Unit 4: Measuring economic performance

Macroeconomics is the study of the large economy as a whole. It is the study of the big picture.• Instead of analyzing one consumer, we analyze everyone. • Instead of one business we study all businesses.

What is Macroeconomics?

Why study the whole economy?• Macro was created to:

1. Measure the health of the whole economy.

2. Guide government policies to fix problems.

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1. Promote Economic Growth2. Keep Prices Stable (Limit Inflation)

3. Limit unemployment

In this unit we will analyze how each of these are measured.

For all countries there are three major economic goals:

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Stats used to measure economic performance:

• 1. Gross domestic product

• 2. productivity

• 3. inflation

• 4. unemployment

Gross Domestic Product

Most important stat used to measure ECONOMC GROWTH!!! 5

GDP

• GROSS DOMESTIC PRODUT (GDP) =

dollar value of all final goods and services produced within a country’s borders in one year.

World GDP Distribution

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2010 Nominal GDP

GDP expenditure approach

• Adds up the value of spending in an economy in one year

*1. Consumer Spending/consumption (C)

Goods and services purchased by consumers (durable and nondurable goods)

*largest category of GDP

2. Investment (I)spending

• When businesses put money back into their own business

Includes spending on:

Capital resources

Construction

Inventory

Equipment, machinery,

factories etc

Capital resources

Construction

• Unsold merchandise

Inventory

3. Government Spending (G)

Any good or service the government

purchases (military, education, roads etc)

Infrastructure:

roads

bridges

4. Net Exports (Xn) spending

Spending on TOTAL exports

Exports vs. Imports

• Exports

items made in the US and sold to another country

• Imports

items made in another country and sold to the US

Imports are counted in

The GDP, but

NEGATIVELY!!

Formula for GDP (expenditure approach)

GDP = C + I + G + XN

For each situation, identify if it is included in GDP the identify the category C, I, G, or Xn

1 You spend $10.00 for movie tickets2 The Government spends $5M Increase in defense spedning 3 Ford builds a new $2M factory4 You buy $20,000 Toyota that was produced in Japan 5 A Canadian purchases a U.S. produced car 6 You spend $10,000 Tuition to attend college7 A Farmer purchases new $100K tractor18

Things excluded in expenditure approach:

1. intermediate goodsItem that goes into

making a final product

2. Transfer payments

• Money is transferred from person or government to another person

• example: social security, welfare, tax refund etc.

3. donations and gifts

4. Financial transactions

Include things like:

Buying and selling of stock

One business buying another

5. used items

6. illegal sales

*Anything in which a record is not kept is NOT counted in the GDP

Example: A man builds a deck on his own house;he does not pay himself to do this

You baby sit your neighbor and arepaid“under the table”

Counted or Not Counted in the GDP????

1. Sam buys an outfit from Plato’s closet, a resale clothing store

2. Sue buys a new outfit from Macy’s

3. Bill gets new brakes installed on his car

4. Ford purchases steel from Germany to build a car

5. France buys computers from the United States

6. Michael buys stock in Disney

Shortcomings of GDP

1. Non-market (production occurs but no $ is exchanged) transactions not counted

2. Does not look at quality

3. Tells nothing about who gets goods

4. Does not account for population

Per Capita GDP

• Looks at the GDP per person

total GDP/population

** Better indication of a country’s standard of living!!!

World GDP Distribution

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2010 Nominal GDP

Topic 2: Interpreting GDP Statistics

GDP measures growth or lack of growth of an

economy

Business Cycle

Calculating GDP over severalyears results in a Business Cycle = ups and downs of the economy

THE BUSINESS CYCLEThe national economy fluctuates resulting in periods of

boom and bust.

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Recession: decline in GDP for 6 months or more

U.S. Business Cycle Blue line NOT trend line;

Above 0% = growth Under 0% = decline

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Predicting Business Cycles

• Economists use Index of Leading Economic Indicators (ILEI) to predict future of the economy

ILEI includes stats such as:

stock prices, unemployment

claims building permits

Pizza Making Factory Materials: 1 black marker, 1 red marker, scissors,sheets of paper, round templateProcedures: 1. Trace the pizza template onto a piece of paper2. Cut out the circle 3. Draw 5 colored in (size of a quarter)pepperoni pieces on the circle

using the RED marker4. Draw 5 colored in (size of a dime) black olives on the circle using

the BLACK marker

Circles must be traced and then CUT using scissors,no tearing!!!! Cut 1 pizza at a time!

Pizza Making Factory

1. What happened to productivity (line 10) from round 1 to round 3? Why?

2. What happened to the quality of the pizzas from round 1 to 3? Why?

3. What effect did productivity have on the average cost of a pizza (line 8)?

Why is this important???

Topic 3: Productivity

Number of goods/ services that a worker can

produce for each hour of work

Productivity and economic growth

Things that increase a country’s productivity:

1. Improvement in capital resources

2. Improvement in labor resources

more training/education

Specialization

incentives

3. better technology

Topic 4: Inflation

Increase in the economy’s overall price level

(does not mean all prices are rising, prices rise

unevenly)

What is Inflation?

