Unit 3: Measuring Economic Performance

1
Unit 3 Measuring Economic Performance

• Chapters 6-7

2
Revisit the Circular Flow Diagram

• On board
• What is Income?
• Rent, profits to the entrepreneur, interest,
  wages
• Leakage in Circular Flow Model
• Imports

3
Measuring Economic Activity

• Three primary ways to measure
• Gross Domestic Product
• Unemployment
• Inflation

4
National Income Accounting

• Measures the economys overall performance
• Why measure?
• Assess the health of the economy by comparing
  production to previous dates
• Track long-run course of the economy
• Formulate policies that will improve economy

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Gross Domestic Product

• Gross Domestic Product (GDP)
• Measure of aggregate output
• Total market value of all final goods and
  services produced by either citizen or foreign
  supplied resources within the country
• Includes everything made in the US for final use
• It is a monetary measure ( value)

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GDP cont.

• What is included?
• All final goods produced within the country
• Goods purchased for final use by consumers, not
  for resale or further processing

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GDP cont.

• What is not included?
• Intermediate goods
• Goods purchased for resale or further processing
  or manufacturing
• Why exclude these?
• Nonproduction transactions
• Financial transactions
• Public transfer payments
• Welfare, unemployment, social security, subsidies
• Private transfer payments
• Birthday money from family
• Stock market transactions
• Secondhand sales

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GDP cont.

• What else is not included?
• Stuff made by American companies in other
  countries
• Illegal activities
• Non-market activities
• Doing things yourself

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GDP cont.

• How do you find the GDP value?
• 2 ways
• Expenditure VS Income Approach
• Expenditure Approach (Super Easy)
• C Ig G Xn
• C Personal Consumption Expenditures
• Ig Gross Private Domestic Investment
• G Government Purchases
• Xn Net Exports

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GDP cont.

• C Personal consumption expenditure
• All households expenditures
• Largest portion
• Ig Gross Private Domestic Investment
• All final purchases of machinery, equipment, and
  tools by business enterprises
• All construction (houses, factories, warehouses,
  and stores)
• Changes in business inventories
• Negative and Positive

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GDP cont.

• G Government Purchases
• Includes all government expenditures on final
  goods and services and purchases of resources,
  including labor
• G/S the government consumes to provide public
  services
• Social Capital like schools and roads
• Xn Net Exports
• Exports (X) Imports (M)

12
GDP cont.

• Income Approach (Super Complicated)
• Add the following to get National Income (All
  income earned through the use of American-owned
  resources)
• Compensation of Employees
• Wages and salaries (largest portion)
• Rents
• Income received by those who rent property
• Gross Rent Depreciation
• Interest
• Loans paid lenders
• Interest paid to savers (bond, CDs, savings
  deposits)
• Proprietors Income
• Profits from partnerships, sole proprietorships,
  unincorporated businesses
• Corporate Profits
• Corporate income taxes, dividends to
  stockholders, undistributed corporate profits
  (retained earnings)
• Taxes on Production and Imports
• Sales taxes, excise taxes, business property
  taxes, license fees, customs duties

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GDP cont.

• Income Approach cont.
• Add or subtract to get final GDP value
• Net Foreign Factor Income
• Money earned by American companies in other
  countries (subtracted from total national income)
• Statistical Discrepancy
• Added to make the income approach the
  expenditure approach
• Consumption of Fixed Capital
• Depreciation of capital over time
• Added to get the true value cost of capital over
  time

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Real VS Nominal

• Real GDP is adjusted for inflation, while nominal
  is not.
• Why would this be an important difference?
• Price index and application
• On board

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GDP cont.

• Shortcomings
• Nonmarket activities
• Leads to understated number
• Leisure time or job satisfaction
• Adds to well-being but cannot be measured
• Product quality
• Underground economy
• Also includes cash-only jobs not reported on
  taxes
• Environment
• Distribution of income
• Noneconomic sources of well-being
• Reductions in crime, civility, drug or alcohol
  abuse

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(a) Real GDP
Billions of
1996 Dollars
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1965
1970
1975
1980
1985
1990
1995
2000
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GDP and the Business Cycle
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Economic Growth

• Growth occurs when
• Increase in real GDP
• Increase in real GDP per Capita
• GDP/population
• Tells more about living standards
• Growth leads to
• Rise in real wages
• Decreases of the burden of scarcity

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Growth cont.

• Rule of 70
• 70 divided by annual growth rate tells us how
  long it will take to double GDP
• Sources of growth
• What shifts PPC?
• Increases in resources
• Increasing productivity
• Real output per input
• 2/3 of US growth comes from this

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Growth cont.

