Economics - 3 Evaluating Economic Performance

National Output Gross domestic product (GDP) —the sum of all goods and services produced within a nation’s boundaries each year. Productivity—relationship between the goods and services produced in a nation each year and the inputs needed to produce them. Output (goods and services produced) Input (human/natural resources, capital) 1. Gross Domestic Product (GDP) is the sum of all goods and services produced within a nation’s boundaries each year. 2. A country’s GDP is an adequate indicator for measuring a country’s business cycle 3. A shrinking GDP indicates a recession; an expanding GDP indicates growth Productivity =

Four Stages of the Business Cycle GDP

Evaluating Economic Performance Recession—cyclical economic contraction that lasts for six months or longer (two quarters). Measure using GDP Must be real GDP Flattening the Business Cycle - a nation’s economy flows through four stages in the business cycle: 1. Prosperity – unemployment remains low, strong consumer confidence exists, record number of purchases, and businesses expansion 2. Recession – contractions of consumers postponing major purchases and a shift in buying patterns toward basic, functional products with lower prices, and businesses slowing production and spending that last at least six months 3. Depression - a continue downward spiral 4. Recovery – the economy emerges from recession and consumer spending increases, unemployment begin to decline again as business activities increase

Inflation Stranded on an island exercise

Price - Level Changes Inflation—rising prices caused by a combination of excess consumer demand and increases in the costs of raw materials, human resources, and other factors of production. Hyperinflation—economic situation characterized by soaring prices What would you do if you faced hyperinflation? Three types of price-level changes exist: Inflation – rising prices caused by a combination of excess consumer demand and increases in production and service costs •Devalues money as persistent price increases reduce the amount of goods and services people can purchase with a given amount of money •Hyperinflation - characterized by soaring prices

Price-Level Changes Demand-pull inflation Excess consumer demand Cost-push inflation Generated by rises in costs of factors of production Low-inflation environment – increased productivity keeps prices steady and has a major positive impact on the economy Deflation -- consumer pessimism about the future causes individuals to stop purchasing which results in a drop in demand followed by a drop in prices, which has an ultimate negative affect on businesses’ growth

Measuring Price Level Changes Consumer Price Index (CPI)—measures the monthly average change in prices of goods and services Market Basket—compilation of the goods and services most commonly purchased by urban consumers Producer Price Index (PPI) For Finished Goods For Intermediate Goods The Governmental Bureau of Labor Standards (BLS) tracks price levels with two indices: The Consumer Price Index (CPI) 1. measures monthly average changes in prices that consumers pay for certain goods and services 2. not a perfect measure of inflation - might actually overstate inflation by not fully accounting for changes in the goods and services that people buy The Producer Price Index (PPI) 1. tracks the differences in goods and services prices from the sellers perspective 2. Uses three measurements – finished goods, intermediate goods, and crude goods

Contents of the CPI Market Basket

Factoring Out Inflation “Real” is an adjective to describe a measure with inflation subtracted out Examples Real raise Real home prices Real gasoline prices Real GDP

Employment Levels Unemployment rate — calculated. Person must be out of work and looking for work Types of unemployment Frictional Seasonal Structural Cyclical A nation's unemployment rate is an indicator of both overall stability and growth. The unemployment rate shows the number of persons actively seeking employment who are unable to find jobs as a percentage of the total labor force.

Managing the Economy and Inflation Monetary Policy — government actions to increase or decrease the money supply and change banking requirements and interest rates to influence banker’s willingness to make loans. Federal Reserve – government body that regulates the money supply The “Fed” Monetary Policy - government action to increase or decrease the money supply, and change banking requirements and interest rates to influence spending via loans 1. Expansionary monetary policy - increases the money supply to cut the cost of borrowing to stimulate new business growth 2. Restrictive monetary policy - reduces the money supply to curb rising prices and over expansion 3. The Federal Reserve System–the Fed–is responsible for formulating and implementing the nation's monetary policy. Interest Rates Economy Inflation If goes up Goes down If goes down Goes up

Managing the Economy’s Performance Fiscal Policy—government spending and taxation decisions designed to control inflations, reduce unemployment, improve the general welfare of citizens, and encourage economic growth. Examples Bush tax rebate Obama stimulus Fiscal Policy - government officials use revenues and expenditures to control inflation, reduce unemployment, improve the citizen’s general welfare, and encourage economic growth. 1. Increased taxes–the primary source of government funds–may reduce inflation, but could also restrict individual and business economic activities 2. Lower taxes and/or increased government spending usually boost spending and profits, cut unemployment rates, and spur economic expansion

Macroeconomics What are the effects of: increasing business taxes a tax rebate? high unemployment? What is the effect of inflation on GDP? What is the effect of increased productivity on GDP? Should the government own businesses? If so, which ones and why?