1. Measuring Economic Performance 12.5.1: Distinguish between nominal and real data 12.5.2: Define, calculate, and explain the significance of unemployment rate, job creation, inflation/deflation, economic growth

2. Measuring a Nation’s Income Determining whether the economy is doing well or poorly. A nation’s income is measured by calculating GDP

3. What Is Gross Domestic Product? Gross domestic product (GDP) is the total market value of all final goods and services produced annually in a country. Gross domestic product can be determined by multiplying the price of each good by the quantity produced of that good. GDP= P x Q

4. Why Count Only Final Goods? An intermediate good is a good that is not ready for use or purchase. It could be a good that is partially assembled. It could even be the components that are used in producing a final product. Suppose economists counted both final and intermediate goods and services when they computed GDP. Then they would be double counting, or counting goods more than once.

5. Does GDP Omit Anything? We do not count illegal goods and services in GDP because we do not have any records of their sale or purchase. Any legal transaction that is not recorded also cannot be counted. If someone is paid in cash, with no sales receipt, the transaction is not likely to be recorded. We do not count goods and services that are traded outside official market settings. Cutting your friends hair would be an example.

6. The sale of used goods is not counted in GDP. Stock transactions and other financial transactions are also not included in GDP. Government payments, such as social security checks, are not exchanged for goods or services, and are also not counted in GDP.

7. GDP vs. GNP GDP= Total market value of final goods and services produced within the borders of the United States (by both citizens and noncitizens) GNP=Total market value of final goods and services produced by U.S. citizens (wherever they reside- US, France, Mexico, etc.)

8. Measuring GDP

9. How Is GDP Measured? The GDP of the United States in 2008 was more than $14 trillion. Economists determined this number by adding up the amount spent by four sectors: household, business, government, and foreign. Amounts spent by the household sector are called consumption. Amounts spent by the business sector are called investment.

10. Amounts spent by the government sector are called government purchases. As mentioned before, government purchases do not include government transfer payments. Spending by residents of other countries on goods produced in the United States is called export spending. Spending by Americans on foreign- produced goods is called import spending.  (Worksheet All About GDP)

11. The Expenditures Made by the Four Sectors of the Economy

12. All goods produced in the economy must be bought by someone in one of the four sectors of the economy. Summing the spending of the four sectors and subtracting import spending will give a good estimate of GDP. GDP = C + I + G + EX – IM

13. Calculating GDP Gross domestic product (GDP) is the total market value of all final goods and services produced annually in a country. GDP = C + I + G + EX – IM Note that import spending is subtracted when calculating GDP.

14. GDP Versus Quality of Life Remember Principle #8: The Standard of Living Depends on a Country’s Production. Greater production of goods and services is only one of the many factors that contribute to being better off or possessing greater well-being. All other things being equal, greater production may result in reduced leisure time or reduced family time. Population must be considered when comparing the GDP of two different nations: Per capita GDP = GDP / Population.

15. (Worksheet 11.2)

16. Real GDP

17. The Two Variables of GDP: P and Q GDP is calculated by multiplying the price of goods produced (P) by the quantity produced (Q). If either price OR quantity rises, the GDP will rise. To get an accurate assessment we need to look at each variable separately. If price is held constant, then any rise in GDP must be due to a rise in quantity. This measurement is called Real GDP

18. Real GDP (quantity variable) How do we keep price constant? Economists do it by choosing the price in a base year and then comparing it with prices in all other years. For example, they may choose 1987 as their base year, and then compare prices in 2003, 2004, and 2005 against prices in 1987. GDP is equal to price in the current year multiplied by quantity in the current year.  Nominal GDP = P current year X Q current year Real GDP is equal to price in the base year multiplied by quantity in the current year.  Real GDP = P base year X Q current year  (Mc Donald’s Worksheet)

19. Computing GDP and Real GDP in a Simple, One-Good Economy p. 298 Real GDP is computed using prices from a base year and applying those prices to quantities produced.

20. GDP Deflator (price variable) It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced This will let us know the percent increase in price level. Or, how inflation has impacted the numbers. GDP Deflator= nominal GDP X 100 real GDP Practice with numbers from p. 298

21. Using the GDP Deflator You can use the GDP deflator to figure out how inflation has impacted the GDP Real GDP= nominal GDP X 100 GDP deflator For example if nominal GDP in 2010 equals $20,000 and you have a GDP deflator in 2010 equal to 125, you would.... $20,000/125=$160 x100= $16,000 in real GDP. So now you know that of the $20K of GDP in 2010, $4K was the result of inflation (Gross Domestic Product Worksheet)

22. Measuring the Cost of Living Monitor the changes in the cost of living over time. Using the Consumer Price Index we can see if we have to spend more dollars to maintain our standard of living.

