Econ 100 exam 3

Frictional unemployment

Between jobs, delays between matching available jobs with job seekers People who are fired for poor performance Job leavers Young workers searching for first job Temporary layoffs because of seasonal demand (seasonal)

Cyclical Unemployment

Deficient demand for products Due to downturns in the economy (recessions) Great Depression- 1933, 25% unemployment, mainly cyclical Great Recession- Oct. 2009, 10.0% unemployment Unemployment lags behind GDP growth Recession ended in June 2009 but the unemployment rate continued to rise, remained above 9.0% until Oct. 2011

Structural Unemployment

Due to a fundamental shift in the job market Technological progress, outsourcing Changes in the demand for certain skills Can you think of some jobs that no longer exist? Can you think of jobs that may not exist in the future?

Types of Unemployment

Frictional Seasonal Structural Cyclical

Natural Rate of Unemployment

No cyclical unemployment Structural and frictional still exist NRU= full-employment level, also known as the potential GDP level Full-employment does NOT equal zero unemployment NRU is around 5% Natural Rate can and does change Some causes of change to natural rate- population growth, changes to unemployment benefits (may create incentive to work or not work)

Under 16 and/or institutionalized

Not part of the labor force Mental hospitals Jail Disabled Military

investment

, investment (I) refers to private spending on the tools, physical plant, and equipment used to produce future output. - Investment can be something as simple as the purchase of a shovel, a tractor, or a personal computer to help a small business produce goods and services for its customers. - But investment also includes more complex endeavors such as the construction of large factories. - For example, when Horizon Wind builds a new wind farm in Ohio, it is making an investment. When Walmart builds a new warehouse, that expense is an investment

During the Great Recession,

- (a) During the Great Recession, real GDP fell further and rebounded more slowly than it did during other postwar recessions. - (b) The unemployment rate during the Great Recession rose to levels far higher than occurred in the other postwar recessions, and it remained high long after the rate typically falls

Consumer Price Index (CPI)

- A measure of the price level based on the consumption pattern of a typical, urban consumer (87% of US) • Measures average change in the price paid for a market basket of goods/services - Goal: include everything purchased by a typical consumer to get a measure of the cost of living • Bureau of Labor statistics - Government agency that reports inflation and unemployment data • Determines how much "weight"to put on certain consumer prices

What Is a Business Cycle, and Why Are Business Cycles So Difficult to Predict?

- A recession is a short-term economic downturn that typically lasts about 6 to 18 months. - Even the mere threat of recession strikes fear into people's hearts because income levels fall and many individuals lose their jobs or cannot find work during recessions. - The U.S. recession that began in 2007 and lasted into 2009 has been dubbed the Great Recession because of its length and depth. - It lasted for 19 months, and real GDP fell by almost 9% in the last three months of 2008. In addition, the recovery from the Great Recession has been very slow.

economic contraction

- After a certain period, the economy enters a recession, or an economic contraction—the period extending from the peak downward to the trough. - During this phase, the economy is shrinking. - During expansions, jobs are relatively easy to find and average income levels climb. - During contractions, more people lose their jobs and income levels often fall.

Frictional unemployment

- Between jobs, delays between matching available jobs with job seekers - Make mistakes in job - Incomponent - People who are fired for poor performance - Job leavers ` quiet job for variety of reasons ` quiet bc they don't like it ` going back to school Young workers searching for first job ` first time job seekers Temporary layoffs because of seasonal demand (seasonal)

Business cycles are short-run fluctuations in economic activity

- Business cycles are short-run fluctuations in economic activity. - Figure 12.1 illustrates a theoretical business cycle in relation to a long-term trend in real GDP growth. - The straight line represents the page 349 long-run trend of real GDP. - The slope of the trend line is the average long-run growth of real GDP. For the United States, this is about 2% per year. - But real GDP doesn't typically grow at exactly 2% per year. - Instead of tracking exactly along the trend line, the economy experiences fluctuations in output. - The wavy line represents the actual path of real GDP over time. - It climbs to peaks (high points) when GDP growth is higher than usual and falls to troughs (low points) when output growth is lower than usual.

Business cycles are short-run fluctuations in economic activity.

- Business cycles are short-run fluctuations in economic activity. - Figure 12.1 illustrates a theoretical business cycle in relation to a long-term trend in real GDP growth. The straight line represents the page 349 long-run trend of real GDP. - The slope of the trend line is the average long-run growth of real GDP. - For the United States, this is about 2% per year. - But real GDP doesn't typically grow at exactly 2% per year. - Instead of tracking exactly along the trend line, the economy experiences fluctuations in output. - The wavy line represents the actual path of real GDP over time. - It climbs to peaks (high points) when GDP growth is higher than usual and falls to troughs (low points) when output growth is lower than usual.

consumption goods can be divided into two categories:

- Consumption goods can be divided into two categories: non-durable and durable. - Non-durable consumption goods are consumed over a short period, and durable consumption goods are consumed over a long period. -- This distinction is important when the economy swings back and forth between good times and bad times. - Sales of durable goods—for example, automobiles, appliances, and computers—are subject to significant cyclical fluctuations that correlate with the health of the economy.

