ECONOMICSWhat Does It Mean To Me?Unit 2: MEASURING THE MACROECONOMYBusiness CycleUnemploymentGDP Equation (nominal/real)Marginal Propensity to Consume/SavePrice DeflatorCPI

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READ: Krugman Chapters 23, 24OR Mankiw, Chapters 23, 24, 28OR, heres an idea!!READ THEM ALL!!

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Copyright 2004 South-Western*MankiwWebsites for government agencies that collect economic data:Bureau of Labor Statisticswww.bls.govFederal Reservewww.federalreserve.govCongressional Budget Officewww.cbo.govDepartment of Commerce www.commerce.govYou have a handout for collecting economic data. Its due tomorrow.

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Ten Propositions about Which Most Economists AgreeCopyright 2004 South-Western*Mankiw

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BUSINESS CYCLE

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The Business Cycle is the short-run alternation between economic downturns and economic upturns. Depression is a very deep and prolonged downturn. (over 3 reporting periods)Recessions are periods of economic downturns when output and employment are falling. (2 reporting periods)Expansions, sometimes called recoveries, are periods of economic upturns when output and employment are rising.

*Krugman

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The Circular-Flow Diagram

SpendingRevenueIncome = Flow of inputs and outputs = Flow of dollars Copyright 2004 South-Western

*Mankiw

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An Expanded Circular-Flow Diagram: The Flows of Money Through the Economy*Krugman

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What happens during a business cycle, and what can be done about it?

the effects of recessions and expansions on unemployment;

the effects on aggregate output; and

the possible role of government policy.

QUESTIONS TO ANSWER:

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Policy efforts undertaken to reduce the severity of recessions are called stabilization policy.

One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate. (raise/lower interest rate, raise/lower reserve requirement, buy/sell T-bills)The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both. (raise/lower taxes, raise/lower spending)

*Krugman

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Secular long-run growth, or long-run growth, is the sustained upward trend in aggregate output per person over several decades.A country can achieve a permanent increase in the standard of living of its citizens only through long-run growth. So a central concern of macroeconomics is what determines long-run growth.*Krugman

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UNEMPLOYMENT

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*MankiwHow Is Unemployment Measured?Categories of UnemploymentThe problem of unemployment is usually divided into two categories, the long-run problem and the short-run problem.Natural rate of unemployment does not go away on its own even in the long run.Cyclical rate of unemployment year-to-year fluctuations in unemployment around its natural rate.

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*MankiwUnemployment is measured by the Bureau of Labor Statistics (BLS).It surveys 60,000 randomly selected households every month.The survey is called the Current Population Survey

Based on the answers to the survey questions, the BLS places each adult into one of three categories:

**Employed**Unemployed**Not in the labor force

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Employment is the number of people working in the economy.

Unemployment is the number of people who are actively looking for work but arent currently employed.

The labor force is equal to the sum of employment and unemployment.

*Krugman

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*MankiwEmployed vs. unemployedThe BLS considers a person an adult if he or she is over 16 years old.A person is considered employed if he or she has spent some of the previous week working at a paid job.A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force.

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*Mankiw

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Discouraged workers are non-working people who are capable of working but are not actively looking for a job. They would like to work but have given up looking for jobs after an unsuccessful search, dont show up in unemployment statistics.

Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to smaller number of hours worked, lower-paying jobs, or both.

The unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force, either currently working

*Krugman

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History of the unemployment rate since 1948*Krugman

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*MankiwThe unemployment rate is calculated as the percentage of the labor force that is unemployed.

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*MankiwThe labor-force participation rate is the percentage of the adult population that is in the labor force.

Labor Force Participation Rate

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*Mankiw

108642019701975196019651980198519902005Percent ofLabor Force19952000

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*MankiwDemographic Groups

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*Mankiw

1008060402001950195519601965197019751980198519902000Labor-ForceParticipationRate (in percent)WomenMen199520051950

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*Mankiw

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*MankiwIn an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers would be fully employed.

Why Are There Always Some People Unemployed?Quantity of laborWage

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*MankiwFrictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suit their tastes and skills.Structural unemployment is the unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

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*MankiwUnemployment insurance is a government program that partially protects workers incomes when they become unemployed.

