Objectives:Objectives:1.1.Determine how economists calculate gross Determine how economists calculate gross domestic product (GDP) and the limitations of domestic product (GDP) and the limitations of

GDPGDP2. Examine the four phases of the business 2. Examine the four phases of the business

cycle and factors that influence the business cycle and factors that influence the business cyclecycle

3. Identify 3 leading indicators used to 3. Identify 3 leading indicators used to determine the current phase of the business determine the current phase of the business cyclecycle

4. Explain why economic growth is important 4. Explain why economic growth is important and the requirements for economic growthand the requirements for economic growth

5. Describe the relationship between economic 5. Describe the relationship between economic growth and productivitygrowth and productivity

Governor Brown, while Governor Brown, while posing with you, I’d like to posing with you, I’d like to

know: know: What is a NIPAWhat is a NIPA??

Nathan, it’s a Nathan, it’s a National Income and Product National Income and Product Account—used to track production, income Account—used to track production, income and consumption in a nation’s economy?and consumption in a nation’s economy?They provide information about a nation’s They provide information about a nation’s economic activities.economic activities.

Simoncini, as lieutenant governor, I’d Simoncini, as lieutenant governor, I’d like to add that the like to add that the most widely used most widely used NIPA is Gross Domestic ProductNIPA is Gross Domestic Product. So, . So, what is that?what is that?

Lieutenant Lieutenant Governor Governor Newsome, Newsome, GDP is GDP is the total dollar the total dollar value of all final value of all final goods and goods and services produced services produced within a country within a country during one during one calendar year.calendar year.

And the And the three components of GDP are: Final three components of GDP are: Final Output—econo- mists include only the value Output—econo- mists include only the value of final goods and services when calculating of final goods and services when calculating GDP;GDP;Current year—only count goods made in that Current year—only count goods made in that yearyear—not secondhand goods; —not secondhand goods; Output Produced Within National Borders, Output Produced Within National Borders, like like Toyotas produced in the USA. Hershey bars Toyotas produced in the USA. Hershey bars produced in Mexico don’t count.produced in Mexico don’t count.

The output-expenditure model The output-expenditure model

C + I + G + (X-M) = GDPC + I + G + (X-M) = GDPC: Personal consumption expenditures—C: Personal consumption expenditures—consumer purchases of durable goods consumer purchases of durable goods ((lifetime more than 1 yearlifetime more than 1 year), nondurable ), nondurable goods (goods (short useful lifetime, i.e. food or short useful lifetime, i.e. food or cosmetics)cosmetics) and services and services

The output-expenditure model The output-expenditure model

C + I + G + (X-M) = GDPC + I + G + (X-M) = GDPI: Gross investment—the total value of all I: Gross investment—the total value of all capital goods produced in a given nation capital goods produced in a given nation during one year as well as changes in the during one year as well as changes in the dollar value of business inventoriesdollar value of business inventories

Fixed investment Fixed investment (residential and (residential and nonres-idential structures, capital goods nonres-idential structures, capital goods (machinery and office equipment))(machinery and office equipment))

Inventory investment: increase or Inventory investment: increase or decrease in total dollar amount of the stock decrease in total dollar amount of the stock of raw materials, intermediate goods and of raw materials, intermediate goods and final goods of domestic businesses during a final goods of domestic businesses during a given periodgiven period

The output-expenditure model The output-expenditure model

C + I + G + (X-M) = GDPC + I + G + (X-M) = GDPG: Government purchases of goods and G: Government purchases of goods and services—total dollar value that federal, services—total dollar value that federal, state and local governments spend on state and local governments spend on goods and services goods and services

The output-expenditure model The output-expenditure model

C + I + G + (X-M) = GDPC + I + G + (X-M) = GDPX-M: net exports (X-M: net exports (total exports minus total total exports minus total importsimports)—GDP includes the value of goods )—GDP includes the value of goods and services produced domestically but and services produced domestically but sold in other countries (exports) sold in other countries (exports) and does and does not include goods and services produced in not include goods and services produced in other countries but purchased locally other countries but purchased locally (imports)(imports)

Nominal GDP and Real GDPNominal GDP and Real GDP

Nominal—current GDP is expressed in the Nominal—current GDP is expressed in the current prices of the period being current prices of the period being measuredmeasuredReal—GDP adjusted for price changesReal—GDP adjusted for price changes10,00010,000

9,5009,500

9,0009,000

8,5008,500

8,0008,000

7,5007,500

1996 1997 1998 1999 2000 1996 1997 1998 1999 2000

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Master, Master, what’s what’s a a price index price index and how is and how is it created?it created?

