Economic Indicators

Define GDP

• The sum dollar value of all the final goods and services produced within a countries borders within a given year.

Based on its definition, what economic activities are not

counted toward GDP?• Purchase of stock or

bonds (commission earned is counted)

• Public transfer payments (welfare, Medicare)

• Private transfer payments (Aunt gives you $2,000 for graduation)

• Sale of used items

• Illegal goods and non-market transactions (no paper trail)

• Goods purchased outside of our country, even if it is an American company

• Intermediate Goods

What is the difference between a final good and an intermediate

good?

• An intermediate good is a product purchased for the use of producing a final good. When Ford buys Firestone tires in the production of a new car that is an intermediate good, however, when you got to Discount Tire 5 years later and buy tires to replace your worn out tires, then those tries are the final good.

What is the equation for GDP?

• C = consumption – the spending by the consumer sector

• I = investment – spending by the business sector

• G = government – government spending on goods and services (gov. spending on welfare and Medicare is not counted)

• Xn = net exports – figured by taking exports - imports

Define the business cycle and define its phases.

• The cycle is a period of macroeconomic expansion followed by a period of macroeconomic contraction. The health of an economy is directly related to the level of spending. If spending is high and growing then the economy is doing well and vice versa.

Phases• Peak: the point where GDP stops

going up• Trough: the turnaround point where

GDP stops falling• Expansion: a period of recovery from

a recession (spending is increasing)• Recession: a period of decline where

spending is falling and unemployment is rising.

Business Cycle

Expansion / Prosperity

Peak

Recession / Contraction

Trough

Expansion

Peak

Recession / Contraction

Trough

Causes of the business cycle?Four main economic variables:

1)Business Investment2)Interest Rates and Credit3)Consumer influences4)External Shocks

• Business Investment – when the economy is doing well, businesses want to take advantage of this to increase their profits so they will start spending money on new plants, technology, and machinery. All of this investment spending creates additional output and jobs further helping the economy. At some point businesses may decide they have expanded enough or the demand for their product is about to fall so they cut back on their investment spending, as a result total spending falls and so does GDP.

Business Investment

Interest Rates and Credit

• Interest rates is the price for credit. If interest rate rises, consumers are less likely to buy those new cars, homes, and furniture.

• Businesses, too, look to interest rates in deciding whether or not to purchases new equipment, expand their facilities, or make any other large investments that must be financed.

Consumer Factors• Indebtedness: High debt slows down

consumer spending and low debt encourages consumer spending.

• Taxes: Low personal taxes frees up money for consumers to spend and high taxes reduce our ability to spend money.

• Wealth and Investments: When our investments are performing well, or our wealth has grown to a high level, consumers are excited to spend money.

Consumer spending cont.

• Consumer expectations: If consumers are optimistic about their current situation and their future they will spend and spend. If they are nervous about their future they will save and save.

• External Shocks – terrorism, sudden and massive increases in energy costs, hurricanes and other natural disasters

What is the definition of unemployment?

• The percentage of the labor force that is unemployed. To figure it out you take the number of people unemployed and divide it by the number of people in the labor force.

For someone to be in the labor force what has to be true?

• For someone to be in the labor force they must be able to work and seeking work.

• The following groups are either not looking for work or able to work and therefore are not in the labor force and are not considered unemployed: homemakers, full time students, people in institutions, children under the legal working age, retired people, profoundly disabled, and bums

Discuss two criticisms of how the U.S. figures out its unemployment

rate.• Bums are not

considered unemployed because they are not seeking work, so our unemployment rate looks smaller than it really is.

• People are forced to work part-time are considered to be full-time workers which again gives the economy more credit then it deserves.

Types of unemployment and two examples.

• Frictional Unemployment – unemployment due to people being in between jobs. Unemployment by choice. For example; you hate your boss so you quit to find a better one, or your spouse is moving across country to take a job so you have to quit yours to follow him/her, or being unemployed while you interview for your first career job after college.

• Seasonal Unemployment – this type of unemployment occurs when industries slow or shut down for a season or make seasonal shifts in their production schedules. Example: Dillard's hires you for the Christmas season then releases you when it is over, or a construction worker in Wisconsin during the winter.

• Technological Unemployment – being replaced by a machine that can do your job.

