Unit 2: Economic Indicators and the Business Cycle

• every country has three goals: promote economic growth, limit unemployment, keep prices stable
• gross domestic product (GDP): dollar value of all final goods and services produced within a country in one year
• expenditures approach: add up all the spending on final goods and services produced in a given year


  $GDP=$$C+$$I+$$G+$$(X-M)$

  
  

  C: consumer spending

  I: business investment

  G: government spending

  X-M: net exports

  X: exports

  M: imports
• income approach: add up all the income earned from selling all final goods and services produced in a given year


  $income=$$W+$$R+$$i+$$PR$

  
  

  W: labor income; wages earned from performing work

  R: rental income; income earned from property owned by individuals

  i: interest income; interest earned from loaning money to businesses

  PR: profit; money businesses have after paying all their costs

  
  

  *also known as factor payments*
• value-added approach: add up the dollar value added at each stage of the production process
• things that don't count in GDP: intermediate goods, nonproduction transactions, nonmarket and illegal activities


  intermediate goods: goods inside the final goods

  nonproduction transactions: financial transactions and used goods

  nonmarket and illegal activities: household production
• what is the equation for percent?

  $\frac{x}{total} *$$100$
• what is the equation for percent change?

  $\frac{new-old}{old} *$$100$
• labor force:

  • 16+ years
  • able and willing to work
  • not institutionalized
  • not in military, in school full-time, or retired
• unemployed: workers that are actively looking for a job but aren't working
• what is the equation for the labor force participation rate?

  $\frac{labor force}{working age population} *$$100$
• what is the equation for the unemployment rate?

  $\frac{unemployed}{labor force} *$$100$
• discouraged workers: no longer looking for a job because they've given up and is not in the labor force
• underemployed worker: a part-time worker that wants more hours but can't get them is still considered employed
• frictional unemployment: temporary unemployment or being between jobs; individuals are qualified workers with transferable skills
• structural unemployment: changes in labor force make some skills obsolete; these workers do not have transferable skills, these jobs will never come back, and workers must learn new skills to get a job
• cyclical unemployment: unemployment caused by a recession; as demand for goods and services falls, demand for labor falls and workers are laid off
• natural rate of unemployment (NRU): the amount of unemployment that exists when the economy is healthy and growing; frictional and structural unemployment
• full employment output (Y): the real GDP created when there is no cyclical unemployment
• consumer price index (CPI): most commonly used measurement of inflation


  $CPI=$$\frac{price current year}{price base year}*$$100$

  • base year index is always 100
• inflation: increase in general prices over time
• deflation: decrease in general prices or a negative inflation rate
• disinflation: prices increasing at slower rates
• GDP deflator measures the prices of all goods produced whereas CPI measures prices of only the goods and services bought by consumers


  an increase in the price of goods bought by firms will show up in GDP deflator but not in CPI

  GDP deflator includes only those goods and services produced domestically because imported goods are not a part of GDP
• what is the equation for GDP deflator?

  $\frac{nominal GDP}{real GDP}*$$100$
• problems with CPI:

  • substitution bias: as prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of market basket
  • result: CPI may be higher than what consumers are really paying
  • new products: the CPI market basket may not include the newest consumer products
  • result: CPI measures the prices but not the increase in choices
  • product quality: the CPI ignores both improvements and decline in product quality
  • result: CPI may suggest that prices stay the same though the economic well being has improved significantly
• hurt by inflation: lenders, people with fixed income, savers
• helped by inflation: borrowers, a business where the product price increases faster than resource prices
• nominal wage: wage measured by dollars rather than purchasing power; not adjusted for inflation
• real wage: wage adjusted for inflation
• positive GDP gap: low unemployment, high inflation
• negative GDP gap: high unemployment, low inflation
• business cycle:

  • peak: business activity reaches a temporary maximum
  • recession: period of decline in total output, income, and employment (6+ months)
  • trough: business activity reaches a temporary minimum
  • expansion: period in incline in total output, income, and employment