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*MankiwStructural unemployment occurs when the quantity of labor supplied exceeds the quantity demanded. Structural unemployment is often thought to explain longer spells of unemployment.Why is there Structural Unemployment?Minimum-wage lawsUnionsEfficiency wagesWhen the minimum wage is set above the level that balances supply and demand, it creates unemployment.

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*MankiwUnemployment from a Wage Above the Equilibrium Level

Quantity ofLabor0 Wage

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A union is a worker association that bargains with employers over wages, benefits and working conditions. In the 1940s and 1950s, when unions were at their peak, about a third of the U.S. labor force was unionized.A union is a type of cartel attempting to exert its market power.The process by which unions and firms agree on the terms of employment is called collective bargaining.A strike will be organized if the union and the firm cannot reach an agreement.A strike occurs when the union organizes a withdrawal of labor from the firm.

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A strike makes some workers better off and other workers worse off.Workers in unions (insiders) reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs.By acting as a cartel with ability to strike or otherwise impose high costs on employers, unions usually achieve above-equilibrium wages for their members.Union workers earn 10 to 20 percent more than nonunion workers.Critics argue that unions cause the allocation of labor to be inefficient and inequitable.Wages above the competitive level reduce the quantity of labor demanded and cause unemployment.Some workers benefit at the expense of other workers.

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Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity. A firm may prefer higher than equilibrium wages for the following reasons:Worker health: Better paid workers eat a better diet and thus are more productive.Worker turnover: A higher paid worker is less likely to look for another job.Worker quality: Higher wages attract a better pool of workers to apply for jobs.Worker effort: Higher wages motivate workers to put forward their best effort.

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*KrugmanUnemployment Rate

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GROSS DOMESTIC PRODUCT

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GROSS DOMESTIC PRODUCT is defined as:The market value of all final goods and services produced within a country in a given period of time. It does NOT include the value of intermediate goods.Intermediate goods and services are inputs for production of final goods and services, such as the purchase of glass or steel to build an automobile*Krugman

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GDP can be calculated in one of 3 ways:Measuring GDP as the Value of Production of Final Goods and Services.Measuring GDP as Spending on Domestically Produced Final Goods and Services.Measuring GDP as Factor Income Earned from Firms in the Economy.

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Calculating GDP*Krugman

2313 ways to calculate GDP

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U.S. GDP in 2004: Two Methods of Calculating GDP*Krugman

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The four major components or determinants of Gross Domestic Product are: Consumption (C)Investment (I)Government Spending (G)Net Exports (X-M)

GDP (Y) is equal to:C + I + G + (X - M)

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GDP and Its Components (2001)

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The most important factor in aggregate demand isCONSUMPTION (C)Therefore, understanding consumption is of vital importance, as it will eventually affect total output and income.

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Is it true that the higher the national income, the more it spends on consumer items?The answer is YES.However, it is also true that what matters most is not the total income but the after-tax income called DISPOSABLE INCOME.

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Milton Friedman, economist, observed that consumption is related to permanent income rather than current income levels. This is called the PERMANENT INCOME HYPOTHESIS. For example, it has been shown that college students and very old persons tend to spend more than their total income. These groups DISSAVE.On the other hand, people in their 30s and 40s tend to save quite a bit and consume relatively less of their income.

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WHY IS THIS?College students expect to make the bulk of their earnings after graduation and, thusly, base consumption on future earnings.Middle age persons expect to retire in the future and tend to save for that eventuality.Older people expect to die in the future and feel withdrawal of their savings is justified.

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Additionally, the consumption rate may be based on occupation.Farmers have good years and bad years. They save more in the good years to maintain consumption in the bad years.A professional football player may save more and consume less during his playing years because he knows that his professional life is limited.

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WHAT IS THE AVERAGE AND MARGINAL PROPENSITY TO CONSUME?Households will generally spend the majority of their total income and save the remainder.The portion of total income consumed is called the AVERAGE PROPENSITY TO CONSUME (APC).(i.e.) If a family spends $1350 out of $1500 total income, it has an APC of 0.9 (1350/1500).

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So, how would an increase in income affect the consumption of this family?That depends on the MARGINAL PROPENSITY TO CONSUME (MPC).MPC is the additional consumption that results from an additional dollar of disposable income.