Cyclical Unemployment

- Deficient demand for products - Due to downturns in the economy (recessions) - Great Depression- 1933, 25% unemployment, mainly cyclical - Great Recession- Oct. 2009, 10.0% unemployment - Unemployment lags behind GDP growth When were coming out of recession and grow as economy unempl rates stay high - As we grow they don't higher more workers, they just give them more hours - When market gets bad they enter to unemployment risk statistics - When economy gets better ppl start looking for jobs again - Recession ended in June 2009 but the unemployment rate continued to rise, remained above 9.0% until Oct. 2011

Structural Unemployment

- Due to a fundamental shift in the job market - Technological progress, outsourcing - Changes in the demand for certain skills -Can you think of some jobs that no longer exist? - tool booth operator Can you think of jobs that may not exist in the future? S ~ skills

Duration

- Duration refers to how long a business cycle lasts. We measure the length of a business cycle from the peak to the next peak. - No two business page 350 cycles last the same amount of time, which makes preparing for and dealing with them more difficult. - Similarly, we don't know how long the phases of any given cycle will last. - For example, the recovery after the recession ending in 1982 lasted almost eight years. The recovery after the 1980 recession lasted just a little over one year.

Dynamic, growing economies are evolving economies. If we want an economy that adapts to changes in consumer demands and technology, we must accept some unemployment,

- Dynamic, growing economies are evolving economies. If we want an economy that adapts to changes in consumer demands and technology, we must accept some unemployment, at least temporarily, as a byproduct of growth. - This dilemma, when the introduction of new products and technologies leads to the end of other industries and jobs, is called creative destruction.

Frictional Unemployment

- Even when jobs are available and qualified employees live nearby, it takes time for workers and employers to find one another and agree to terms. - Frictional unemployment is caused by delays in matching available jobs and workers. - Frictional unemployment is another type of natural unemployment. - No matter how healthy the economy may be, there is always some frictional unemployment.

Government regulations on hiring and firing also contribute to

- Government regulations on hiring and firing also contribute to frictional unemployment. - Regulations on hiring include restrictions on who can and must be interviewed, paperwork that employers must complete for new hires, page 289 and additional tax documents that must be filed for employees. - Regulations on firing include mandatory severance pay, written justification, and government fines.

Long run

- However, in the short run, only some parts of the economy can adjust. - The aggregate demand-aggregate supply model we examine in the second part of this chapter considers both time frames. - Business cycles, however, illustrate changes only in the short run.

Americans Don't Appear to Want Farm Work

- In September 2010, Garance Burke of the Associated Press wrote an article about the frustration of U.S. farmers trying to find Americans to harvest fruit and vegetables. - Even though the unemployment rate at the time was very high, Americans didn't apply for available farm jobs. - Burke notes that the few Americans who do take such jobs usually don't stay in the fields for long. The AP analysis showed that from January to June 2010, California farmers advertised 1,160 farm-worker jobs available to U.S. citizens and legal residents; only 36 were hired.

The depth

- The depth of a business cycle indicates its severity. How low the trough goes, and how high the peak might be, are unique to each cycle. - No one knows beforehand whether the next recession will be like the Great Recession or whether it will be like the recession of 1991, which was so minor that most people didn't even know about it until after it was over.

The long run in macroeconomics is a period of time sufficient for all parts of the economy to adjust to economic conditions

- The long run in macroeconomics is a period of time sufficient for all parts of the economy to adjust to economic conditions. - The long run doesn't arrive after a set period of time; it arrives when all prices have adjusted. - However, in the short run, only some parts of the economy can adjust. - The aggregate demand-aggregate supply model we examine in the second part of this chapter considers both time frames. - Business cycles, however, illustrate changes only in the short run.

The Depth and Duration of the Great Recession

- The official duration of the Great Recession was 19 months (December 2007 to June 2009), making it the longest recession since World War II. - But even this duration understates the full amount of time that it affected the U.S. economy. - For several years after the recession was deemed to be over, unemployment remained high and real GDP grew slowly. - One way to grasp the depth and duration of the Great - Recession is to compare it with the other recessions that have occurred since World War II.

Transfer payments

- Transfer payments that the government makes to households, such as welfare payments or unemployment insurance, are not direct purchases of new goods and services. - These transfer payments merely move income from one group to another. - For instance, Social Security payments made to your grandparents are movements of money from those who are working to those who are retired.

