Chapter 13 Measuring the Economy

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Chapter 13 Measuring the Economy by Mind Map: Chapter 13 Measuring the Economy

1. 13.2--How Do Economists Measure the Size of an Economy?

1.1. GDP is based on the market price of every “final” good or service that can be legally sold in a country.

1.1.1. A final good is any new good that is ready for consumer use.

1.1.2. An intermediate good is a good used in the production of a final good; intermediate goods are not included in the calculation of GDP (it is already included in the market value of the final good).

1.2. Gross domestic product (GDP) is the market value of all final goods and services produced within a country during a given period of time

1.2.1. Goods and services MUST be produced within the country’s borders

1.2.2. The Bureau of Economic Analysis calculates GDP every quarter, or three-month period. They study Macroeconomics, the workings of the economy as a whole. Annual GDP includes all final goods and services produced between January 1 and December 31.

1.2.3. C + I + G + NX = GDP Household consumption (C) goods and services bought by people in households for personal use. Business investment (I) business investment in capital goods, such as buildings and machinery. It also includes goods produced but not yet sold. Government purchases (G) federal, state, and local government purchases of goods and services Net exports (NX) the value of all exports minus all imports

1.3. Market value is the price buyers are willing to pay for a good or service in a competitive marketplace.

1.4. Simply calculating GDP by adding the spending on its four components yields what economists call nominal GDP.

1.4.1. Nominal GDP measures the output of an economy valued at today’s prices, or in current dollars. Current dollars reflects the purchasing power of the dollars in the year they are spent. Using current dollars does not take the effect of inflation into account. Inflation can cause prices in current dollars to rise from year to year. And if prices go up, nominal GDP will increase over time, even if the actual output of the economy does not.

1.4.2. Constant dollars are have a constant value of the dollar fixed; A measure of the dollar’s value adjusted for inflation to reflect purchasing power over time

1.5. Adjusting for population is accomplished by calculating per capita GDP. Per capita means “per person.”

1.5.1. Per capita GDP is a nation’s real gross domestic product divided by its population. It is an accepted measure of a society’s standard of living GDP has several limitations GDP leaves out unpaid household and volunteer work GDP ignores informal and illegal exchanges GDP counts some negatives as positives GDP ignores negative externalities GDP places no value on leisure time GDP says nothing about income distribution

1.6. As a country’s per capita GDP increases, so does the literacy rate and education, health and life expectancy, and standard of living.

1.6.1. Infant mortality is the rate at which babies die during their first year of life; a key indicator of a nation’s health and well-being.

1.6.2. Life expectancy is the number of years, on average, that a person is expected to live.

2. 13.3--What Does the Unemployment Rate Tell Us About an Economy’s Health?

2.1. In hard economic times, the number of people who are unemployed rises. When business is booming, the number falls.

2.1.1. Unemployment rate is the percentage of the labor force that is not employed but is actively seeking work The BLS surveys about 60,000 households each month, they are interviewed about their activities during a normal 5 week day period. Based on the interview data, the BLS classifies those who are eligible as employed, unemployed, or not in the labor force. Employed members of the labor force who have jobs are classified as employed. This category includes people who worked for at least one hour for pay or profit during the survey week Unemployed members of the labor force who are jobless, but are looking for work, are classified as unemployed. To be counted as unemployed, individuals must have actively looked for work in the four weeks preceding the survey week Not in labor force everyone who is eligible to be in the labor force but is neither working nor looking for work is classified as not in the labor force. Retired/Disabled

2.1.2. To calculate the unemployment rate, it then divides the number of unemployed people by the number in the labor force. The result is multiplied by 100 to express this ratio as a percent Unemployment rate = number unemployed/number in labor force x 100

2.2. Four types of unemployment: frictional, structural, seasonal, and cyclical.

2.2.1. Frictional is a type of unemployment that results when workers are seeking their first job or have left one job and are seeking another

2.2.2. Structural is a type of unemployment where the demand for certain skills declines, often because of changes in technology or increased foreign competition; under such conditions, workers may need retraining to find new jobs

2.2.3. Seasonal when businesses shut down or slow down for part of the year, often because of weather. (Construction)

2.2.4. Cyclical is period of decline in the business cycle; unemployment caused by a contraction

2.3. When an economy is healthy and growing, it experiences little cyclical unemployment. But there will always be some frictional, seasonal, and structural unemployment

2.3.1. Natural rate of unemployment is % of the labor force without work when the economy is at full employment

2.3.2. Unemployed workers who have stopped looking for work; discouraged workers are not considered part of the labor force and are not factored into the unemployment rate

2.3.3. Involuntary part-time workers are people who settle for part-time employment because they are unable to find full-time work

2.3.4. The underground economy is a sector of the economy based on illegal activities, such as drug dealing and unlawful gambling

2.3.5. In general, when the rate is high, the overall health of the economy is poor. High unemployment is also costly for society at large. Unemployed workers no longer contribute income taxes to the government. In fact, many begin taking money from the government in the form of unemployment insurance and other benefits.

3. 13.4--What Does the Inflation Rate Reveal About an Economy’s Health?

3.1. The inflation rate is the percentage increase in the average price level of goods and services from one month or year to the next.

3.1.1. It is tracked by the same government agency that tracks the unemployment rate, the Bureau of Labor Statistics (BLS) CPI is calculated by the BLS, they survey thousands of households about their spending habits. This information is used to develop a detailed list of items to track. Each month, BLS data collectors visit 25,000 retail stores and record the prices of these items.