23. The Consumer Price Index The consumer price index is a measure of the overall cost of the goods and services bought by a typical consumer. It is taken monthly. A price index is a measure of the price level, or the average level of prices. The most widely used price index is the consumer price index (CPI). The consumer price index is calculated using a sampling of thousands of households. The Bureau of Labor Statistics surveys what consumers paid for a group of goods that represent all the types of goods they might purchase in a year. This group of goods is called the market basket.

24. How the Consumer Price Index Is Calculated 1. Fix the Basket: Determine what goods and services are most important to the typical consumer. 2. Find the Prices: Find the prices of each of the goods and services in the basket for each point in time 3. Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. P X Q, then add them up

25. How the Consumer Price Index Is Calculated 4. Choose a Base Year and Compute the Index: Designate one year as the base year, making it the benchmark against which other years are compared. Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100. CPI current year = Price of basket in current year X 100 Price of basket in base year

26. 5.Compute the inflation rate (percentage change in CPI): The inflation rate is the percentage change in the price index from the preceding period Inflation Rate ( percentage change in CPI)= CPI later year- CPI earlier year X100 CPI earlier year

27. Calculating the Percentage Change in a Single Price When a good increases in price from one year to the next, it is easy to calculate the percentage of change in price. Percentage change in price = Price later year – Price in earlier year X 100 Price in earlier year By comparing price changes and Inflation rates you can see if things are going well or not. Example: If prices increase more than income, its not good.

28. Price in Today’s Dollars To calculate how much something is in today’s dollars, you must know the CPI from both years. Price Today = Price (earlier year) X (CPI (today) /CPI (earlier)

29. Examples and Practice Exhibit 11-8 p. 302 Practice: Calculate the CPI if the basket was 10 Cheetos and 5 Dr. Peppers and the prices in the base year were $3 and $.50 and prices in the current year are $5 and $1. Exhibit 11-9 p. 303 Practice: Calculate Inflation Rate 1995-1996 1999-2000 2003-2004

30. Measuring the Unemployment Rate

31. Unemployment Rate Unemployment is measured by the Bureau of Labor Statistics (BLS). It surveys 60,000 randomly selected households every month. The survey is called the Current Population Survey Based on the answers to the survey questions, the BLS places each adult into one of three categories: Employed Unemployed Not in the labor force

32. Who’s who?? Adult or Not? Military or Institutionalized? The BLS considers a person an adult if he or she is over 16 years old. We don’t count people in the military or institutions Employed or Not? A person is considered employed if he or she has spent most of the previous week working at a paid job. A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.

33. Types of Unemployment Frictional: Workers who are either searching for jobs or waiting to take jobs in the near future. Examples are people who are transitioning between jobs or who have recently graduated. Structural: Caused by changes in the structure of demand for consumer goods and in technology. This category includes workers who are unemployed because their skills to obtain employment, or because they cannot easily move to locations where jobs are available. Cyclical: Caused by the recession phase of the business cycle, that is, by a deficiency of total spending. As the overall demand for goods and services decreases, less labor is needed, so employment falls and unemployment rises.

34. Labor Force Labor Force or Not? A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force. The labor force is the total number of workers, including both the employed and the unemployed. The BLS defines the labor force as the sum of the employed and the unemployed. Labor Force= Unemployed+Employed

35. Figure 1 The Breakdown of the Population in 2001 Copyright©2003 Southwestern/Thomson Learning Adult Population (211.9 million) Labor Force (141.8 million) Employed (135.1 million) Not in labor force (70.1 million) Unemployed (6.7 million)

36. The unemployment rate is calculated as the percentage of the labor force that is unemployed Unemployment rate = # unemployed X100 labor force The employment rate is calculated as the percentage of the adult population that is employed Employment rate = # employed X100 adult population

37. It is difficult to distinguish between a person who is unemployed and a person who is not in the labor force. Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics. Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t looking for work

38. September 2011 Stats (#’s in the thousands) (Civilian noninstitutional) Adult population 240,071 (Civilian) Labor force 154,017 Unemployed 13,992 Employed 140,025 You do the math. Find the unemployment and employment rates.

39. Aggregate Supply and Demand Economy-wide supply and demand Remember Principle #10: Society Faces a Short-run Tradeoff Between Inflation and Unemployment.

40. Business Cycles (Fluctuations) Economic fluctuations are irregular and unpredictable GDP and CPI fluctuate together When GDP declines, unemployment increases When production and incomes fall, and unemployment rises it is known as a recession when its mild and a depression when its severe.

