ECON131 Chapter 5: Introduction to Macroeconomics

The U.S. median household income in 2013 was about . . .

$55,000.

Counterclockwise Direction of the CFD

1. Businesses pay for inputs (factors) of production: land, labor, capital, and entrepreneurship. Factors are paid rents, wages, interest, and profits. 2. These payments become income for the economy's households, which use these funds to purchase goods and services in the product market. 3. This spending for goods and services becomes sales revenues for the business sector.

Clockwise Direction of the CFD

1. Households supply labor (and other inputs or factors of production) to the resource market; that is, they become employees of businesses. 2. Businesses use this labor (and other inputs) to produce goods and services that are supplied to the product markets. 3. In the end, such products find their way back into households through consumer purchases.

Four Phases of the Business Cycle

1. Peak 2. Recession (Contraction) 3. Trough 4. Recovery (Expansion).

National Bureau of Economic Research (NBER)

A committee of economists tasked with officially dating business cycles and dating "turning points" like the beginning and end dates of a recession

GDP per capita

A country's GDP divided by its population. It provides a useful measure of a country's relative standard of living.

Gross Domestic Product (GDP)

A measure of the economy's total output; it is the most widely reported value in the national income and product accounts (NIPA) and is equal to the total market value of all final goods and services produced by resources in a given year

Double-dip Recession

A recession that begins after only a short period of economic recovery from the previous recession

National Activity Index

A weighted average of 85 indicators of national economic activity. These indicators are drawn from a huge swath of economic activity including production, income, employment, unemployment, hours worked, personal consumption, housing, sales, orders, and inventories. Negative values mean that the economy is growing slower and positive rates imply it's growing faster than its long-term trend.

National Income

All income, including wages, salaries and benefits, profits (for sole proprietors, partnerships, and corporations), rental income, and interest

Personal Income

All income, including wages, salaries, and other labor income; proprietors' income; rental income; personal interest and dividend income; and transfer payments (welfare and Social Security payments) received, with personal contributions for social insurance subtracted out.

The Income Approach to Calculating GDP

All payments to factors of production are added together. Major categories for income include compensation to employees, proprietors' income, rental income, corporate profits, and net interest, along with some statistical adjustments.

The Expenditures (Spending) Approach to Calculating GDP

All spending on final goods and services is added together. Major categories for spending include personal consumption expenditures, gross private domestic investment (GPDI), government spending, and net exports (exports minus imports).

Business Cycles

Alternating increases and decreases in economic activity that are typically punctuated by periods of recession and recovery; the periodic fluctuation of economic activity

Median Household Income

An alternative measure of the standard of living that reduces the effect of outliers (that is, the very destitute or the super rich) skewing the averages. It means that half of all households make less income and the other half make more

Recovery (Expansion)

An increase in the growth of the economy; the period marked from trough to peak. A speedup in the pace of economic activity defined by high growth, low unemployment, and increasing prices

Equation for GDP

C (consumption), I (investment), G (government), and X - M (net exports; exports minus imports). GDP = C + I + G + (X - M)

Recession (Contraction)

Decrease in the growth of the economy from its peak; officially ends when the economy is at the trough, which occurs when the economy is at its worst (or near worst) condition A slowdown in the pace of economic activity defined by low or stagnant growth, high unemployment, and declining prices. It is the period from peak to trough.

Corporate Profits

Defined as the income that flows to corporations, adjusted for inventory valuation and capital consumption allowances

Simon Kuznets

Devised the gross national product as a way of measuring a nation's economic output

Net Exports

Exports minus imports for the current period. Exports include all the items we sell overseas such as agricultural products, movies, and technology products. Imports are all those items we bring into the country, such as vegetables from Mexico, wine from Italy, and cars from Germany.

Gross Private Domestic Investment (GPDI)

Fixed investments or Investments in such things as structures (residential and nonresidential), equipment, and software, and changes in private business inventories

When Mr. Wilson worked full time, he paid a cleaning service to have his house cleaned twice a month. Now that he is retired, Mr. Wilson does his own cleaning. What is the effect on GDP?

GDP falls as a result of this change.

Personal Consumption Expenditures

Goods and services purchased by residents of the United States, whether individuals or businesses; they include durable goods, nondurable goods, and services The largest component of GDP

Net Domestic Product

Gross domestic product minus depreciation, or the capital consumption allowance. It represents the output the economy produced after adjusting for capital used up in the process.

National Income and Product Accounts (NIPA)

Helps economists judge our nation's economic performance, compare American income and output to that of other nations, and track the economy's condition over the course of the business cycle

Circular Flow Diagram (CFD)

Illustrates how households and firms interact through product and resource markets and shows that economic aggregates can be determined by either examining spending flows or income flows to households

Alternative Measures of Business Cycles

National Activity Index, Leading Economic Index, and Yield Curve

Benefits

Include the social insurance payments made by employers to various government programs, such as Social Security, Medicare, and workers' compensation and unemployment insurance, employer-provided pensions, profit-sharing plans, group health insurance, and in-kind benefits such as day care service

Informal Economy

Includes all transactions that are conducted but are not licensed and/or generate income that is not reported to the government (for tax collection).