Woman, Woman, a price index a price index is a set of statistics is a set of statistics that allows economists that allows economists to compare prices over to compare prices over time.time.

But But Master, Master, how is it how is it created?created?

Well, toWell, to create a price index, create a price index, economists first select a economists first select a base year base year against which to measure changes against which to measure changes in prices.in prices.Second, they assign the base year Second, they assign the base year an an index number of 100index number of 100..Third, they Third, they calculate index numbers calculate index numbers for other yearsfor other years to to indicate the indicate the amount prices are higher or lower amount prices are higher or lower relative to the base year. relative to the base year.

OK, now I’m really confused. So, OK, now I’m really confused. So, what are the limitations of GDP?what are the limitations of GDP?

I, Richard Nixon, will answer that, I, Richard Nixon, will answer that, Savannah! Savannah! Initial figures are often Initial figures are often inaccurate. GDP does not include inaccurate. GDP does not include nonmarket activities nonmarket activities (activities like (activities like you washing your parents’ car for you washing your parents’ car for free) free) or the underground economy or the underground economy (illegal and non-reported legal (illegal and non-reported legal activities—under the table.) activities—under the table.) GDP GDP does not accurately measure a does not accurately measure a nation’s well-being. nation’s well-being.

So President Nixon, So President Nixon, Colonel Sanders here. Colonel Sanders here. How does GDP differ How does GDP differ from GNP?from GNP?

Colonel, Colonel, GNP is the final output GNP is the final output produced with factors of production produced with factors of production owned by the residents of a given owned by the residents of a given country. GDP is the final output country. GDP is the final output produced within a nation’s borders.produced within a nation’s borders.

The four stages or phases of the business The four stages or phases of the business cyclecycleExpansion and growth or recoveryExpansion and growth or recoveryPeak—the economy is at its strongest and Peak—the economy is at its strongest and most most prosperousprosperousContraction—business slowdown aka Contraction—business slowdown aka recessionrecession

Recession is a decline in real GDP for 2 Recession is a decline in real GDP for 2 or or more consecutive quartersmore consecutive quartersTrough—when demand, production and Trough—when demand, production and employment reach their lowest levels employment reach their lowest levels (1933)(1933)

OK, then, Mr. President. OK, then, Mr. President. What are three signs What are three signs that the business cycle that the business cycle is entering a period of is entering a period of expansion?expansion?

Ms. Bacon, Ms. Bacon, high levels of high levels of business investment, low business investment, low interest rates, and increased interest rates, and increased consumer spending.consumer spending.

You see, You see, investment investment creates a demand for creates a demand for goods, which encourages goods, which encourages further increases in further increases in production; businesses production; businesses use new capital to use new capital to moderate production moderate production methods and promote methods and promote efficiency; third, increased efficiency; third, increased business investment business investment (particularly in R&D) (particularly in R&D) tends tends to stimulate technological to stimulate technological change and generally change and generally results in higher output at results in higher output at lower production costs.lower production costs.

Leading indicatorsLeading indicators

……anticipate the direction in which the anticipate the direction in which the economy is headed economy is headed (changes in building (changes in building permits issued, orders for new capital and permits issued, orders for new capital and consumer goods, price of raw materials, consumer goods, price of raw materials, stock prices)stock prices)

Coincident indicatorsCoincident indicators

……change as the economy moves from one change as the economy moves from one phase of the business cycle to another and phase of the business cycle to another and tell economists that an upturn or a tell economists that an upturn or a downturn in the economy has arrived downturn in the economy has arrived (personal income, sales volume, industrial (personal income, sales volume, industrial production levels)production levels)

Lagging indicatorsLagging indicators

……change months after an upturn or a change months after an upturn or a downturn in the economy has begun and downturn in the economy has begun and help economists predict the duration of help economists predict the duration of economic upturns or downturnseconomic upturns or downturns (use of (use of consumer installment credit, number and consumer installment credit, number and size of business incomes)size of business incomes)

My question is, what My question is, what does the term does the term “Real “Real GDP per capita” GDP per capita” mean?mean?