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If consumption goes from $1350 to $1800 while disposable income goes from $1500 to $2100, what is the MPC? Firstly, calculate change ( ) in consumption:1800 - 1350 = 450Secondly, calculate change ( ) in income:2100 - 1500 = 600MPC = consumption/disposable income450/600 = 3/4 = 0.75

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We interpret this by saying ..for each additional dollar in after-tax income, this family will consume an additional 0.75 or 75 cents.

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Examples of changes in CONSUMPTION (C) might include:Increase/decrease in consumer confidence or consumer expectations of the future. (i.e. raise in salary)Increase/decrease in wealth. (i.e. land, stocks, homes) Increase/decrease in taxes.Increase/decrease in population.Increase/decrease in savings or debt.

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The next determinant in determining aggregate demand is:INVESTMENT (I)Investment expenditures are an important part of aggregate demand, as well as GDP; therefore, changes in investment spending will also be responsible for changes in the level of economic activity.

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If you will recall, spending on investments is the most unstable portion of GDP because of its sensitivity to changes in political, social, and economic conditions..First, we need to determine the difference between INDUCED INVESTMENT and AUTONOMOUS INVESTMENT.

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INDUCED INVESTMENT occurs when good business climate induces firms to invest, as an increasing growth in future demand is likely.The elements which impact Induced Investment include:OPTIMISM: Investment is greater when people are more optimistic.LEVEL OF AND RATE OF CHANGE in PROFITS: When economic growth is high,profits are high and rising. If total revenue is high, the resulting profit enables businesses to invest more.

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AUTONOMOUS INVESTMENT is investment that is not determined by the level of income.The elements which impact Autonomous Investment include:INTEREST RATES: The higher the interest rate, the higher the opportunity cost in capital; fewer investments will now have benefits greater than the new higher costs.RATE of CAPITAL UTILIZATION: When output is relative to the ability of business capital to produce goods, capital utilization rates are also low, and new investment will be lower.INVENTORIES: High inventories occur when sales are less than expected.. Inventory investment will be high, causing a reduction in planned investment.

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Examples of changes in INVESTMENT (I) might include:Increase/decrease in interest rates.Increase/decrease in business confidence or expected returns on investment projects.Increase/decrease in business taxes.New and improved technology will stimulate investment.Degree in excess capacity (unused existing capital) will retard demand for new capital goods and reduce aggregate demand.

*In this instance, we are NOT referring to the so-called interest rate effect due to a change in the price level. Instead we are identifying a change in the interest rate resulting from (I.e.) a change in the nations money supply. An increase in the money supply reduces the interest rate, increasing investment and aggregate demand. A decrease in the MS increases the IR, reducing investment and aggregate demand.

Higher expected returns on investment projects will increase the demand for capital goods and shift the AD curve rightward.

An increase in business taxes reduces after-tax profits from corporate investment and reduces investment spending and aggregate demand.

New and improved technology stimulate investment and increases aggregate demand. Recent advances in microbiology and electronics have spawned new labs and production facilities to exploit the new technologies.

Other things being equal , firms operating factories at well below capacity have little incentive to build new factories. But when firms collectively discover their excess capacity is dwindling, they build new factories and buy more equipment.

A third determinant of aggregate demand is:GOVERNMENT SPENDING (G)Government spending can vary over time for a variety of reasons. While volatile shifts may occur at the beginning or end of wars, for example, the tendency is that spending will increase with rising income because of the decrease in welfare payments and unemployment compensation.

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An increase in GOVERNMENT SPENDING (G) would also shift the aggregate demand curve to the right, while a decrease in spending would shift the curve to the left. An example would be a decision by government to expand the interstate highway system. In contrast, a reduction in spending, such as a cutback in orders for the military, will reduce aggregate demand.

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The fourth determinant of aggregate demand is:NET EXPORTS (X - M)The impact of international trade effects has become increasingly important. Exports (X) must be added to the demand side of the equation to realize the effect of foreign buyers on our economy. Additionally, Import (M) must be subtracted from the equation to realize purchases made which have no direct impact on our economy.