Problems of Inflation

- Uncertainty about price changes creates problems for firms and workers • Long-term wage contracts difficult to agree upon - COLAs- cost of living adjustments • Consumers may change buying patterns due to uncertainty • Expected vs. Unexpected inflation - Menu costs- the act of physically changing prices is expensive • ex. Restaurants have to print new menus, grocery stores have to print new price labels, etc. - Some firms can respond to price changes more quickly than others - Ex. Gas station prices change every day

Structural Unemployment

- Unemployment is difficult on households, and resources are wasted when idle workers sit on the sidelines. - However, a dynamic, growing economy is an economy that adapts and changes. - No one would consider it an improvement page 285 if we returned to the economy of early America, where 90% of Americans toiled in manual farm work and earned wages that just barely provided the basic necessities of life.

government spending (G)

- government spending (G), which includes spending by all levels of government on final goods and services. For example, every government employee receives a salary, which is considered a part of GDP. - Similarly, governments spend money by purchasing buildings, equipment, and supplies from private-sector firms. - Governments also make expenditures on public-works projects, including national defense, highway construction, schools, and post offices.

recessions, which are short-term economic downturns that typically last about 6 to 18 months, and healthy macroeconomic conditions

- recessions, which are short-term economic downturns that typically last about 6 to 18 months, and healthy macroeconomic conditions. - Notice that structural and frictional unemployment are always present. - However, during healthy economic periods, cyclical unemployment falls toward zero.

Unemployment insurance

--Unemployment insurance, also known as federal jobless benefits, is a government program that reduces the hardship of joblessness by guaranteeing that unemployed workers receive a percentage of their former income while they're unemployed. --Governments provide unemployment insurance to workers for many reasons. --The benefit cushions the economic consequences of being laid off, and it provides workers time to search for new employment. --In addition, unemployment insurance can help contain macroeconomic problems before they spread to other industries.

Formulas

--Unemployment rate= # unemployed/ x 100 # in labor force --Labor Force Participation Rate (LFPR)= # in labor force/ x 100 # in adult population - economy is getting better - falls = people are unhappy about economy ppl are less willing to work, bc there not producing output -- Labor Force Participation Rate measures people's willingness to work

The Accuracy of the CPI

--computing the CPI isn't simple. Yet for economists to understand what's happening in the macro economy, it's that the CPI be accurate. For example, sometimes a rapid fall in inflation signals a recession, as it did in 1982 and 2008. Like real GDP and the unemployment rate, inflation is an indicator of national economic conditions. --How accurate is the CPI? If consumers always bought the same goods from the same suppliers, it would be extremely accurate, and economists would be able to compare the changes in price from one year to the next very easily. But this isn't a realistic scenario. Consumers buy different goods from different stores at different locations, and the quality of goods changes over time.

Looking at GDP as Different Types of Expenditures

--in this section, we look more closely at different categories of goods and services included in GDP. The U.S. Bureau of Economic Analysis (BEA) is the U.S. government agency that tallies GDP data in a process known as national income accounting.* The BEA breaks GDP into four major categories: page 314 consumption (C), investment (I), government purchases (G), and net exports (NX). - GDP = C + I + G + NX

-Gross domestic product (GDP)

-Gross domestic product (GDP) is the market value of all final goods and services produced within a nation during a specific time period. - GDP is the primary measure used to gauge a nation's output. But it also measures a nation's income. - GDP is the sum of the value of all the output from coffee shops, doctor's offices, software firms, fast-food restaurants, and all the other firms that produce goods and services within a nation's borders. - The sale of this output becomes income to the firms' owners and the resource suppliers. - This dual function of GDP is part of the reason we focus on GDP as a barometer of the economy. - When GDP goes up, national output and income are both higher.

Inflation

. Inflation is the growth in the overall level of prices in an economy. There are two ways to view inflation. First, inflation occurs when there is a sustained increase in the general price level. - At the macroeconomic level, we are concerned with all goods and services produced. As a result, we can no longer simply focus on the price of one good. Rather, we need to consider the prices of all things bought and sold. - The fact that the price of gasoline goes up doesn't mean there is inflation. - It could be that the price of video games falls to offset the rise in gas prices. Inflation happens only when prices as a whole increase

Leisure Time

= Since GDP only counts market activity, it fails to capture how long laborers work to produce goods and services. For most developed nations, according to the Organization for Economic Cooperation and -=Development (OECD), the average workweek is slightly over 35 hours. However, there are wide variations in how hard laborers work. At the high end, laborers in -South Korea average 46 hours per week. -In contrast, laborers in the Netherlands average fewer than 28 hours per week. - This means that comparisons of GDP across countries don't account for the extra time available to workers in countries with substantially fewer hours worked. - For example, in the United States page 322 the average workweek is 36 hours. - A comparison with Japan, which also averages 36 hours per workweek, would be valid; but a comparison of GDP in the United States with that of Sweden (31-hour workweek) or Greece (41-hour workweek) would be misleading.

What Is a Business Cycle, and Why Are Business Cycles So Difficult to Predict?

A recession is a short-term economic downturn that typically lasts about 6 to 18 months. Even the mere threat of recession strikes fear into people's hearts, because income levels fall and many individuals lose their jobs or cannot find work during recessions.

Not in the labor force

Adults who could be in the labor force but choose not to participate Homemakers, retired, full-time students Discouraged workers- people who have given up looking for work because they believe that the job market is so bad

How Is GDP Computed?

As we learned in Chapter 10, output is measured by calculating gross domestic product (GDP). Recall that GDP is the market value of all final goods and services produced within a country during a specific period. In this section, we break down the components of GDP in order to give you a deeper understanding of what is counted in GDP and what is not.

