrease
  in supply
• Decreasing supply leads to increasing prices
• Used as a short-run leading indicator (before
  CPI)
• There are PPIs for selected types of products as
  well as for production stages or particular
  industries
• Food materials
• Intermediate goods
• Finished goods

101
Price Indexes

• GDP Deflator
• A price index measuring the changes in prices of
  all new goods and services produced in the
  economy
• Unlike CPI and PPIs, the GDP deflator is not
  based on a fixed market basket
• Broadest measure of prices reflects both price
  changes and the publics market responses to
  those price changes (i.e. new expenditure
  patterns)
• Very small statistical difference from CPI

102
Price Indexes
103
Appendix Unit Three Review of Formulas
103
104
Real GDP
Nominal GDP Price level
Real GDP
?x 100
Price level measured by the GDP deflator
8-104
105
Per Capita Real GDP

8-105
106
Economic Growth Rate
RGDP in year 2 RGDP in year 1 RGDP in year 1
Growth Rate
?x 100
7-106
107
Unemployment Rate
Unemployed Labor Force
Unemployment Rate
?x 100
7-107
108
Price Index
109
Inflation Rate
Price index in year 2 Price index in year
1 Price index in year 1
Inflation Rate
?x 100
7-109