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Exports minus imports (X - M) is what we call NET EXPORTS.It represents BALANCE OF TRADE.A higher level of U.S. exports constitutes an increased foreign demand for U.S. goods.A reduction of U.S. imports implies an increased domestic demand for U.S.-produced products.

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Positive net exports (X - M), as a result of greater demand for U.S. goods will create a higher level of aggregate demand.This might explain why a country in a recession might like to run a trade surplus by increasing exports.The non-price-level factors which alter net exports are primarily NATIONAL INCOME ABROAD and EXCHANGE RATES.

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NATIONAL INCOME ABROADRising national income in a foreign nation increases the foreign demand for U.S. goods, increasing aggregate demand in the United States.Declines in national income abroad have the opposite effect: U.S. net exports decline, shifting the U.S. aggregate demand curve leftward.

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EXCHANGE RATESA change in the exchange rate between the dollar and other currencies also affects net exports and hence aggregate demand.Suppose the dollar price of yen rises, meaning the dollar depreciates in terms of the yen. This is the same as saying the yen price of dollar falls--the yen appreciates.The new relative values of dollars and yen means consumers in Japan can obtain more dollars with any particular number of yen. Consumers in the U.S. can obtain fewer yen for each dollar. Japanese consumers therefore discover that U.S. goods are cheaper in terms of yenthey buy more U.S. goods. Consumers in the U.S. find that fewer Japanese products can be purchased with a set number of dollars..they buy fewer Japanese goods.

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With respect the U.S. exports, a $30 pair of U.S.-made blue jeans now might be brought for 2880 yen compared to 3600 yen. In terms of U.S. imports, a Japanese watch might now cost $225 rather than $180. Under these circumstances, U.S. exports will rise and imports will fall. This increase in NET EXPORTS translates into a rightward shift in U.S. aggregate demand.

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A closed economy is an economy that does not trade goods, services, and assets. The United States has become increasingly open, so that open-economy macroeconomics has become increasingly important.Open-economy macroeconomics is the study of those aspects of macroeconomics that are affected by movements of goods, services, and assets across national boundaries.

*Krugman

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One of the main concerns introduced by open-economy macroeconomics is the exchange rate, the price of one currency in terms of another. Exchange rates can affect the aggregate price level. They can also affect aggregate output through their effect on the trade balance, the difference between the value of the goods and services a country sells to other countries and the value of the goods and services it buys in return.Economists are also concerned about capital flows, movements of financial assets across borders.

*Krugman

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Movements of the exchange rate between the U.S. dollar and the euro*Krugman

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When major trading partners are experiencing economic slowdowns, causing the demand for exports to fall, shifting the curve to the left.When major trading partners are experiencing economic booms, causing the demand for exports to rise, shifting the curve to the right.

Examples of changes in NET EXPORTS (X - M) might include:

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The Consumer Confidence Survey measures the level of confidence individual households have in the performance of the economy.Questionnaires are sent to 5,000 households; about 3,500 are returned.

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The five questions include:A rating of current business conditions in the households area.Rating of expected business conditions in six months.Current job availability in the area.Expected job availability in six months.Expected family income in six months.

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The results are compiled into indexes for the present and expected future economic situations.The Consumer Confidence index has the potential to reflect important aggregate demand shifters.Will expected stock market wealth increase their spending?Will inflation on the horizon increase saving?Will expected joblessness decrease spending?

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We can conclude, therefore, the PERCEPTIONS of consumers and businesses on the state of the economy are important aggregate demand shifters and can have a significant impact on price level, real output, and employment.

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NOMINAL GDP vs. REAL GDP

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Real GDP: the value of the final goods and services produced calculated using the prices of some base year.

Nominal GDP: output valued at current prices.

Real GDP per capita is a measure of average output per person, but is not by itself an appropriate policy goal.

*Krugman

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REAL VERSUS NOMINAL GDPNominal GDP values the production of goods and services at current prices.Real GDP values the production of goods and services at constant prices.

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*Krugman

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*KrugmanReal vs. Nominal GDP

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*KrugmanReal vs. Nominal GDP

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*KrugmanThe Relationship between Real GDP and Unemployment, 1949-2004

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To calculate REAL GDP, we must choose a base year.The current base year used for federal statistics is 2001.Therefore 2001 prices are used to calculate REAL GDP.Because REAL GDP uses a constant base year, changes in REAL GDP measure only the amounts being produced.