Inflation reduces the “purchasing power” of money

•When inflation occurs, each dollar of income will buy fewer goods than before.

Degrees of Inflation:

1. Creeping inflation

Prices grow up to 4%a year

Prices “creep” up

2. Galloping

Price level DOUBLES in a year

3. Hyperinflation

Prices increase 500% a year or more

“Ducktales – inflation”

Inflation types: consider a Polar Pop ($.74)

Next year’s price

Creeping inflation $.76 (3%)

Galloping inflation $1.48 (double)

Hyperinflation $3.70 (500%)

Measuring Inflation

1. Consumer Price Index (CPI)

Index used to measure INFLATION

CPI looks at a consumer market basket of goods such as food, clothing, transportation, entertainment & medical care

CPI formula

CPI =

Current price/base price X 100

CPI exampleYear Price of

bread CPI - using 2000 as base

2000 $1.19

2002 $1.32

2006 $1.49

Year Price of bread

CPI - using 2000 as base

2000 $1.19 1.19/1.19 X 100 = 100

2002 $1.32 1.32/1.19 X 100 = 110.9

2006 $1.49 1.49/1.19 X 100 = 125.2

CPI info.

• To find % rate of change in inflation, take the CPI and subtract 100 from it

• Base year will always have a CPI of 100

Adjusting numbers for inflation

• To be able to compare the value of items or statistics, they must be adjusted for inflation– WHY?? Prices increases over the years; a

2012 statistic would always be more than a 2011, 2005 1990 etc. statistic because prices have increased during that time period

Example of adjusting for inflation (highest grossing movies in U.S. history)

How can you figure out which is the most popular movie of all time?

What is the problem with this method? Nominal Box Office Receipts

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How can you figure out which is the most popular movie of all time?

Real Box Office Receipts (adjusted for inflation)

Did the economy below actually grow???

If apples are the only thing being producedYear 1: 10 apples at $1 each; GDP = $10$10

Year 2: 10 apples x $2.00; GDP = $20$20 65

• Real GDP - GDP adjusted for price increases

• best indicator of economic growth, uses a BASE year to make comparisons

• More accurate statistic when trying to determine growth of an economy

 

• GDP deflator

removes the effects of inflation from the GDP

REAL GDP = Nominial GDP

GDP deflator X 100

Did this economy really grow?

Year GDP GDP deflator

Real GDP

1 $450 100 450/100 X 100 =

2 $452 106 452/106 X 100 =

Example of Real GDP

Year GDP GDP

deflator

Real GDP

1 $450 100 $450

2 $452 106 $426

Once real GDP is calculated it shows the economy did not really grow from year 1

Rule of 70

Can find the # of years it will take for

prices to double

Take % increase in prices and divide into 70

How long will it take for prices to double if prices increase by 3% a year:

70/3 = 23 years

Does GDP accurately measure standard of living?

Real GDP per capita is the best measure of anation’s standard of living.

Real GDP per capita is real GDP divided by the total population.

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4. Real Income

Income adjusted for inflation; DETERMINES PURCHASING POWER

Purchasing Power = howmuch stuff $ will buy

Cost of Living in U.S.

Highest cost of livingNew York, NY Honolulu, HawaiiSan Francisco, CA San Jose, CAStamford, Conn.Washington DCFairbanks, AL Boston, MassSan Diego, CALA, CA

Lowest cost of livingBrownsville, TXPueblo, CoFt. Hood, TXFort Smith, ArkSherman, TX Springfield, IllWaco, TX Fayetteville, Ark Austin, TXSpringfield, MO

Formula for Real income

Real income =

nominal income/ CPI X 100

* Shows purchasing power

Example of real income

Year Income CPI Real income

1 $30,000 100 30,000/100 x 100

= ??

2 $30,900 (3%raise)

105 30,900/105 X 100 = ???

Example of real income

Year Income CPI Real income

1 $30,000 100 $30,000

2 $30,900 (3%raise)

105 $29,428.57

Person made more $

But ….. purchasing power actually went down

Reasons for Inflation

1. Cost push inflation

IT COST COMPANIES MORE TO PRODUCE - They PUSH this price increase on to consumers

Example: the price of beef goes up, so McDonalds raises the price of their hamburgers

2. Demand Pull inflationCaused by demand exceeding supply or a

rapid increase in the money supply

spending PULLS price level up

Zimbabwe 2008

Inflation rate

79,600,000,000%

Amount of time for price to double: 24.7 hours

Inflation practice

 

 

Item Year 1 Year 2

Food $5000 $5400

Clothing $2250 $2700

Gas $3200 $3000

CPI = Current price/ Base price X 100

What is the CPI for food in year 2 using year 1 as a base?

What is the CPI for gas in year 2 using year 1 as a base?

• Food CPI = 108

• Gas CPI = 93.8

Did the economy in the chart below grow from year 1 to year 2? Why or why not?