Net Exports (NX)

Because we use spending to measure GDP, it's important that we include spending only on goods produced in the country. Therefore, spending by people in other countries who buy things made in the United States is counted in GDP.

Consumption

Consumption (C) is the purchase of final goods and services by households, with the exception of new housing. Most people spend a large majority of their income on consumption goods and services. Consumption goods include everything from groceries to your cellphone plan.

Consumption goods can be divided into two categories: non-durable and durable

Consumption goods can be divided into two categories: non-durable and durable. Non-durable consumption goods are consumed over a short period, and durable consumption goods are consumed over a long period. This distinction is important when the economy swings back and forth between good times and bad times. Sales of durable goods—for example, automobiles, appliances, and computers—are subject to significant cyclical fluctuations that correlate with the health of the economy.

Unemployment Rate 2004-2014

Cyclical unemployment (seasonally adjusted) Ages 16 and older

Deflation

Deflation occurs when overall prices fall; it is negative inflation. Notice, too, that periods of recessions—the blue-shaded vertical bars in Figure 11.8—often (but not always) coincide with falling inflation rates. See, for example, 1982, 1991, and 2009.

Dispersion

Dispersion refers to the segments of the economy that are affected by the recession. - Firms in industries that sell necessities perform more consistently during the ups and downs of the business cycle. People need food, medicine, and gasoline whether the economy is good or bad, and they tend to hold their levels of consumption of these goods fairly constant regardless of the state of the economy. - They might buy more generic products in particularly bad times, but they're still buying food. - Other industries are more prone to harm from economic downturns. - They also are the industries that do very well during recoveries. - For example, companies that sell high-end electronics, designer clothing, and automobiles are more subject to the fluctuations in the business cycle. - People will put off buying a new car or a pair of expensive Lucky Jeans when times are tight. When the economy is roaring along, though, people are more willing to purchase these products.

Each month, the BLS conducts surveys by sending employees into stores in 38 different geographic locations to

Each month, the BLS conducts surveys by sending employees into stores in 38 different geographic locations to gather and input price information on over 8,000 goods. The BLS estimates prices on everything from apples in Chicago, Illinois, to electricity in Scranton, Pennsylvania, to gasoline in San Diego, California.

Economic growth

Economic growth is measured as the percentage change in real per capita GDP from one period to another. - Notice that this measure starts with GDP data but then adjusts for both population growth and price increases. - Given this definition, you should view Figure 10.2 as a picture of economic growth in the United States.

Output

Economists measure the total output of an economy as a gauge of its overall health. An economy that produces a large amount of valuable output is a healthy economy. If output falls for a certain period, there's something wrong in the economy.

Financial Incentive

Entrepreneurs are willing to risk their own money and reputation to follow an idea to completion and get it to market. - They are instrumental in the market economy because they take the risks to get a business started. Why do people start businesses? Some people think they have a better idea for doing something and want to try it out. - Many people like the idea of being their own boss. Some aspiring business owners see a need going unfulfilled, while others want to provide a service to help humanity. - Regardless of the reason, businesses begin because someone wants to make money (as in the case of for-profit businesses) or do something for others (as in the case of non-profit businesses). Starting a business takes a lot of work and a fair amount of risk. Obviously, this isn't for everyone. - Once the business is under way, there's a lot to do to make sure that it stays in business: employees have to be paid, inputs need to be acquired, customers must be courted, and the company website must be maintained. All these things need to be done before the entrepreneur pays herself. - After paying all the bills, the owner can keep the rest of the money that the company brings in. This is the entrepreneur's chief financial incentive.Incentives The first role that profits play in an economy, then, is as a financial incentive to start and maintain a business. Entrepreneurs don't necessarily have to sell a new or improved product. - Sometimes, they just organize things better than others do. - For example, Ray Kroc earned billions of dollars as the president of McDonald's. But Kroc didn't start the company. Rather, the McDonald brothers of San Bernardino, California, first opened the hamburger stands. Kroc believed that the brothers' production processes could be used on a large scale. He coordinated with the McDonald brothers and eventually bought them out, becoming the sole owner of McDonald's. Ray Kroc didn't invent the hamburger; he invented a way to make hamburgers of consistent taste and quality in a way that the average family could afford. In addition to making hamburgers, the early McDonald's restaurants made a profit—often, a very large profit. Profits enabled McDonald's to expand its operations to the point where the company now has over 34,000 restaurants in 116 countries. Those profits also made the Kroc family extremely wealthy. Even though Kroc was a very driven individual, it's doubtful that McDonald's would have expanded to the extent that it has without the potential for the entrepreneurs involved in its creation to make money. However, profits do more than just make people rich. They also allocate resources.

Final

Final goods are goods that are sold to final users. The sale of the cell phone is included as part of GDP, but the value of the intermediate goods is not.

Growth Rates

For many macroeconomic applications, it's useful to calculate growth rates. For example, let's say you read that the GDP in Mexico in 2010 was about $1 trillion. You might consider this information to be troubling for the future of the Mexican economy, since $1 trillion is very small compared to U.S. GDP. But maybe you also read that Mexico's GDP grew by 18% in 2010 (it did!). In that case, you'll probably get a different, and more positive, impression.