41. TRANSPARENCY 12-3: The Phases of the Business Cycle Changes in money supply Changes in business investment, residential construction, and government spending Politics Innovation Dramatic changes to supply Business cycles can be caused by several types of events:

42. Explaining Short-run Fluctuations We use aggregate supply and aggregate demand to explain economic fluctuations. The aggregate-demand curve shows the quantity of goods and services households, firms, and government wish to buy at each price level. It slopes negatively. The aggregate-supply curve shows the quantity of goods and services that firms produce and sell at each price level. It slopes positively. The price level and production adjust to balance aggregate supply and demand.

43. Aggregate Demand Curve The reason it slopes downward has to do with the effect of price levels on consumption, investment, and net exports. If there is a change in C, I, G, or NX the curve will shift. When aggregate demand shifts left it will create a recession.

44. Aggregate Supply Curve The reason it slopes upward has to do with the amount of production at each price level. If there is a change in labor, capital, natural resources, or technology the curve will shift. If aggregate supply shifts left it will create a recession.

45. Inflation and Deflation Remember Principle #9: Prices Rise When the Government Prints Too Much Money.

46. What Is Inflation? Inflation is an increase in the price level, or the average level of prices.

47. How Do We Measure Inflation? One way of determining inflation is to look for changes in the consumer price index (CPI). For example, if the CPI increases from 180 in one year to 187 in the next year, the inflation rate is 3.89 percent. Between 1960 and 2006, the United States experienced wide fluctuations in inflation rates. Approximately what was the highest rate during those years? (Answer: 13.25 percent) Approximately what was the lowest rate? (Answer: 0.5 percent)

48. TRANSPARENCY 12-1: Measuring Inflation

49. Demand-Side Versus Supply-Side Inflation Inflation can originate on either the demand side of the economy or the supply side of the economy. If aggregate demand increases and aggregate supply stays the same, inflation will occur. Demand-side inflation occurs when an increase in the price level originates on the demand side of the economy. Demand-side inflation can be caused by an increase in the money supply. Supply-side inflation occurs when an increase in the price level originates on the supply side of the economy.

50. The Simple Quantity Theory of Money The simple quantity theory of money presents a clear picture of what causes inflation. To understand this theory, you need to understand velocity and the exchange equation. Velocity is the average number of times a dollar is spent to buy final goods and services in a year. The exchange equation says that the money supply multiplied by velocity equals the price level (or average price) multiplied by the quantity of output. The simple quantity theory of money predicts that changes in the price level will be strictly proportional to changes in the money supply.

51. TRANSPARENCY 12-2: The Exchange Equation M x V = P x Q M = Money supply V = Velocity P = Price level Q = Quantity of output

52. According to this theory, if the money supply doubles from $500 to $1,000, the price level will double from $10 to $20—assuming that velocity and quantity of output remain constant. In reality, the change will not be perfectly proportional. A 100 percent increase in the money supply may result in a 50 percent increase in the price level. Nevertheless, in the real world, we see that the greater the change in the money supply, the greater the change in the price.

53. The Effects of Inflation Inflation increases the amount that people must spend on particular goods or services. It can affect people on fixed incomes, savers, and partners in contracts. Inflation reduces the buying power of people on fixed incomes, such as social security or investment proceeds. If the inflation rate is greater than the interest rate earned on savings accounts, the money in those accounts loses value. As time goes on, savers will be able to buy fewer goods with the same amount of money.

54. Over time, inflation can eat up the profits factored into a long-term contract. As the costs of supplies and labor increase during the length of the project, the profit that was factored into the contract begins to disappear. To hedge against inflation is to try to avoid or lessen a loss by taking some counterbalancing action. People try to figure out the best protection against inflation by investing in items such as gold, real estate, and art.

55. What Is Deflation? Deflation is the opposite of inflation. Deflation is a decrease in the price level, or the average level of prices. A downward change in the CPI indicates deflation. Demand-Side Deflation Versus Supply-Side Deflation Like inflation, deflation can result from a change in price or a change in supply. For example, if aggregate demand decreases and aggregate supply stays the same, deflation will occur.

56. Simple Quantity Theory of Money and Deflation The simple quantity theory of money can be used to explain deflation, just as it was used to explain inflation. According to this theory, if the money supply drops from $1,000 to $500, the price level will drop from $20 to $10—assuming that velocity and quantity of output remain constant.

57. A Major Effect of Deflation When prices fall, they do not all fall at the same time. When prices do not fall at the same time, deflation can lead to firms going out of business and workers being laid off. These are common results during times of deflation.

58. Economic Growth