Year Nominal GDP GDP deflator

1 $5,000 100

2 $6,600 125

Find REAL GDP for each year and compare

Real GDP = actual GDP/GDP deflator X 100

• Real GDP year 1 = $5,000

• Real GDP year 2 = $5,280

– YES economy did grow

In which of the cities below will you earn the MOST REAL

income?

City Income CPI

Cleveland $30,000 101

Atlanta $30,000 103

Chicago $30,000 110

Real income = Actual income/ CPI X 100

• You receive a 2% raise at your job. Inflation increases by 3%. Does your purchasing power increase, decrease or stay the same? _______________________

• You receive a 4% raise at your job. Inflation increases by 2%. Does your purchasing power increase, decrease or stay the same? _______________________

write CP is the statement refers to cost push inflation and DP if the statement refers to DP

inflation.

____The price of sugar increases. As a result, bakeries charge more for a cake.

 ____ Americans have more money. As a result their demand for items is higher which causes prices to go up

____ The auto workers union is successful in negotiating pay raises – as a result, the price of cars go up

 

Effects of Inflation• Anticipated inflation

• inflation that is expected

• Able to plan for

• Unanticipated Inflation

• Inflation whose full extent was not expected; not planned for

1. Fixed Income Groups

- elderly living on fixed retirement funds - landlords receiving fixed payments - minimum wage workers

* are hurt by inflation because the amount of $ being received is FIXED for a number of years.

Prices go up, but income stays the same = decreasein purchasing power

2. Savers

• *depends on interest rate given and what happens to price level.

• For example: if you earn 1% interest on a savings account but inflation goes up 1.5%, your $ will buy less; If you earn more interest than the inflation rate purchasing power will go up

3. Lenders

• * depends on interest rate charged and what happens to price level.

• For example: if a bank charges a 6% interest rate and inflation goes up 7%, the $, once it is paid back will be worth less than when it was borrowed

4. Borrowers

* Depends on interest rate charged and what happens to price level.

Helped or hurt by inflation??

• 1. A man lends $100 to his friend in 2010. The friend pays him back today.

• 2. A tenant signs a one year lease to rent an apartment for $800 a month?

• 3. An elderly couple lives off fixed retirements payments $2,000 a month

• 4. A woman who is saving money in a savings account earning 1% a year. Inflation is going up by 3% a year.

Topic 5: Unemployment

The % of people who are not

working, but actively seeking

employment

Unemployment rates

Highest rates: Lowest rates:

Yuma, AR 27.5%

El Centro, CA 26.6%

Yuba City CA 15.8%

Merced, CA 15.7%

Ocean City, NJ 14.5%

Modesto, CA 14.5%

Bismark, ND 2.6%

Fargo, ND 3%

Lincoln, Neb 3%

Midland, TX 3%

Ames, Iowa 3.1%

Lafayette, LA 3.1%

Types of Unemployment

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1. Frictional Unemployment“Temporarily unemployed” Skills are present

• Results from “normal” changes in the labor market

Reasons for frictional unemployment •Graduating from school •In between jobs•Re-enter workforce

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2. Seasonal Unemployment•Due to time of year and the nature of the job.•These jobs will come back

Examples:

Life Guards

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3. Structural Unemployment•Changes in the organization of the labor force or the structure of a company

•Workers DO NOT have skills needed and these jobs will not come back OR skill of worker is obsolete

•Workers must learn new skills to get a job.

Examples: •VCR repairmen•Carriage makers 102

Change in technology

Company relocates

Merger takes place

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Reasons why structural unemployment occurs:

4 Cyclical Unemployment•Unemployment that results from

a RECESSION

- the company doesn’t have $ to keep the worker

Examples: •Steel workers laid off during recessions.•workers laid off due to people not spending $

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Practice1. Joe just graduated from school and is

looking for his first management job

2. Sally lost her job at Sears due to declining sales

3. Tim was replaced by a robot on the assembly line

4. Kim just graduated from school and cannot find a job in her field so she is working as a waitress

5. Jim lost his job when his company consolidated and moved to another state

Video clip

• “unemployment benefits - the 99ers”

•This is the normal amount of unemployment that we SHOULD have.

The Natural Rate of Unemployment

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Full employment means NO Cyclical unemployment!

Unemployment rate of around 4-6% = FULL EMPLOYMENT

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What is wrong with the unemployment rate? It can misdiagnose the actual unemployment rate because of the following:

Discouraged workers-• Some people are no longer looking for a job

because they have given up.

Part-Time Workers- • Someone who wants more shifts but can’t get

them is still considered employed.

Criticisms of the Unemployment Rate

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Cost of Unemployment

GDP GAP - potential production is lost

Okun’s Law

• For every 1% point by which the actual unemployment rate exceeds the natural rate, a GDP gap of about 2% occurs

• Example: The unemployment rate is 8% (2% over acceptable)

GDP gap 2 X 2 = 4

Tradeoff between inflation and unemployment.

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In general, there is an inverse relationship between unemployment and inflation

• When UNEMPLOYMENT is low (more $ circulating in the economy) the value of the dollar goes down INFLATION is higher

• When UNEMPLOYMENT is high (less $ circulating in economy) INFALTION is lower