3.2. Economists at the BLS track changes in the cost of living using what is known as the consumer price index.

3.2.1. A price index measures the average change in price of a type of good over time.

3.2.2. The consumer price index (CPI) is a price index for a “market basket” of consumer goods and services. Changes in the average prices of these items approximate the change in the overall cost of living

3.3. The cost in current dollars of all the basic goods and services that people need is the nominal cost of living.

3.3.1. The real cost of living is the nominal cost of basic goods and services, adjusted for inflation

3.3.2. Consumers pay nominal costs with nominal wages, or wages based on current prices. As prices go up, wages generally go up as well. By using the CPI to adjust for inflation, economists can calculate real wages and compare them over time.

3.4. Prices are always changing. The result can be creeping inflation, hyperinflation, or deflation.

3.4.1. In the United States we have come to expect a certain amount of gradual inflation, or creeping inflation, every year. Creeping inflation is a gradual, steady rise in the price of goods and services over time

3.4.2. When inflation goes into overdrive. The result is hyperinflation. Runaway inflation creates extreme uncertainty in an economy. Nobody can predict how high prices will go

3.4.3. The inflation rate is usually a positive number, meaning that the overall price level is rising. But the inflation rate can be negative, a condition that economists call deflation. Deflation occurs when prices go down over time In a deflationary spiral, falling prices lead to business slowdowns, which lead to lower wages, which lead to still lower prices Sometimes consumers try to purchase more goods and services than the economy can produce. This increase in overall demand results in demand-pull inflation. The extra demand by buyers put a “pull” on prices, forcing them up. Inflation can also be caused by increases in the cost of the factors of production. Higher production costs reduce the economy’s ability to supply the same output at the same price level. The result is cost-push inflation. The rising cost of land, labor, or capital “pushes” the overall price level higher. A wage-price spiral is an upward trend in wages and prices; an inflationary pattern in which rising prices lead to demands for higher wages, causing producers to raise prices further and workers to demand additional wage hikes This spiral starts when workers demand higher wages in order to keep up with inflation. Employers pay the higher wages but then raise prices still higher to cover their increased production costs.

3.5. Biases that distort CPI

3.5.1. Substitution bias. Because the CPI measures the price changes of a fixed list of goods, it does not take into account consumers’ ability to substitute goods in response to price changes.

3.5.2. Outlet substitution bias. The CPI is slow to reflect changing trends in shopping patterns.

3.5.3. New product bias. In a market economy, new products are introduced all the time. Because the BLS cannot predict which new products will succeed, the new products are not incorporated into the market

3.5.4. Quality change bias. Over time, technological advances may improve the quality or add to the lifetime of a product.

3.6. Loss of purchasing power is when inflation erodes purchasing power, the amount of goods and services that can be bought with a given amount of money.

3.6.1. Retired people living on fixed incomes are the hardest hit by a continual increase in the overall price level.

3.6.2. Working people have less to worry about. As long as wages keep pace with inflation, workers will not lose purchasing power.

3.6.3. The expectation that inflation will erode future purchasing power drives up interest rates. In inflationary times, lenders pay close attention to the real interest rate on the money they loan. The real interest rate is the nominal interest rate minus the inflation rate. Many economists consider uncertainty about prices to be a bigger problem than loss of purchasing power or higher interest rates.

4. 13.5--How Does the Business Cycle Relate to Economic Health?

4.1. Business cycle is a recurring pattern of growth and decline in economic activity over time

4.1.1. The business cycle consists of 4 phases. These phases include a period of growth and a period of decline A period of economic growth is known as an expansion. During this phase of the business cycle, economic activity generally increases from month to month The point at which an expansion ends marks the peak of the business cycle. At that peak, economic activity has reached its highest level. The peak also marks the start of a decline in economic activity. A contraction is a period of general economic decline marked by a falling GDP and rising unemployment. The lowest point of a contraction is called the trough; usually followed by economic growth

4.1.2. Leading economic indicators measure that constant rise or fall several months before an expansion or a contraction begins

4.1.3. Coincident economic indicators are measures that consistently rise or fall along with expansions or contractions. They coincide with the phases of the business cycle. Most helpful in tracking expansions and contractions as they happen

4.2. Measures that consistently rise or fall several months after an expansion or a contraction are known as lagging economic indicators

4.2.1. One of the most important lagging indicators is the unemployment rate. The reason is that firms have a hard time deciding to lay off or hire workers until they are sure about the direction of the economy

4.3. A key characteristic of a growing economy is an increase in business investment.

4.3.1. When firms invest in capital goods, such as factories, machinery, and equipment, their productivity increases. Increased productivity contributes to a rise in real GDP.

4.3.2. Consumer confidence is typically high during an expansion since jobs are plentiful and both business profits and wages are rising.

4.4. A number of different obstacles to growth can push an economy into recession

4.4.1. A negative shock to the economy, such as rapidly rising oil prices, a terrorist attack, or a stock market crash.

4.4.2. A rise in interest rates, which makes it harder for consumers and firms to borrow money.

4.4.3. Shortages of raw materials, which can cause price increases.

4.5. As sales slow, businesses begin to see profits fall and inventories rise.

4.5.1. Inventory is merchandise that companies or stores have on hand

4.6. On rare occasions, a recession will last a long time and cause serious damage to the economy. Economists refer to this kind of severe contraction as a depression.

4.6.1. A depression is a prolonged economic downturn characterized by a plunging real GDP and extremely high unemployment.