OOOOH!! I know that!OOOOH!! I know that! It’s an It’s an increase in the real dollar increase in the real dollar value of all final goods and value of all final goods and services that are produced services that are produced per person for a specified per person for a specified period of timeperiod of time

Relationship between economic growth and Relationship between economic growth and a nation’s standard of livinga nation’s standard of living

A nation’s standard of living increases A nation’s standard of living increases when its real GDP per capita grows. when its real GDP per capita grows. Said Said another way, another way, the standard of living the standard of living improves improves when production per person when production per person increases faster than the total increases faster than the total population.population.

““For a nation to increase its long-term For a nation to increase its long-term output and income, it must either increase output and income, it must either increase its inputs . . . or increase the productivity of its inputs . . . or increase the productivity of these inputs.” What are examples of these inputs.” What are examples of inputs that should be increased?inputs that should be increased?

OK: OK: Natural Natural resources, human resources, human resources, capital resources, capital resources and resources and entrepreneurs.entrepreneurs.

What is labor productivity? What is labor productivity?

A measure of how much each worker A measure of how much each worker produces in a given period of time, usually produces in a given period of time, usually one hour.one hour.

What factors have significant affects on What factors have significant affects on productivity growth?productivity growth?Level of available technologyLevel of available technologyQuantity of capital goods available per Quantity of capital goods available per worker—capital deepening means an worker—capital deepening means an increase in the amount of capital goods increase in the amount of capital goods available per worker; occurs when the available per worker; occurs when the amount of a nation’s capital goods amount of a nation’s capital goods increases faster than the size of that increases faster than the size of that nation’s workforcenation’s workforceEducation and skill level of the labor forceEducation and skill level of the labor force

Objectives:Objectives:1.1.Define the unemployment rateDefine the unemployment rate2.2.Identify the 4 major types of unemploymentIdentify the 4 major types of unemployment3.3.Discuss the main economic costs of Discuss the main economic costs of

unemploymentunemployment4.4.Explain how economists evaluate price Explain how economists evaluate price

changes over timechanges over time5.5.Describe what causes inflationDescribe what causes inflation6.6.Identify the main two price indexes that Identify the main two price indexes that

economists use to measure inflationeconomists use to measure inflation7.7.Analyze how inflation affects the economyAnalyze how inflation affects the economy8.8.Explain how economists determine the Explain how economists determine the

number of poor people in the U. S. and how number of poor people in the U. S. and how they measure the distribution of incomethey measure the distribution of income

9.9.Identify U. S. government policies to reduce Identify U. S. government policies to reduce the income gap and decrease povertythe income gap and decrease poverty

Rats! I just lost my Rats! I just lost my job and now I’m job and now I’m

unemployed. I wonder unemployed. I wonder how high rates of how high rates of

unemployment hurt unemployment hurt the nation’s economythe nation’s economy..

Well, Trevor, the Well, Trevor, the nation loses nation loses the goods and services that the goods and services that the unemployed would the unemployed would produce if they were working produce if they were working and businesses lose sales and businesses lose sales because the unemployed because the unemployed cannot buy as many productcannot buy as many products.s.

The government must The government must decide how and to what decide how and to what extent to support the extent to support the unemployed and their unemployed and their dependentsdependents..

Definition of employed peopleDefinition of employed people

During the week surveyed, people who:During the week surveyed, people who:Worked for pay or profit one or more hoursWorked for pay or profit one or more hoursWorked without pay in a family business 15 Worked without pay in a family business 15 or or more hoursmore hoursHave jobs but did not work as a result of Have jobs but did not work as a result of illness,illness, weather, vacations or labor disputesweather, vacations or labor disputes

Okun’s Law Okun’s Law (Arthur Okun)(Arthur Okun)

For every one percent rise in the For every one percent rise in the unemployment rate, real gross unemployment rate, real gross domestic product (GDP) drops 3 domestic product (GDP) drops 3 percent. The reverse is also true.percent. The reverse is also true.