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In the year 2001, the economy produces 100 loaves of bread that sell for $2 each. In the year 2002, the economy produces 200 loaves of bread that sell for $3 each. Calculate nominal GDP, real GDP and the GDP price deflator for each year. (use 2001 as the base year) by what percentage does each of these three statistics rise from one year to the next?Year 2001100 x $2 = 200 nominal GDP100 x $2 = 200real GDP($200/$200) x 100 = 100 GDP deflatorYear 2002200 x $3 = 600 nominal GDP200 x $2 = $400real GDP($600/$400) x 100 = 150 GDP deflator

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In the year 2001, the economy produces 100 loaves of bread that sell for $2 each. In the year 2002, the economy produces 200 loaves of bread that sell for $3 each. Calculate nominal GDP, real GDP and the GDP price deflator for each year. (use 2001 as the base year) By what percentage does each of these three statistics rise from one year to the next?Year 2001100 x $2 = 200 nominal GDP100 x $2 = 200real GDP($200/$200) x 100 = 100 GDP deflatorYear 2002200 x $3 = 600 nominal GDP200 x $2 = $400real GDP($600/$400) x 100 = 150 GDP deflatorPercentage change in nominal GDP is (600 - 200)/200 x 100 = 200%Percentage change in real GDP is (400 - 200)/200 x 100 = 100%Percentage change in the deflator is (150 - 100/100 x 100 = 50%

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You borrowed $1,000 for one year.Nominal interest rate was 15%. During the year inflation was 10%.

Real interest rate = Nominal interest rate Inflation= 15% - 10% = 5%

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The GDP Price Deflator measures the current level of prices relative to the level of prices in the base year.GDP DEFLATOR = X 100Nominal GDPReal GDP

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*KrugmanCalculating GDP and Real GDP in a Simple EconomyWhat is the total value of sales in the 1st year?

What is the total value of sales in the 2nd year?(2000b x .25) + (1000b x .50) = $1000b(2200b x .30) + (1200b x .70) = $1500bNotice the 2nd year is 50% larger.Although the quantities of both apples and oranges increased the prices of both apples and oranges also rose.So part of the 50% increase in the dollar value of GDP simply reflects higher prices, not higher production of output.

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*KrugmanCalculating GDP and Real GDP in a Simple EconomyWhat is the total value of sales in the 1st year?

What is the total value of sales in the 2nd year?(2000b x .25) + (1000b x .50) = $1000b(2200b x .30) + (1200b x .70) = $1500bSo, how much would GDP have gone up if price had NOT changed?To do this, simply calculate Q at year 1 prices.

.25)

.50)$1150B

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Now, we can define REAL GDP as the total value of final goods and services produced in the economy during a year, calculated as if prices had stayed constant at the level of some given base year.*Krugman

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U.S. real gross domestic product per person from 1900 to 2004*Krugman

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INFLATION and the Consumer Price Index (CPI)

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The aggregate price level is the overall level of prices in the economy.

A rising aggregate price level is inflation.

A falling aggregate price level is deflation.

The inflation rate is the annual percent change in the aggregate price level.

The economy has price stability when the aggregate price level is changing only slowly. *Krugman

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Inflation and deflation since 1929*Krugman

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Consumer price index from 1913 to 2004*Krugman

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CPI -- prime indicator of inflation and recessionComprised of a market basket of goods and services.Measures current cost of living against base year (2000)

INFLATION: when the economys overall price level is rising.INFLATION RATE: percentage change in the price level from the previous period

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*KrugmanPrice Indexes and the Aggregate Price LevelA price index is the ratio of the current cost of that market basket to the cost in a base year, multiplied by 100.

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Calculating the Cost of a Market BasketSuppose a frost in Florida destroys most of the citrus crop. As a result, the price of oranges go from $.20 to $.40 and the price of grapefruit rises from $.60 to $1.00 and lemons rise from $.25 to $.45.We could recite three prices OR calculate an overall measure of the AVERAGE price increase.Economists measure average price changes by comparing a consumers consumption bundle from year to year. This is also called the MARKET BASKET.*Krugman

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*KrugmanCalculating the Cost of a Market BasketIn the example above, the MARKET BASKET cost $95 before the frost.After the frost, it cost $175.Since 175/95 = 1.842, the post-frost basket costs 1.842 times the cost of the pre-frost basket, an increase of 84.2%.In this case, we would say that the average price of citrus fruit increased 84.2% as a result of the frost.

