Measuring the Economy

The Business Cycle The periodic and cyclical ups and downs of the economy

The Business Cycle The Peak: - Highest point - Lots of production - Lots of jobs Many businesses start Why must the government be careful during a peak period?? Peak Period

The Business Cycle Contraction: Production slows down Unemployment goes up Demand goes down Less new businesses Also called “recession” and can lead to an overall recession (low period) Contraction Period

The Business Cycle Trough: Lowest point Low production High Unemployment Low demand If it is very severe or lasts a long time, it is called a depression Trough Period

“The Great Depression” The Business Cycle “The Great Depression” 1929-1939 Unemployment reached 25% Before: The cycle is natural and cannot be changed After: The government can influence the economy Regulate banks Provide jobs Gov’t Spending (Ex. The Stimulus Act of 2008)

The Business Cycle Expansion/Recovery: Economy starts to improve Production goes up More jobs created, employment goes up More services for people Why must the government be careful during an expansion period? Expansion Period

Inflation Value of money has gone DOWN Overall prices have gone UP Purchasing Power: What can you buy for your dollar? When inflation happens, purchasing power goes

Inflation People helped by inflation: - Borrowers People hurt by inflation: Banks (same example) Solution: Variable Interest Rates – change with inflation - People on fixed incomes (less purchasing power for their money) You borrowed $1000 (with a fixed interest rate) After inflation of 3%/yr, after 10 years, that $1000 will be worth $1,344, but you still are paying back $1000 (plus interest)

What Causes Inflation? “Cost-Push” (seller’s inflation) – production costs went up  sellers transfer that cost to the consumer “Demand-Pull” (buyer’s inflation) – people have more money  more people demand products

How Do We Measure Inflation? CPI – Consumer Price Index: Measures the prices of many staple items; then they can be compared to prices in different years PPI – Producer Price Index: Measures the costs to produce products; used to predict future inflation as producers pass on the higher costs to the consumer

How Do We Measure Inflation?

The “GDP” GDP – Gross Domestic Product Measures the value of all goods and services sold in the US in a year Only counts FINISHED products (no “intermediate” products) Only counts NEW products Only counts products produced INSIDE the United States

Potential Problems with the GDP When it comes to comparing GDPs of different years, two problems can occur…. Suppose the GDP of 1945 was $5 Trillion, and the GDP of 2010 was $15 Trillion. Can we assume that the economy in 2010 was 3x better than it was in 1945? Why not? SOLUTION: “Real GDP” – Use one year as a base, and adjust the other year accordingly (based on the inflation rate) PROBLEM: Due to inflation, we cannot compare raw numbers from two different years.

Potential Problems with the GDP When it comes to comparing GDPs of different years, two problems can occur…. Suppose the Real GDP of 1820 was $5 Trillion, and the Real GDP of 2010 was $10 Trillion. What main problems occur when comparing these two years, even if adjusted for inflation? PROBLEM: If there were only 10 million people living in the country then and 350 million now, the economy was proportionally better, even though the GDP was less. SOLUTION: “Per Capita GDP” – Divide GDP by the # of people in the population; “Standard of Living” – what is the people’s quality of life?

Unemployment Who is counted in the unemployment rate? People who are out of a job AND actively looking for work! Does not count… Retired people Kids People who have given up looking Handicapped or unable to work

Types of Unemployment Seasonal Unemployment: Due to the time of the year, some people are without jobs Examples?? Cyclical Unemployment: Due to a the natural ups/downs of the economy, some people may be without jobs

Types of Unemployment Structural Unemployment: Due to advances in technology, less human labor is needed (machines replacing workers) Examples?? Frictional Unemployment: Temporary unemployment; looking for a better job; voluntary

Other Unemployment Terms “Full Employment”: Nearly all people who are able and willing to work can find a job. This is the ideal. However, SOME unemployment is seen as good…why?? “Underemployment”: People are employed in jobs beneath their skill or education level