Government Purchases

Includes the wages and salaries of government employees (federal, state, and local); the purchase of products and services from private businesses and the rest of the world; and the purchase of new structures and equipment

Major Components of the NIPA

Income and Spending

Rental Income

Income that flows to individuals engaged in renting real property (calculated as rent collected less depreciation, property taxes, maintenance and repairs, and mortgage interest) but does not include the income of real estate agents or brokers

Net Interest

Interest paid by businesses less the interest they receive, from this country and abroad Interest expense is the payment for the use of capital and includes payments from home mortgages, home improvement loans, and home equity loans.

Private Investment

Key factor driving economic growth and an important determinant of swings in the business cycle

Peak

Means that the economy is operating at its capacity; usually followed by downturns or recessions The upper turning point of a business cycle; the point at which expansion turns into contraction.

Positive Effects of the Informal Economy

People working in the informal economy are generating and spending income, contributing to national economic activity. Countries with large informal markets have total output that is significantly larger than what is officially reported in their GDP statistics.

Negative Effects of the Informal Economy

People working in the informal economy do not pay much if any taxes, placing a greater tax burden on the rest of society. Also, the informal economy is less regulated, which increases the probability of corruption and crime.

Disposable Personal Income

Personal income minus taxes.

Leading Economic Index

Predicts a recession whenever the index falls for three months in a row (compared to the same month the previous year). Indicators include average weekly hours, manufacturing, average weekly initial claims for unemployment insurance, manufacturers' new orders, consumer goods and materials, etc.

Change in Inventories

Refers to a change in the physical volume of the inventory a private business owns, valued at the average prices over the period.

Compensation of Employees

Refers to payments for work done, including wages, salaries, and benefits.

Proprietors' Income

Represents the current income of all sole proprietorships, partnerships, and tax-exempt cooperatives in the country

Yield Curve

Shows the relationship between the interest rate earned on a bond (measured on the vertical axis) and the length of time until the bond's maturity date (shown on the horizontal axis) Shaded bars indicate recessions. In all but one recession since 1960, the difference in rates turned negative prior to the recession.

Trough

The lowest turning point of a business cycle in which a contraction turns into an expansion

Turning Points

Times at which the economy switches from peak to downturn or from trough to recovery Hhelp form expectations of how the economy might perform based on the phase of the business cycle it has reached

Components of Income

Wages and salaries, rents, interest, and profits

GDP provides . . .

a simple and consistent way of measuring the overall economic activity in an economy.

The main idea of a circular flow diagram is that every dollar spent in an economy . . .

becomes a dollar of income to someone else.

Since everything that is spent on the right side represents income on the left side . . .

both factors (spending and income) equal each other.

Macroeconomics studies . . .

economic activity that focuses on the entire economy. This includes economic growth and its determinants fall into this category, recessions and their effect on unemployment, changes in the stock market, and monetary policy and its effect on interest rates.

U.S. business cycles since 1950 have shown that

expansions to be longer than recessions.

The arrows pointing clockwise represent . . .

flows of hours worked, goods and services produced and purchased.

The arrows pointing counterclockwise represent . . .

flows of money.

Business cycles vary in . . .

intensity, duration, and speed

We are most likely to see a recession if interest rates on long-term bonds are . . .

lower than interest rates on short-term bonds.

Income flows . . .

through the left side of the circular flow diagram

GDP and GDP per capita do not include . . .

most of the benefits and costs from environmental, quality, natural resources, and nonmarket activities or the informal economy (under-the-table payments).

NIPA accounts focus . . .

on market-produced goods and services. The major exceptions to this approach include substituting payroll costs for the value of government services and estimating (imputing) the rental value of owner-occupied housing.

NIPA uses market values . . .

or the prices paid for products, to compute GDP. Therefore, even if a firm must sell its product at a loss, the product's final sales price is what figures into GDP, not the firm's production costs.

People can do three things with the money they receive as personal income . . .

pay taxes, spend the money (engage in consumption), or put the money into savings.

Which of the following is NOT included in gross private domestic investment (GPDI)?

purchases of common stock by investors

Spending flows . . .

through the right side of the circular flow diagram

Business cycles are usually dated . . .

some time after the trough and peak have been reached

What event was a major influence on the development of macroeconomics?

the Great Depression

The value of the cars that the Ford Motor Company produces in a German plant is a part of . . .

the US GNP.

GDP reflects . . .

the final value of goods and services produced and do not include the value of intermediate goods used to produce other products.

GDP is measured by . . .

the output produced by resources within United States borders by both American citizens and foreign nationals. It does not include goods or services produced abroad, even if the producers are American citizens or companies.

Gross National Product (GNP)

the standard measure of output the Department of Commerce used until the early 1990s that reflects the market value of all goods and services produced domestically and abroad using resources supplied by U.S. citizens It excludes the value of goods and services produced in the United States by foreign-owned businesses.

The NIPA is used . . .

to judge economic performance over time, to compare the economies of different nations, to measure a nation's saving and investment, to track the business cycle, and to take a crude measure of our standard of living.

The informal economy includes . . .

transactions dealing with illegal goods and services (ex. drugs, prostitution, or unlicensed gambling) and the income earned by undocumented residents (those easily paid under the table).

An economy has historically grown at a rate of 1.25%. Economic activity decreased every quarter over the past year, but the decline stopped this quarter. The economy is expected to grow at a rate of 1.4% in the near future, and the monetary authorities are concerned that inflation may increase. This economy is probably in the _____________ stage of the business cycle.

trough

During each recession, GPDI . . .

turns down and turns up when the recession ends.