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*KrugmanThe Makeup of the Consumer Price Index in 2004

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FYI: Whats in the CPIs Basket?Copyright2004 South-Western

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*KrugmanThe CPI, the PPI, and the GDP Deflator

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Problems in Measuring the Cost of LivingSubstitution bias*Consumers substitute toward goods that have become relatively less expensive.*The index overstates the increase in cost of living by not considering consumer substitutionIntroduction of new goods*New products result in greater variety, which in turn makes each dollar more valuable.*Consumers need fewer dollars to maintain any given standard of living.Unmeasured quality changes*If the quality of a good rises from one year to the next, the value of a dollar rises, even if the price of the good stays the same.*If the quality of a good falls from one year to the next, the value of a dollar falls, even if the price of the good stays the same.*The BLS tries to adjust the price for constant quality, but such differences are hard to measure.

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To calculate CPI:Choose what goes into your market basket. The Bureau of Labor Statistics conducts surveys to determine the consumption of the typical consumer.

For example: 2 pizzas,3 sodasWhen the CPI rises, a family will have to spend more money to make the same purchases.

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To calculate CPI:2)Determine the prices of the market basket for each point in time.YearPricePizza(2)PriceSoda(3)2001$5$12002$8$22003$10$3

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To calculate CPI:3)Determine the total cost of the market basket.YearPricePizza(2)PriceSoda(3)2001$5$12002$8$22003$10$32001: (2x5) + (3x1) = $132002: (2x8) + (3x2) = $222003: (2x10) + (3x3) = $29

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To calculate CPI:4)Select a base year and compute the CPI in each year2001: (2x5) + (3x1) = $132002: (2x8) + (3x2) = $222003: (2x10) + (3x3) = $292001: (13/13) x 100 = 1002002: (22/13) x 100 = 1692003: (29/13) x 100 = 223

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To calculate CPI:2002: (169-100)/100 x 100 = 69%2003: (223-169)/169 x 100 = 32%

IR:yr2 = x 100 CPI:yr2 - CPI:yr1CPI:yr15)Compute the Inflation Rate.2001: (13/13) x 100 = 1002002: (22/13) x 100 = 1692003: (29/13) x 100 = 223

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The CPI is used to calculate how prices have changed over the years.Lets say you have $7 in your pocket to purchase some goods and services today. How much money would you have needed in 1950 to buy the same amount of goods and services?

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The CPI for 1950 = 24.1The CPI for 1999 (based on first 5 months of 1999 = 166.2

Use the following formula to compute the calculation:1950 price = 1999 Price * (1950 CPI / 1999 CPI)

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THE ANSWER:

$7.00 * 24.1 / 166.2 = $1.02

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Lets say your parents told you that in 1950 a movie cost 25 cents. How could you tell if movies have increased in price faster or slower than most goods and services? To convert that price into todays dollars, use the CPI.

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The CPI for 1950 = 24.1The CPI for 1999 (based on first 5 months of 1999 = 166.2Use the following formula to compute the calculation:1999 price = 1950 Price * (1999 CPI / 1950 CPI)

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THE ANSWER:

$0.25 * 166.2 / 24.1 = $1.72

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In 1999, a full priced movie in South Florida cost between $5.00 and $7.00. It looks like movies have increased in price faster than most other goods and services.

