Macroeconomic Measurements

Full Employment Act - 1946

Ensure economic stabilityMaintain low unemploymentKeep prices stablePromote economic growth

How do we measure progress?

Macroeconomic Goals

Inflation: 3 percent Unemployment: 4 percent Economic growth: 4 percent

Bureau of Labor Statistics

BLS Chart for latest unemployment.

Unemployment Rate 2011 to 2012

GDP 1007 to 2012 Q3

GDP Growth to March, 2013

Now- was that a bad recession????

Gross Domestic Product (GDP)

The dollar (market) value of all final goods and services produced within the nation’s borders in one year. total production total expenditures total income

Transactions Not Included in GDP Transfer payments

Entitlement programsTransfers in kindCash payments

Unreported incomeLegal and illegal

Work for which no money changed handsProduction within household

Sale of used goods

Basic Circular Flow

This shows the interactions between households (income earners and resource owners) and businesses (resource buyers)

Figure 8-1. Basic Circular Flow

Businessfirms

Consumers inHouseholds

Productmarket

Resourcemarket

ConsumerSpending

Income

Business SalesRevenues

BusinessCosts

Expenditures The components of total spending are:

C – Consumption spending I – Investment spendingG – Government spending

X – Exports From which we subtract M – Imports to get

NX = Net exports (exports – imports)

C – Consumption spending

Three kinds:durable goodsnon-durable goodsservices

Determining factors: incomeexpectations about the future

I – Investment spending

Three kinds:new or replacement capital goods inventory changesnew housing construction

Determining factors: interest ratesexpected return on investmentexpectations about the future

G – Government spending

Three kinds:Federalstate local

Determining factors:Politics - goalsunexpected external events

X – Exports and M - Imports

Exports - Determining factors: income of foreign customerscomparative advantage of American goods

Imports – Determining factors: income of American customerscomparative advantage of foreign goods

Macro Equilibrium

Total spending = total output = total income No unexpected changes in inventories Full-employment equilibrium is the goal:

total spending = total production at the economy’s capacity to produce

Total Income = Total SpendingFor every transaction, when someone spends

money, it is income to someone else

Macro Equilibrium

Equilibrium with high unemployment: total spending is less than the economy’s

capacity to producerecessionunderperforming economy idle labor and capital goods

Macro Equilibrium

Equilibrium with low unemployment: total spending is greater than the economy’s

capacity to produce inflationoverheated economyshortages of labor and capital goods

Leakages

Leakages – funds leaving the circular flow Households do not spend all of their

income on American goodsThe following leak out of the circular flow:

saving (S) taxes (T) imports (M)

Injections

Injections – funds entering the circular flow Not all American made products are

bought by US households.The following are injected into the circular

flow: investment spending (I) government spending (G) exports (X)

Basic Circular Flow

Businessfirms

Consumers inHouseholds

Productmarket

Resourcemarket

ConsumerSpending (C)

Income (Y)

BusinessRevenues (GDP)

BusinessCosts

S + T +M

I + G + X

Leakages and Injections

For equilibrium: leakages = injectionsS + T + M = I + G + X

It is not necessary that S = I and T = G and M = X to have equilibrium

Recessions

Usually caused by a decrease in total spendingSpending < production Inventories rise Investment spending fallsUnemployment rises Income fallsTax collections fall and transfer payments rise

Recessions

Real GDP decreases To be called a recession, real GDP must

decrease two quarters (six months) in a row.

Recessions

Possible causes:Decreases in injections (I, G, X) Increases in leakages (S, T, M)

Result: injections < leakagesspending < productionultimately reach an equilibrium in an

underperforming economy

Real GDP

Terminology:“nominal” means ‘as measured’ – current $ or

rate“real” means with ‘the effects of inflation

removed’

Is the Growth of GDP real or inflated?This is the real test!!!!!!!

Was there actual increase in production and services or did the prices just skew the GDP statistics when C+I+G was added?

Have to correct GDP for price changes so we can measure actual production.

CPI tells the consumer if they have to spend more dollars to get that loaf of bread… but other measures have to be evaluated.

Still another way to test the health of the U.S. economy

The GDP Deflator…. The broadest price index and covers all output including consumer goods, investment goods and government services. (C+I+G)

The GDP deflator isn’t a pure measure of price change. Its value reflects both price changes AND market responses to those price changes as reflected in new expenditure patterns.

The GDP deflator typically registers a lower inflation rate than CPI and the government watchdogs use this barometer more readily than current CPI

Historical Record Graph

20

16

12

8

4

0

4

8

12

1920 1930 1940 1950 1960 1970 1980 1990 2000

Inflation

B

A

Deflation

Real GDP

A change in Nominal GDP can include changes in both prices and quantities.

Economic growth wants to consider only the change in quantitiesRemember – GDP measures production.