• Structural Unemployment – occurs when workers’ skills do not match the jobs that are available. No one demands your skills. Example: typewriter repair man loses his job because people are not buying typewriters anymore, or do to globalization factory workers are losing their jobs because those jobs are leaving the country and they are currently not qualified for the jobs that are being created in the U.S.

• Cyclical Unemployment – this is the one we do not want. This type of unemployment is the result of a poorly performing economy. There simply is not enough spending in the economy and therefore business sales are hurting and people are getting laid off. (result of a recession)

What positives can we derive from frictional and structural unemployment?

• Frictional Unemployment is the result of economic freedom. The fact that you have the freedom to quit and chase your dreams in another state or in another career is a positive thing. If you don’t want frictional unemployment simply do not give your citizens the freedom to quit their jobs.

• Structural unemployment represents progress and development. What were we suppose to do, not let the personal computer be developed because the people in the typewriter industry may lose their jobs. The economy has jobs available in this scenario; it is up to the people to make themselves qualified to fill the positions.

What is the concept of full employment?

• We consider ourselves to be at full employment when our cyclical unemployment rate is at zero. Right now we consider 5% unemployment to be full employment. You will never have 0% unemployment because you are always going to have some frictional, seasonal, or structural unemployment in the country.

What is inflation?

• It means that average price level in the entire country is rising. In other words, prices in the aggregate are rising, although some particular prices may be falling.

What is demand pull inflation?

• Inflation that occurs when the demand for goods and services exceeds existing supplies or exceeds the ability to produce enough to satisfy the demand. The heavy demand drives up prices across the board.

What is cost push inflation?

• Inflation that occurs when producers raise their prices in order to meet increased business costs, such as materials or energy.

What is the wage-price spiral?• This is the most common example of cost

push inflation.• workers ask for higher wages increase

business costsbusinesses have to raise their prices to cover the increase of costsprice of goods goes upemployees income does not buy as much as it use to so they ask for another raise (process starts all over again)

What effects does unanticipated inflation have on our economy? Why

are stable prices so important?• Inflation erodes the purchasing power

of consumers incomes and business profits.

• People with fixed incomes are hit the hardest, because their incomes are not allowed to increase with prices.

• The money you pay back on bank loans is worth less and less as the years move on, banks are forced to raise their interest rates to make sure they get back the same purchasing power they loaned out.

• Our savings are being eaten up. Every year the money we have in the bank or in investments is buying us less and less each year. We have to make sure that are savings or investments are growing faster than prices.

• If businesses cannot predict what is going to happen to prices, they will refuse to invest money in the future, so business spending falls and we enter into a recession.

Classical Theory of economics• Believes that the economy self-corrects itself

during recessions therefore it is unnecessary for the government to get involved. In fact, they believe government involvement may make things worse.

• They believe that interest rates are the number one influence on whether or not businesses invest money on projects.

• They believe that wages are flexible downward and therefore prices are flexible downward.

Why did Classical Theory work before the Great Depression? Why

didn’t it work during the Great Depression? Why did it start

reemerging in 2006?

• During recessions before the Great Depression the economy did self-correct. Here is why. When our economy entered a recession consumers stopped spending their money and started saving it. Banks would get filled up with money and would want to loan it out as fast as possible, so banks would lower interest rates. Lower interest rates would stimulate business spending.

• In addition, to the lower interest rates, before the Great Depression workers were forced to except lower wages during recessions (they had no bargaining leverage). The lower wage did two important things, it kept people employed and it allowed businesses to lower their prices during recessions because now their costs were lower. The lower prices combined with the fact that people still had jobs lead to a resurgence of consumer spending.

• This plus the increase in business spending due to low interest rates generated enough spending to pull us out of a recession without government involvement.

• This did not work during the Great Depression because of the bank failures and the stock market crash. People were not saving their money in the banks or stock market so even if businesses wanted to spend money they could not get their hands on it. Also despite the lower interest rates business profit expectations were so bad that businesses did not increase their spending.

• In addition, the development of unions did not allow businesses to lower wages. Therefore to cut costs businesses had to fire people, the result was rising unemployment. The rising unemployment lead to a major lack of spending and things simply got worse.

Keynesian Theory of Economics

• Believe that the economy will not fix itself and government policy is necessary to ensure prosperity.

• Believe that business profit expectations (not interest rates) are the main influence on whether or not businesses invest money on projects.

• Believe that wages and therefore prices are not flexible downward, only upward.