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Do the following to convert (inflate) Babe Ruths wages in 1931 to dollars in 2001:

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Two Measures of Inflation

1965Percentper Year1510501970197519801985199020001995Copyright2004 South-Western

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QUESTIONS FOR REVIEW

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PriceQuantityPriceQuantityYearHot DogsHot DogsHamburgersHamburgers2005$1100$2502006$2150$31002007$3200$4150Two goods are produced: hot dogs and hamburgers:What is the NOMINAL GDP for each year?Nominal GDP for 2005 = ($1 x100) + ($2 x50) = $200Nominal GDP for 2006 = ($2 x150) + ($3 x100) = $600Nominal GDP for 2007 = ($3 x200) + ($4 x150) = $1,200

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PriceQuantityPriceQuantityYearHot DogsHot DogsHamburgersHamburgers2005$1100$2502006$2150$31002007$3200$4150Two goods are produced: hot dogs and hamburgers:What is the REAL GDP for each year assuming a base year of 2005?Real GDP for 2005 = ($1 x100) + ($2 x50) = $200Real GDP for 2006 = ($1 x150) + ($2 x100) = $350Real GDP for 2007 = ($1 x 200) + ($2 x150) = $500

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PriceQuantityPriceQuantityYearFootballsFootballsBasketballsBasketballsYear 1$10120$12200Year 2$12200$15300Year 3$14180$18275The country of Coltsville produces two goods: footballs and basketballs.What is the nominal GDP for each year?Nominal GDP for year 1 = ($10 x120) + ($12 x200) = $3,600Nominal GDP for year 2 = ($12 x200) + ($15 x300) = $6,900Nominal GDP for year 3 = ($14 x 180) + ($18 x275) = $7,470

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PriceQuantityPriceQuantityYearFootballsFootballsBasketballsBasketballsYear 1$10120$12200Year 2$12200$15300Year 3$14180$18275The country of Coltsville produces two goods: footballs and basketballs.What is the real GDP for each year using year 1 as the base year?Real GDP for year 1 = ($10 x120) + ($12 x200) = $3,600Real GDP for year 2 = ($10 x200) + ($12 x300) = $5,600Real GDP for year 3 = ($10 x 180) + ($12 x275) = $5,100NOTE that nominal GDP rises from Year 2 to Year 3, but real GDP falls.

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PriceQuantityPriceQuantityYearFootballsFootballsBasketballsBasketballsYear 1$10120$12200Year 2$12200$15300Year 3$14180$18275The country of Coltsville produces two goods: footballs and basketballs.What is the GDP deflator for each year?GDP deflator for year 1 = (3600/3600) x 100 = 1 x 100 = 100GDP deflator for year 2 = (6900/5600) x 100 = 1.2321 x 100 = 123.21GDP deflator for year 3 = (7470/5100) x 100 = 1.4647 x 100 = 146.71

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During 2009, the country of Meachotopia recorded a GDP of $65b, interest payments of $15b, imports of $13b, profits of $7b, exports of $15b, and rent of $7b. This would mean wages during 2009 in Meachotopia were:$36b65b -15b -7b - 7b =

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In the US, consumer spending accounts for what percentage of GDP?70%In the US, investment spending accounts for what percentage of GDP?16%

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GDP tends to understate our economic well being because it:excludes the value of leisureIf real GDP rises while nominal GDP falls, then prices on average havefallen

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GDP tends to understate our economic well being because it:excludes the value of leisureIf real GDP rises while nominal GDP falls, then prices on average havefallen

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Compiled by:Virginia H. Meachum, Economics TeacherCoral Springs High School

Sources:Principles, Problems, and Policies, by Campbell McConnell & Stanley Brue

Exploring Economics, by Robert Sexton

Principles of Economics, by N. Gregory Mankiw

Economics, by Paul Krugman & Robin Wells

Notes by Florida Council on Economic Education and FAU Center for Economic Education

Notes by Foundation for Teaching Economics

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*In this instance, we are NOT referring to the so-called interest rate effect due to a change in the price level. Instead we are identifying a change in the interest rate resulting from (I.e.) a change in the nations money supply. An increase in the money supply reduces the interest rate, increasing investment and aggregate demand. A decrease in the MS increases the IR, reducing investment and aggregate demand.

Higher expected returns on investment projects will increase the demand for capital goods and shift the AD curve rightward.

An increase in business taxes reduces after-tax profits from corporate investment and reduces investment spending and aggregate demand.

New and improved technology stimulate investment and increases aggregate demand. Recent advances in microbiology and electronics have spawned new labs and production facilities to exploit the new technologies.

Other things being equal , firms operating factories at well below capacity have little incentive to build new factories. But when firms collectively discover their excess capacity is dwindling, they build new factories and buy more equipment.*

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