Three shortcomings of unemployment Three shortcomings of unemployment raterateDoes not indicate the differences in Does not indicate the differences in intensity with which people look for jobsintensity with which people look for jobs

Three shortcomings of unemployment Three shortcomings of unemployment raterateThe conditions for being included among The conditions for being included among the unemployed excludethe unemployed exclude

Marginally attached workers Marginally attached workers (people (people who once held productive jobs but have who once held productive jobs but have given up looking for work)given up looking for work)

Discouraged workersDiscouraged workers

Three shortcomings of unemployment Three shortcomings of unemployment raterateDoes not indicate the number of Does not indicate the number of underemployed workersunderemployed workers—workers who —workers who have jobs beneath their skill level or who have jobs beneath their skill level or who want full-time work but are only able to find want full-time work but are only able to find part-time jobspart-time jobs

Four types of unemploymentFour types of unemployment

Frictional—workers moving from one job to Frictional—workers moving from one job to another another

Four types of unemploymentFour types of unemployment

Structural—changes in technology or the Structural—changes in technology or the way the economy is structuredway the economy is structured

Four types of unemploymentFour types of unemployment

SeasonalSeasonal

Four types of unemploymentFour types of unemployment

Cyclical—unemployment resulting from Cyclical—unemployment resulting from recessions and economic downturns recessions and economic downturns This type of unemployment harms the This type of unemployment harms the economy more than any other type of economy more than any other type of unemploymentunemployment

Price Level Price Level

Price level influences aggregate supply—Price level influences aggregate supply—the total amount of goods and services the total amount of goods and services produced throughout the economy—and produced throughout the economy—and aggregate demand—the total amount of aggregate demand—the total amount of spending by individuals and businesses spending by individuals and businesses throughout the economythroughout the economy

InflationInflation

Inflation is an increase in the average price Inflation is an increase in the average price level of all products in an economy.level of all products in an economy.Usually, inflation occurs when aggregate Usually, inflation occurs when aggregate demand increases faster than aggregate demand increases faster than aggregate supply. As prices increase, the amount that supply. As prices increase, the amount that a dollar buys decreases. Thus inflation a dollar buys decreases. Thus inflation reduces the real purchasing power of the reduces the real purchasing power of the dollar.dollar.

Federal Reserve Board is Federal Reserve Board is responsible for monetary policyresponsible for monetary policy

Determines how much money is available Determines how much money is available to businesses and individuals from to businesses and individuals from financial institutions; can increase or financial institutions; can increase or decrease the money supply decrease the money supply

More money: lower interest rates & moreMore money: lower interest rates & moreconsumer spending—aggregate demand consumer spending—aggregate demand increases as more goods purchased increases as more goods purchased Spending outpaces available supply of goodsSpending outpaces available supply of goods and demand-pull inflation results and demand-pull inflation results

Cost-Push InflationCost-Push Inflation

……when producers raise prices to cover when producers raise prices to cover higher resource costs (crop failures, natural higher resource costs (crop failures, natural disasters, political problems abroad)disasters, political problems abroad)The relationship between wages and prices The relationship between wages and prices can also lead to cost-push inflation. Higher can also lead to cost-push inflation. Higher wages will cause prices to increase (wage-wages will cause prices to increase (wage-price spiral)price spiral)

Consumer Price Index Consumer Price Index

CPI is a measure of the average change CPI is a measure of the average change over time in the price of a fixed group of over time in the price of a fixed group of productsproductsThe Bureau of Labor Statistics The Bureau of Labor Statistics (BLS)(BLS) selects selects a base year against which to measure price a base year against which to measure price changes—still 1982-1984changes—still 1982-1984

Consumer Price IndexConsumer Price Index

Second, the BLS selects a representative Second, the BLS selects a representative sample of commonly purchased consumer sample of commonly purchased consumer items, called the market basket—items items, called the market basket—items that the typical urban consumer might buy. that the typical urban consumer might buy. Each item in the market basket is Each item in the market basket is weighted based on its importance in weighted based on its importance in consumers’ budgets. The BLS then consumers’ budgets. The BLS then samples the prices of those goods and samples the prices of those goods and services in selected areas services in selected areas across the nation.across the nation.

