PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 21 The Macroeconomic Environment

Copyright © 2004 South-Western. All rights reserved.21–2 Fundamental Issues 1.What is gross domestic product, and how is it calculated? 2.How do economists measure international transactions? 3.What is the difference between nominal GDP and real GDP? 4.What are business cycles, and what are their key features?

Copyright © 2004 South-Western. All rights reserved.21–3 The Gross Domestic Product (GDP) Defined as:  The total of all final goods and services produced during a given period, evaluated at market prices.  A measure of an economy’s total output and a measure of the total income of all individuals in the economy. Depreciation:  The total market value of capital goods that are expended during the process of production.

Copyright © 2004 South-Western. All rights reserved.21–4 Computing the Gross Domestic Product The product approach:  Calculating GDP as the total of consumption spending, investment spending, government expenditures, and net export spending. The income approach  Calculating GDP as the sum of wages and salaries, net interest, rental income, profits, indirect taxes, and depreciation.

Copyright © 2004 South-Western. All rights reserved.21–5 The Circular Flow of Income and Product Figure 21–1

Copyright © 2004 South-Western. All rights reserved.21–6 The Product Approach to GDP Consumption spending:  Total purchases of goods and services by households. Investment spending:  The sum of purchases of new capital goods, spending on new residential construction, and inventory investment. Government spending:  Total state, local, and federal government expenditures on goods and services.

Copyright © 2004 South-Western. All rights reserved.21–7 The Product Approach to GDP Net export spending:  The difference between spending on domestically produced goods and services by residents of other countries and spending on foreign-produced goods and services by residents of the home country.

Copyright © 2004 South-Western. All rights reserved.21–8 The Product Approach to Calculating Gross Domestic Product Table 21– * Consumption Spending3,356.64,454.75,856.07,701.1 Investment Spending ,538.71,831.0 Government Spending1,036.91,293.01,538.52,013.2 Net Export Spending Gross Domestic Product5,108.36,642.38, ,174.8 Note: Amounts are in billions of dollars. *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues).

Copyright © 2004 South-Western. All rights reserved.21–9 The Income Approach to GDP National income:  The sum of all factor earnings, or net domestic product minus indirect business taxes. Gross national product (GNP):  The value, tabulated using market prices, of all final goods and services produced by a nation’s residents during a given period.

Copyright © 2004 South-Western. All rights reserved.21–10 The Income Approach to Calculating Gross Domestic Product (GDP) Table 21– * Wages and Salaries2,973.83,814.44,989.66,522.2 Interest Income Rental Income Business Profits ,401.31,662.5 National Income4,151.15,251.97,041.48,980.1 Indirect Taxes and Transfers Net National Product4,499.45,853.97,706.19,827.8 Depreciation ,072.01,367.2 Gross National Product5,126.86,666.78, ,195.0 Net Income Payments Abroad Gross Domestic Product5,108.36,642.38, ,174.8 Note: Amounts are in billions of dollars. *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues).

Copyright © 2004 South-Western. All rights reserved.21–11 Limitations of GDP The exclusion of nonmarket production:  GDP includes only the value of goods and services traded in markets and does not account for nonmarket production. Country differences:  GDP does not account for population differences. Per capita GDP must be used to compare different countries’ economic performances. Measurement:  GDP is a quantitative measure of production and not of welfare (well-being).

Copyright © 2004 South-Western. All rights reserved.21–12 Measuring International Transactions Balance of payments accounts:  Statements by economists of the measure of the values of cross-border exchanges.  Current account:  Tracks international exchanges of goods and services, unilateral transfers, and income flows.  Capital account:  Tabulates private (nongovernmental) international asset transactions.  Official settlements balance accounts:  Lists governmental agencies’ asset transactions.

Copyright © 2004 South-Western. All rights reserved.21–13 The U.S. Merchandise Trade Balance ($ Millions) Table 21–3 *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues) * Merchandise Exports456,943670,416789,765 Merchandise Imports589,394917,1121,252,315 Merchandise Trade Balance132,451246,696462,550

Copyright © 2004 South-Western. All rights reserved.21–14 The U.S. Current Account ($ Millions) Table 21–4 *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues) * Merchandise Trade Balance+132, , ,550 Net Service Transactions-63,660-79,868-83,895 Balance on Goods and Services-68, , ,655 Net Income Flow+23,905+7,510+16,140 Unilateral Transfers-37,637-44,509-52,858 Current Account Balance-82, , ,373

Copyright © 2004 South-Western. All rights reserved.21–15 The Capital Account And The Private Payments Balance Private payments balance:  The sum of the current account balance and the private capital account balance, or the net total of all private exchanges between U.S. individuals and businesses and the rest of the world.