Notice that imports enter the GDP calculations as a negative value:

GDP = C + I + G + (exports - imports)

Including Only Production from a Particular Period

GDP only counts goods and services that are produced during a given period. Goods or services produced in earlier years don't count in a current year's GDP. For instance, when a new car is produced, it adds to GDP in the year it is sold. However, a used car that is resold doesn't count in current GDP since it was already counted in GDP for the year when it was produced and sold the first time.

Great Recession because of its length and depth. It lasted for 19 months

Great Recession because of its length and depth. It lasted for 19 months, and real GDP fell by almost 9% in the last three months of 2008. In addition, the recovery from the Great Recession has been very slow.

How do employment, growth, and inflation interact in terms of economic stability?

How do employment, growth, and inflation interact in terms of economic stability? - We want people to be employed. If there aren't enough jobs to go around, we aren't using our resources very well and our economy is less productive than it could be. - When we aren't productive, economic growth will slow down. GDP per person may even stagnate, and quality of life will decrease. - A government policy to help growth also usually helps employment, and policies to promote employment often stimulate growth. - The problem is inflation. - We want inflation to be low so that prices aren't rising too quickly and so that purchasing power stays strong.

Allocating Resources

How to distribute limited resources - Profits allocate the scarce resources that companies need to produce the goods that consumers are willing to pay for. - Consider gold, which is used in a surprising number of products. Gold is an excellent conductor of electricity, helping to speed information from one location to another.

The Great Recession

In December 2007, the U.S. economy entered the downturn we now call the Great Recession. Some analysts named it the Great Recession because the downturn was longer and deeper than typical recessions (although not nearly as long or as deep as the Great Depression). In addition, the Great Recession was accompanied by significant problems in the financial markets—another similarity with the Great Depression. Finally, the name stuck when the effects of the recession refused to subside for several years after the recession was technically over. Let's look more closely at just how serious the contraction was.

New Products and Locations

In a dynamic, growing economy, new goods are introduced and new buying options become available. For example, tablet computers, iTunes downloads, and even cell phones weren't in the typical consumer's basket 20 years ago. In addition, Amazon.com and eBay weren't options for consumers to make purchases before the 1990s.

The Cause of Inflation

Inflation poses a problem. If purchasing power declines as prices rise, individuals have a more difficult time satisfying their needs and wants with their current income. Since inflation presents this serious macroeconomic cost, you might assume that there's significant debate about the causes of inflation. But the answer is much simpler. Economist Milton Friedman famously said, "Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output." What he meant is that inflation is consistently caused by increases in a nation's money supply relative to the quantity of real goods and services in the economy.

Inflation in the United States

Inflation rate- percentage change in overall price level from one period to the next, measured monthly

Non-Market Goods

Many goods and services are produced but not sold. Those goods and services aren't counted in GDP data even though they create value for society. For page 320 instance, washing your own dishes, raking leaves in your yard, or just changing a light bulb are services, but they aren't counted in GDP. When the non-market segment of an economy is large, there can be a dramatic undercounting of the annual output being produced. For example, Haiti's GDP is very low. In 2013, its GDP was $8.5 billion. This is one-third the output of Vermont. However, Haiti's recorded GDP doesn't mean that there was less production. In Haiti, if you don't work, you may not have enough food to survive. Many households live off the land and produce goods for their own consumption. This output doesn't get counted in GDP. As a result, Haiti's GDP is understated.

Defining Unemployment

Measured by the Bureau of Labor Statistics, measured monthly Some Important Terms: Working age/ adult population- 16 plus Civilian Labor Force- # of people 16 plus who are not in the armed forces and who are employed or a seeking a job Note: employed includes part-time workers who wish they had full-time jobs Unemployment rate- percentage of the civilian labor force that is looking for a job but can't find one In order to be classified as unemployed, a person has to be doing what? Unemployment Rate in March 2015- 5.5%

Measuring Economic Growth

Measuring Economic Growth. We also use GDP data to measure economic growth. You can think of economic growth as changes in living standards over time. When economies grow, living standards rise. This result is evident in GDP data.

Measuring Living Standards

Measuring Living Standards. - Imagine two very different nations. - In the first nation, people work long hours in physically taxing labor, yet their pay enables them to purchase only life's barest necessities—meager amounts of food, clothing, and shelter. - In this nation, very few individuals can afford a high school education or health care from a trained physician. - In the second nation, virtually no one starves, people tend to work in an air-conditioned environment, almost everyone graduates from high school, and many receive college degrees.

Production Equals Income

Nations and individuals that produce large amounts of highly valued output are relatively wealthy. Nations and individuals that don't produce much highly valued output are relatively poor. This is no coincidence. National output and national income are very closely linked—so closely, in fact, that they're essentially interchangeable.