Thus, the change in prices must be removed from the data.Convert Nominal GDP to Real GDP

GDP Deflator

GDP Deflator = Nominal GDP x 100

Real GDP

Real GDP = Nominal GDP x 100

GDP deflator

Nominal GDP is GDP measured at current prices

Real GDP is GDP measured at base year prices

Year (base

Price of good Quantity GDP Real GDP

1 $10 100 $1,000 $1,000

2 $12 120 12x120 = $1,440

10 x 120 = $1,200

3 $14 140 14 x 140 = $1,960

10 x 140 = $1,400

GDP Growth Rates

Growth economy – increases 3% or more Stagnant economy – grows less than 3% Declining economy – growth is negative

Business Cycle

The long run trend in economic growth is positive, 3 to 3.5 percent per year

Short run, there are periods of greater growth and of decline this variation is called the business cycle

Business Cycle

Four phases:peakrecession/contraction troughrecovery/expansion/prosperity

Figure 8-3.A Stylized Business Cycle

time

realGDP

peak

peak

trough

recession

recession

recovery

prosperity(“boom” times)

long-runtrend of realGDP

Peak

economic activity at its highest unemployment is low income is at its highest

tax collections are high transfer payments are low

danger of inflation

Recession/Contraction

economic activity slows inventory levels rise unexpectedly sales fall off production decreases unemployment rises incomes fall

tax collections fall and transfer payments rise

Trough

economic activity is at its lowest unemployment is high incomes are at their lowest

tax collections are low and transfer payments are high

Recovery/Expansion/Prosperity

economic activity increases sales rise production rises unemployment falls income rises

tax collections rise and transfer payments fall when real GDP increases beyond the previous peak,

prosperity sets in in the late stages, inflation may become a problem

Inflation

A rising general/average level of prices Measured monthly similar to the GDP

deflatorSpecial basket of goods urban consumers buyConsumer Price Index (CPI)

Inflation then is the %change in the CPI from year to year

How to measure rate of inflation

Measuring the Rate of Inflation Market Basket

Representative bundle of goods and services

Base YearThe point of reference for comparison of

prices in other years

Macroeconomic Measures - Prices

Base Year - The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year. (82-84)

Computing the Consumer Price Index

Consumer Price Index (CPI)

By observing the extent of price increases, we can calculate the inflation rate.

The inflation rate is the annual percentage rate of increase in the average price level.

Changes in Prices

In 2005 the CPI was 195.3; in 2006 the index was 201.6. What was the percentage change in prices from 2005-2006?

Click below for answer.

3.22 %

Here’s a little hint if you forget…C-L/L

Percentage change in prices = Current year - later year x100 later year

CPI determined

Calculates the inflation rate Market basket of goods and

services (same each year.) Bureau of Labor Statistics

determines cost in 85 cities by shopping 184 items.

19,000 stores visited and 60,000 landlords,renters and homeowners surveyed each month

Statistics released each month.(3.15- .7%)

Yearly average compiled.

CPI expressed in base year ’82-84

Constructing the CPI The base period is the

time period used for comparative analysis — the basis of indexing, for example, of price changes.

Shopping for CPI

CPI is constructed by identifying a typical bundle of goods that the average consumer buys. This bundle stays the same each year.

The base year is changed periodically. The base year used is ’82-’84 and prior to that it was ’63.The price level in the base period is designated as 100.

The market basket (bundle) can be changed if BLS research shows that the “average” consumer no longer is purchasing that good or service.

Each item in the bundle is weighted percent-wise in the market basket figures.

The Market Basket

Transportation19.0%

Housing32.6% Food

13.6%

Clothing 4.7%

Miscellaneous 10.5%

Health care 5.3%

Entertainment 5.1%

Insurance and pensions 9.3%

Inflation’s Harmful Effects

Purchasing power falls Redistribution of income and wealth Savings rate tends to fall Businesses plan only in very short time

horizons Interest rates rise – business investment

falls

Bottom LineCPI is designed to measure the impact of price changes on

the cost of a typical bundle of goods purchased by households(remember, market basket and only for urban purchasers.)

GDP deflator is a broader price index and is designed to measure the change in the average price of the market basket of goods included in GDP (in addition to consumer goods it includes capital goods, & g & s by government.)

CPI measures money income of consumers in relation to rising prices (only consumer goods.)

GDP deflator measures economy wide inflation- more g & s included in measurement.

Types of Inflation Monetary

Money supply rapidly increases – ‘too many dollars chasing too few goods and services’

Demand-pull Total spending exceeds production of goods and

services Cost-push

Decrease in production – may be caused by rising production costs/external shocks

Unemployment

Definitions: labor force = those at least 16 years old who are

working or are actively seeking work Labor Force = # E + # UE

Employed (#E) = those in the labor force who are working

Unemployed (#UE) = those in the labor force who are not working but are actively seeking work

Unemployment

Unemployment rate = # unemployed / labor force x 100

Types:seasonalcyclical frictionalstructural

Full Employment

No cyclical unemployment exists. Only frictional and structural

unemployment exists.Full employment exists when the

unemployment rate is 4 to 6 percent.Occurs at or near the peak of the business

cycle.

Macroeconomic Measurements

Study Questions

1. What is Gross Domestic Product (GDP)?

2. Why must Nominal GDP be corrected for inflation?

3. How is economic growth calculated? 4. What is the difference between growth,

stagnation, and decline?

Study Questions

5. What are the phases of the business cycle? 6. What are the three types of inflation? 7. What are the four types of unemployment? 8. Which is the one of most concern to policy

makers? 9. What is the full employment goal?