Copyright © 2004 South-Western. All rights reserved.21–16 The U.S. Private Payments Balance ($ Millions) Table 21–5 *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues) * Current Account Balance82,523217,457415,373 Capital Account Balance11,46590,917352,111 Private Payments Balance71,058126,54063,262

Copyright © 2004 South-Western. All rights reserved.21–17 The Overall Balance of Payments for the United States ($ Millions) Table 21–6 *Authors’ estimates. SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues) * Private Payments Balance71,058126,54063,262 Official Settlements Balance69,935139,31423,050 Statistical Discrepancy1,12312,77440,212 Overall Balance of Payments000

Copyright © 2004 South-Western. All rights reserved.21–18 U.S. Gross Domestic Product (GDP) Figure 21–2 SOURCE:SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues).

Copyright © 2004 South-Western. All rights reserved.21–19 Real GDP versus Nominal GDP Nominal GDP:  The value of final production of goods and services calculated in current-dollar terms with no adjustment for effects of price changes. Real GDP:  A price-adjusted measure of aggregate output, or nominal GDP divided by the GDP price deflator. GDP price deflator:  A flexible-weight measure of the overall price level; equal to nominal GDP divided by real GDP.

Copyright © 2004 South-Western. All rights reserved.21–20 Calculating Real GDP Base year:  A reference year for price-level comparisons, which is a year in which nominal GDP equals real GDP, so that the GDP deflator’s value equals one. Real GDP is calculated by:  Dividing nominal GDP by the GDP deflator, which measures the price level relative to the price level of goods and services in a base year.

Copyright © 2004 South-Western. All rights reserved.21–21 The GDP Deflator Figure 21–3a SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues).

Copyright © 2004 South-Western. All rights reserved.21–22 Real and Nominal GDP Figure 21–3b SOURCES: 2002 Economic Report of the President; Economic Indicators (various issues).

Copyright © 2004 South-Western. All rights reserved.21–23 Price Indexes Consumer price index (CPI):  A weighted sum of prices of a full set of goods and services that the Bureau of Labor Statistics (BLS) in the U.S. Department of Labor determines a typical U.S. consumer purchases each year. Producer price index (PPI):  A weighted average of prices of goods that the BLS determines a typical business charges for the goods and services it sells.

Copyright © 2004 South-Western. All rights reserved.21–24 The Distribution of Expenditures in Computing the Consumer Price Index Figure 21–5 SOURCE: Bureau of Labor Statistics.

Copyright © 2004 South-Western. All rights reserved.21–25 Cycles in Economic Activity Business cycles:  Real GDP variations around its long-run growth path.  Natural GDP:  The level of real GDP that is consistent with the economy’s natural rate of growth. Recession:  A decline in real GDP lasting at least two consecutive quarters, which can cause real GDP to fall below its long-run, natural level.  Depression: An especially severe recession.

Copyright © 2004 South-Western. All rights reserved.21–26 Cycles in Economic Activity (cont’d) Trough:  The point at which real GDP is at its lowest level relative to the long-run natural GDP level. Expansion:  A point at which actual GDP begins to rise, perhaps even above its natural, long-run level. Peak:  The point at which real GDP is at its highest level relative to the long-run, natural GDP level.

Copyright © 2004 South-Western. All rights reserved.21–27 A Hypothetical Business Cycle Figure 21–4

Copyright © 2004 South-Western. All rights reserved.21–28 Annual Hours Worked per Person in Selected Nations Figure 21–6 SOURCE: International Labor Organization.

Copyright © 2004 South-Western. All rights reserved.21–29 Unemployment and the Business Cycle Unemployment rate:  The percentage of the civilian labor force that is unemployed. Frictional unemployment:  The portion of total unemployment arising from the fact that a number of workers are between jobs at any given time. Structural unemployment:  The portion of total unemployment resulting from a poor match of workers’ abilities and skills with current needs of employers.

Copyright © 2004 South-Western. All rights reserved.21–30 Unemployment and the Business Cycle Natural rate of unemployment:  The portion of the unemployment rate that is accounted for by frictional and structural unemployment. Cyclical unemployment:  The portion of total unemployment resulting from business-cycle fluctuations.

Copyright © 2004 South-Western. All rights reserved.21–31 Unemployment Rates and Phases of the Business Cycle. Figure 21–7 SOURCES: Economic Report of the President, 2002; National Bureau of Economic Research, Economic Indicators.

Copyright © 2004 South-Western. All rights reserved.21–32 Actual and Predicted Productivity Growth Figure 21–8 SOURCES: Evan Koenig,“Productivity, the Stock Market, and Monetary Policy in the New Economy,” Federal Reserve Bank of Dallas Southwest Economy, January/February 2000, pp.6–12.