Counting Market Values

Nations produce a wide variety of goods and services, which are measured in various units. Computation of GDP literally requires the addition of apples and oranges, as well as every other final good and service produced in a nation. How can we add everything from cars to corn to haircuts to gasoline to prescription drugs in a way that makes sense? Certainly, we can't just add quantities. For example, in 2013 the United States produced about 11 million motor vehicles and about 13.9 billion bushels of corn.

Nominal GDP is GDP

Nominal GDP is GDP measured in current prices and not adjusted for inflation.

Note that this is a growth rate, computed just like the growth rate of GDP we computed earlier

Note that this is a growth rate, computed just like the growth rate of GDP we computed earlier. Assume the CPI rises from 100 to 125 in one year. The inflation for that year would be 25%, computed as:

Measuring Inflation Rates

Once the CPI is computed, economists use it to measure the inflation rate. The inflation rate (i) is calculated as the percentage change in the price level (P). Using the CPI as the price level, the inflation rate from period 1 to period 2 is:

Changes in Quality

Over time, the quality of goods generally increases. For example, the movies that you watch at home are probably on Blu-ray Discs. You can still get DVDs, but Blu-ray Discs are a higher quality and thus more expensive: the price of movies has risen from about $15 to about $25.

What Are the Roles of Profits?

Profits play three very important roles in the economy. First, they provide financial incentives. - Second, profits make sure that resources are being directed to the businesses that are providing things customers value most. - Third, profits determine which companies stay in business and which ones do not. - It is essentially survival of the fittest. If you operate a well-run company providing valuable products, you will survive. If not, your business will fail.

Real GDP is

Real GDP is GDP adjusted for changes in prices. page 294 This is a very important distinction. Anytime we evaluate GDP figures over time, we must use real GDP. Otherwise, we aren't comparing data on an equal footing.

Services

Services are outputs that provide benefits without the production of a tangible product. Consider a service like a visit to your doctor for a physical. The doctor examines you and offers some medical advice, but you leave with no tangible output. Other services include entertainment, financial, transportation, education, and technology services.

Quality of the Environment

Since GDP only measures the final amount of goods and services produced in a given period, it cannot distinguish how those goods and services are produced. Imagine two economies, both with the same real GDP per capita. One economy relies on clean energy for its production, and the other has lax environmental standards. Citizens in both countries enjoy the same measured standard of living,

Stagflation

Stagflation occurs when inflation rises during times of recession. (The term is a combination of the words "stagnation" and "inflation.") Stagflation occurred during the recession of the mid-1970s. This unexpected outcome caused economists to re-evaluate the deficit spending suggestions of Keynesian economists (for more on Keynesian economics, see Appendix 10A). The result was the supply-side revolution of the 1980s,

The intuition is straightforward

The intuition is straightforward: when the money supply in an economy grows relative to the quantity of goods and services, then it takes more money to buy any particular good or service. - Money then becomes less valuable relative to goods and services—and this relationship constitutes inflation. - The principle holds true regardless of the type of money used. - For example, when page 298 Spanish conquistadors brought gold back to Europe from Latin America in the sixteenth century, the supply of money (gold) in Europe increased, and the result was inflation.

the long run

The long run in macroeconomics is a period of time sufficient for all parts of the economy to adjust to economic conditions. The long run doesn't arrive after a set period of time; it arrives when all prices have adjusted.

An economic expansion

The peaks and troughs divide the business cycle into two phases: expansions and contractions. An economic expansion occurs from the bottom of a trough to the next peak, when the economy is growing.

The price level (P)

The price level (P) is a measure of the average prices of goods and services throughout an economy.

The raw GDP data, based on market values, is computed on the

The raw GDP data, based on market values, is computed on the basis of the prices of goods and services current at the time the GDP data is produced. Economists refer to these prices as the current prices. The GDP calculated from current prices is called nominal GDP.

Underground Economy

The underground economy (also known as the shadow economy) encompasses transactions that are not reported to the government and therefore are not taxed. Usually, these transactions are settled in cash. Some of these page 321 transactions are legal, such as when contractors build additions to homes, landscapers mow lawns, or teenagers babysit for their neighbors.

The word "domestic" in the phrase

The word "domestic" in the phrase "gross domestic product" is important. GDP includes only goods and services produced domestically, or within the physical borders of a nation. The output of foreign-owned firms that is produced inside the United States is included in U.S. GDP, but the output of U.S. firms that is produced overseas is included in the GDP of the overseas nation. For example, Nike is a U.S. firm that produces shoes in Thailand. Thus, all the Nike shoes produced in Thailand count as GDP for Thailand.

Sleuthing for Prices

Tracking the prices in the CPI requires a great deal of effort and precision. In September 2007, Nancy Luna of the Orange County Register followed one of the 350 employees of the Bureau of Labor Statistics who is charged with finding current prices of the goods included in the CPI. The BLS employee, Frank Dubich, traveled 800 miles per month tracking prices.

Transfer Payment

Transfer payments that the government makes to households, such as welfare payments or unemployment insurance, are not direct purchases of new goods and services. These transfer payments merely move income from one group to another. For instance, Social Security payments made to your grandparents are movements of money from those who are working to those who are retired. This isn't production; it's just moving money around.