Consumer Price Index Economists set the index price for the base year Economists set the index price for the base year at 100. To calculate the CPI for another year, the at 100. To calculate the CPI for another year, the BLS determines the price of the market basket for BLS determines the price of the market basket for that year, divides the amount by the cost of the that year, divides the amount by the cost of the market basket in the base year, and multiplies market basket in the base year, and multiplies the result by 100the result by 100

If the market basket cost $4,000 in 1982-1984 If the market basket cost $4,000 in 1982-1984 and $7,000 in a later year, the CPI for the later and $7,000 in a later year, the CPI for the later year would be 175: ($7,000 / $4000) x 100 = 175. year would be 175: ($7,000 / $4000) x 100 = 175. The average price level in the later year is 75% The average price level in the later year is 75% higher than it was in 1982-1984—purchasing higher than it was in 1982-1984—purchasing power has declined and consumers must spend power has declined and consumers must spend 175% of the cost in 1982-1984175% of the cost in 1982-1984

How does the How does the U.S. government U.S. government

calculate the calculate the inflation rate inflation rate

using the CPIusing the CPI??

Inflation rate =Inflation rate =[(CPI year B – CPI year A) divided [(CPI year B – CPI year A) divided

by CPI Year A] times 100by CPI Year A] times 100

Say, in that Say, in that regard, regard, what are what are things in which things in which inflation causes inflation causes

changes?changes?

Changes caused by inflation Changes caused by inflation

Purchasing power of the dollar—particularly Purchasing power of the dollar—particularly hurts people on fixed incomes hurts people on fixed incomes

Changes caused by inflation Changes caused by inflation

Decreased value of real wages—when pay Decreased value of real wages—when pay increases fail to keep pace with rising increases fail to keep pace with rising pricesprices (teachers in Oakdale: a pay cut plus (teachers in Oakdale: a pay cut plus increase in medical insurance)increase in medical insurance)

Changes caused by inflation Changes caused by inflation

Increased interest rates—as prices Increased interest rates—as prices increase, interest rates increase increase, interest rates increase particularly on goods that are usually particularly on goods that are usually purchased on credit or through loanspurchased on credit or through loans (but (but the Fed can keep them low) the Fed can keep them low)

Changes caused by inflation Changes caused by inflation

Decreased saving and interest plus Decreased saving and interest plus increased production costs in business increased production costs in business

Poverty threshold Poverty threshold

Or poverty level, is the Or poverty level, is the lowest income—as lowest income—as determined by the government—that a determined by the government—that a family or household of a certain size or family or household of a certain size or composition needs to maintain a basic composition needs to maintain a basic standard of livingstandard of living. In 2000 the poverty . In 2000 the poverty threshold for a family of 4 was $17,603.threshold for a family of 4 was $17,603.The Social Security Administration bases The Social Security Administration bases thresholds on economical food plans (1955 thresholds on economical food plans (1955 study, family of 3 or more spent 1/3 of study, family of 3 or more spent 1/3 of after-tax income on food.) after-tax income on food.) Today poverty Today poverty thresholds are adjusted annually based on thresholds are adjusted annually based on changes in the CPIchanges in the CPI..

Lorenz Curve Lorenz Curve

Percent Distribution of Aggregate Household Income in 1978, by Fifths of

Households

Households Percent of Income

Lowest Fifth(under $6391)

4.3

Second Fifth($6392 - $11955)

10.3

Third Fifth($11956 - $18122)

16.9

Fourth Fifth($18122 - $26334)

24.7

Top Fifth($26335 and over)

43.9

Gini Index Gini Index

But what are the But what are the main main causes of the widening causes of the widening

disparity in income within disparity in income within the U.S.?the U.S.?

Causes of U.S. Income Disparity Causes of U.S. Income Disparity

Changes in householdsChanges in households—many more single —many more single parentparentChanges in labor marketChanges in labor market—corporate —corporate downsizing, downsizing, sending jobs overseassending jobs overseasChanges in technologyChanges in technologyGrowth of a global economyGrowth of a global economy