• Again, what are the limitations of growth
  information?
• What are the limitations of GDP?
• Improved products
• Added leisure
• Environment
• Gains in well-being

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Business Cycle and Growth

• What causes the business cycle?
• Really controversial
• Innovations
• Changes in productivity
• Monetary phenomenon
• Changes in spending
• Government interference
• Who is affected most/least?
• Least
• Non-durable good producers
• Most
• Durable good producers and capital good producers

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Enemies of the Economy

• Inflation and unemployment
• Usually dont occur at the same time
• High rates are either have negative effects on
  the economy
• Therefore, societies want to avoid both

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Unemployment

• Civilian Labor Force (CLF)
• Men and women 16 and up not in the military,
  prison, or otherwise institutionalized who are
  working or actively looking for a job.
• Who does this not include? (IMPORTANT!!!)
• The number of people in the CLF is determined by
  the Bureau of Labor Statistics (BLS)

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Unemployment cont.

• Unemployment rate
• of Civilian Labor Force without a job
• Calculation?
• On board
• They also determine the unemployment rate
• Current Rate?
• http//www.bls.gov/cps/
• Limitations
• Part-time employment
• Underemployed
• Discouraged workers

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Unemployment cont.

• 4 types of unemployment
• Frictional
• Not necessarily bad
• Labor market is not perfect and it takes time to
  match jobs to workers
• Usually short term
• Structural
• Replaced by machines, changes in demand for
  products, movement of businesses
• Longer term
• Cyclical
• Downturn in economy
• Seasonal
• Seasonal demand for employees

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Unemployment cont.

• Is zero unemployment desirable?
• Why or why not?
• Full Employment rate of unemployment or natural
  rate of unemployment (NRU)
• Economy is at potential output
• Job seekersjob vacancies
• Economy can be above potential output temporarily
• NRU can change over time
• In the 1980s it was around 6
• Today between 4-5
• Changes in population
• Welfare laws
• Internet job sites

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Unemployment cont.

• GDP gap
• Gap between PPC and point inside the curve due to
  unemployment
• GDP Gap actual GDP potential GDP
• Okuns Law
• For every 1 actual unemployment exceeds NRU, a
  negative GDP gap of about 2 occurs
• We can use this to find how much loss of wealth
  unemployment causes

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Unemployment cont.

• Unequal burdens
• Low skilled or less educated
• Teenagers
• AA and Hispanics
• Costs of unemployment
• Loss of wealth (GDP)
• Social costs
• Poverty, racial and ethnic tensions, loss of hope
  and morale, sociopolitical unrest, family
  disintegration, loss of skills
• Long term unemployed

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Inflation

• What is inflation?
• Rise in the general level of prices
• Real income is declining
• Does NOT mean all prices are rising
• Inflation is monetary phenomenon!!!
• Hyperinflation
• Deflation

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Inflation cont.

• How is it measured?
• Consumer Price Index (CPI)
• market basket of 300 consumer goods and
  services
• Compiled by the BLS
• CPI (Price of most recent basket) / (Price
  estimate of same basket in 1982-1984) X 100
• Inflation Rate (year 2 year 1) / (year 1) X
  100
• GDP Deflator
• Uses GDP instead of market basket
• (Nominal / Real) X 100

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Inflation cont.

• Types
• Demand Pull
• Too much money chasing too few goods
• Loans increasing at a rapid rate
• Cost Push
• Increasing in factor of production costs
• Per-unit production costs rise
• Per-unit cost (total input cost) / unit of
  output
• Supply shocks
• Leads to increases in unemployment and inflation
  at the same time (stagflation)
• Hard to know which is causing inflation

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Effects of Inflation

• Nominal and real income changes
• Real income (nominal income) / (price index in
  hundredths)
• Doesnt necessarily change real income for
  everyone
• Anticipated VS Unanticipated Inflation
• If we expect it we can plan for it

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Effects cont.

• Who is hurt?
• Almost everyone, but in particular
• People on fixed incomes
• Savers
• Creditors
• Who is helped or unaffected?
• Flexible-income receivers
• People who receive Cost-of-Living Adjustments
• Debtors
• Governments

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Effects cont.

• Planning for inflation
• Real VS Nominal Interest rates
• Real is true cost to borrow the money
• Nominal is real plus the extra cost of due to
  inflation
• Nominal Real Expected Rate of Inflation
• Effects on output
• Cost-push reduces output
• Demand-pull
• Harder to know. Some say
• Costs associated with changing prices
• Distinguishing between real and nominal interest
  rates
• Costs of getting cash