Unemployment occurs when a worker who is not currently employed is searching for a job without success.

Unemployment occurs when a worker who is not currently employed is searching for a job without success.

What Are Some Shortcomings of GDP Data?

We now have a picture of GDP, but as the misconception at the beginning of the chapter noted, there are some challenges with relying on GDP data as a measure of a nation's well-being. In this section, we highlight four shortcomings that limit the effectiveness of GDP as a measure of the health of an economy. At the end of this section, we consider why economists continue to rely on GDP.

When the Times-Picayune became primarily an online newspaper (with three printed editions per week), the company laid off over 200 employees, including almost half of its reporters

When the Times-Picayune became primarily an online newspaper (with three printed editions per week), the company laid off over 200 employees, including almost half of its reporters. At that point, the laid-off Times-Picayune employees found themselves the victims of structural unemployment: they lost their jobs as a result of changes in the industrial make-up (structure) of the economy

Substitution

When the price of a good rises, consumers instinctively look to substitute less expensive alternatives. This substitution makes CPI calculations difficult because the typical consumer basket changes. If you go to the store looking for potato chips but find that pretzels are on sale, you're substituting away from a more expensive good if you buy the pretzels instead of the potato chips. This substitution alters the weights of all the goods in the typical consumption basket. If the CPI didn't acknowledge the substitution of less-expensive items, it would exaggerate the effects of the price increase, leading to upward bias (that is, an estimate of inflation that is too high)

How Is Inflation Measured?

You might notice inflation on a routine shopping trip or especially when you see a reference to prices in an old book or movie. For example, in the 1960 movie Psycho, a hotel room for one night was priced at just $10. Recall that inflation is defined as the growth in the overall level of prices in an economy—so inflation occurs when prices rise throughout the economy. When overall prices rise, our budget is affected; we can buy less with our income. When overall prices fall, our income goes farther and we can buy more goods and services.

Real GDP: Adjusting GDP for Price Changes

ccording to the U.S. Bureau of Economic Analysis, in 2004 the nation's economy produced a GDP of $12.3 trillion. Just over a decade later, in 2014, it produced over $17.4 trillion. That's a 41.9% increase in just ten years. Is that really possible? Think about this question in long-run historical terms.

consumer price index (CPI)

consumer price index (CPI) is a measure of the price level based on the consumption patterns of a typical consumer. When you read or hear about inflation in the media, the report almost certainly focuses on this measure. The CPI is essentially the price of a typical "basket" of goods purchased by a representative consumer in the United States. Think about this situation as if you were going to the planet's hugest Super Walmart.

cyclical unemployment

cyclical unemployment occurs during economic downturns. This type of unemployment generates the greatest concern among economists and policymakers. It is the most serious type of unemployment because it means that jobs are not available for many people who want to work.

Exports

exports as we calculate GDP because they're produced in the United States but bought by people in other countries. However, people in the United States buy many things made in other countries.

Government Spending (G)

government spending (G), which includes spending by all levels of government on final goods and services. For example, every government employee receives a salary, which is considered a part of GDP. Similarly, governments spend money by purchasing buildings, equipment, a Governments also make expenditures on public-works projects, including national defense, highway construction, schools, and post offices.nd supplies from private-sector firms.

hyperinflation

hyperinflation, an extremely high page 331 rate of inflation that completely stymies economic activity. In Zimbabwe, for example, average citizens could barely afford necessities like bread and eggs.

Imports

imports are produced elsewhere but are used domestically within the United States. Because our goal is to measure domestic production accurately, GDP includes only

Investement

investment (I) refers to private spending on the tools, physical plant, and equipment used to produce future output. Investment can be something as simple as the purchase of a shovel, a tractor, or a personal computer to help a small business produce goods and services for its customers. But investment also includes more complex endeavors such as the construction of large factories. For example, when Horizon Wind builds a new wind farm in Ohio, it is making an investment.

net exports (NX)

net exports (NX) = exports - imports

net exports (NX), w

net exports (NX), which are exports minus imports of final goods and services. We can write the calculation of net exports in equation form as: net exports (NX) = exports - imports

nominal data

nominal data—that is, data not adjusted for price changes. Column 2 shows GDP adjusted for changes in price (what we call being adjusted for inflation). - page 295 Notice the difference. Both columns are growing through time, but the non-adjusted data begins at a much lower level because it specifies the - GDP of that particular year as reported in that year. - In contrast, all the data in column 2 are adjusted to remove the impact of price changes. - Two issues are apparent in the non-adjusted column: output is rising and prices are rising, which skews our evaluation of the economy when we want to compare one year to another.

To earn a profit, a firm must produce goods or services that consumers are willing to

pay for. - These goods and services are known as its output. - By selling its output, the firm generates revenue. It must also control its costs. - To do so, the firm must use resources efficiently. Those resources, or inputs, are the things a firm needs to make its output. - There are four categories of inputs, known as the factors of production: labor, land, capital, and entrepreneurship.

per capita GDP

per capita GDP, or GDP per page 293 person (column 4 of Table 10.2). - That is, we divide the country's total GDP by its population. - When using this measure, the average Canadian appears to be much better off than the average Indian. - GDP per person shows that there was almost $51,000 worth of GDP for every person in Canada in 2013, while there was less than $1,500 worth of GDP for every person in India in 2013.

Will the Company Stay in Business?

profits determine winners and losers. To stay in business, a company needs a stream of income in order to pay its operating expenses. Workers rarely work for free, and the electric company won't keep the lights on just because the owner is a nice guy. Profits signal that a company is doing something right: it is efficiently providing a product that the public values. As much as people like to bash Walmart, the fact that the company is profitable indicates that it's providing things the general public values.

purchasing power

purchasing power, or how much your money can buy. - If the dollars in your pocket can buy a lot, purchasing power is high. - Your purchasing power increases when prices page 297 are lower. - Purchasing power falls when prices rise. - Thus, when inflation rises, your purchasing power falls.

The BLS releases CPI estimates every month; however, inflation rates are officially measured over the course of a year,

showing how much the price level grows in a 12-month period. Over time, we see significant changes in the overall price level. The CPI was just 30 in 1961 and rose to 233 by 2013. This means that the typical basket of consumer goods rose in price nearly eightfold between 1961 and 2013.

unemployment rate

unemployment rate (u) is the percentage of the labor force that is unemployed. Figure 10.1 plots the U.S. unemployment rate from 1960 to 2014. This graphic is one way of quickly measuring national economic frustration. As the unemployment rate climbs, people are more likely to be disappointed in their pursuit of a job.

Going to the Movies (market basket ex.)

• 2 Movie tickets-$12 ea.= $24.00 • 1 Popcorn- $4.00 • 2 Cokes- $2.50 ea.= $5.00 • Market Basket Total Price= $33.00 • 2 Movie tickets-$14 ea.= $28.00 • 1 Popcorn- $5.00 • 2 Cokes- $2.50 ea.= $5.00 • Market Basket Total Price= $38.00

Computing the CPI

• BLS surveys - Price information on over 80,000 goods/services each month - 38 geographic locations (urban areas) calculate an average for the nation - Also must estimate how each good impacts a typical consumer budget • The goods and services included in the market basket are fixed over time. - Some adjustment for technological changes are made.

Prices Don't All Move Together

• Clearly, most prices rise over time (see the previous figure) • Ex. Travel, Education, Healthcare • However, some prices fall over time - Ex. Consumer electronics • Usually due to a result of great technological advancements • Flat panel TV 1997: $7,000, TV 2012: $500 • Some prices- food and energy- change rapidly. • Core CPI (Core Inflation)- removes food and energy from the index, makes it less volatile

Inflation

• Inflation - Rise in the general (overall) price level - Measured as a growth rate in the average level of prices - Deflation: opposite of inflation . . . price level falls - Misconception: the dollar value decreases when inflation occurs, but this is a result of inflation, not what inflation actually is. • Ex. You have $10. • How many Starbucks latte's can you buy if they're $5 each? • How many could you buy if the price increased to $7 each? - Result of the higher price (inflation) is the decrease in the value of the dollar.

Concerns about CPI Accuracy

• Most common concern is that CPI overstates true inflation (upward bias)—three possible reasons: - Substitution- people look to buy less expensive products (they find substitutes) - Changes in quality - New products, technology updates • Correction - The BLS formula accounts for these changes.

Hyperinflation

• Rapid, out of control inflation • Zimbabwe- 2008 -79.6 billion%- Nov. 2008

What causes inflation?

• Two types: -Demand-pull- people spending beyond economy's capacity to produce • Too much spending chasing too little output, people willing to pay more so prices rise • Also caused by growth in the money supply -Cost-push- higher production costs lead to higher prices • Rising prod. costs push prices upward as firms raise prices to cover their increased costs • Ex. Increase in crude oil prices

Inflation's Effects

• Who is helped? • Borrowers/debtors- dollars paid back in the future are worth less - Fisher equation: real int. rate= nominal int. rate - inflation rate • Firms- get to sell goods for a higher price • Government- biggest debtor • Who is hurt? - People on fixed incomes (retirees) - Lenders- dollars receiving in payments are worth less - Savers- dollars being saved lose purchasing power, even when earning interest in an account at the bank

•Labor generally consists of workers and the skills those workers bring to a job.

•Labor generally consists of workers and the skills those workers bring to a job. •Land consists of the geographic location and natural resources used in production. •Capital consists of all the man-made resources that workers use to create the final product. This category includes machinery, tools, and other man-made goods. page •Entrepreneurs are the people who conceive and start a business. Entrepreneurship is a form of labor. - Let's consider McDonald's as an example. The labor input includes managers, cashiers, cooks, and janitorial staff. The land input includes the land on which the McDonald's restaurant sits. The capital input includes the building itself, the pavement for the parking lot, the equipment used to make fast food, the signs, and all the hamburger patties, buns, fries, ketchup, and other foodstuffs. The entrepreneur is the person who decides to buy a McDonald's franchise and open the restaurant.