Understanding GDP, Inflation, and Economic Growth

1. Unit 4 Macroeconomics: Policies Ch 13 – Economic Performance Ch 14 – Economic Instability Ch 15 – The Fed and Monetary Policy Ch 16 – Achieving Economic Stability

2. GDP (Gross Domestic Product) The dollar amount of all final goods + services produced w/in a country’s borders in a year. USED TO MEASURE OUTPUT. It’s the most important measure of an economy’s performance. Foreign companies operating w/in the US are included in the GDP; however, American companies operating in other counties are NOT included. In 2008, the GDP of the US was over 14 trillion. What is excluded? Intermediate products (a baker buys flour to bake a pie – but only the pie is added in the GDP to avoid counting the flour twice) Non-market transactions (like homemakers) Secondhand sales (like used cars + homes b/c nothing new was created) Underground economy (illegal activities) Ch 13 – Economic Performance

3. Economic sectors(Different parts of the economy) Consumer sector: individuals/families Largest sector Represented by a “C” Investment sector: businesses (including sole proprietorships, partnerships + corporations) It’s responsible for bringing together the factors of production to produce output Represented by an “I” Gov.’t sector: local, state, + national Represented by a “G” Foreign sector: The exchange of goods/services b/w nations Represented by “(X-M)” (exports – imports)

4. How do we determine GDP? By determining how much each sector spends on goods/services, we can determine the GDP. So: GDP = C + I + G + (X – M)

5. GNP (Gross National Product) The dollar amount of all final goods + services produced w/ labor + property supplied by a country’s residents. USED TO MEASURE INCOME. Usually very close to a nation’s GDP. Excludes goods + services produced w/ labor + property supplied by foreigners in the US. End Section 1

6. Determining inflation Inflation is the in the general price level. To determine the rate of inflation, economists create a price index (a series of prices compared over time to measure the change in price). To create a price index, you must have a base year (the year to which all other years’ prices are compared to) + a market basket (a representative selection of commonly purchased goods/services). The price of the market basket is compared over a series of time to the base year which shows how prices have changed.

7. Real vs. Current GDP To compare GDP over time, economists need to know what increases in GDP are due to increases in production/income + what are just do to inflation. Current GDP is the GDP when it is NOT adjusted for inflation. When distortions from inflation have been removed, it is called the real GDP. End Section 2

8. GDP + population Another factor which can distort GDP data besides inflation is population. If the population is at a faster rate than the GDP is, on average individuals aren’t producing as much. GDP per capita is the measurement of the output per person (it is NOT a measurement of income). In 2008, the GDP per capita of the US was $47,500.

9. Other important population factors in the economy: Overall population growth Regional population change (people are born, die, + move – not in that order) Fertility rate (the number of births that 1,000 women are expected to undergo in their lifetime) Net immigration (includes those coming + going) Age – median (average) the dependency ratio (number of children + elderly for every 100 people 16-64 – currently around 65:100) Gender Race End Section 3

10. Benefits of economic growth: It standard of living (quality of life based on possessions). It gov.’t spending to provide more services. It domestic problems as fewer people are poor +/or unemployed Can provide more help for foreign nations. Turns us into a global role model.

11. Factors influencing economic growth Same as the original factors of production: Land, capital, labor, + entrepreneurs Examples of things that would improve economic growth: Land – more oil is discovered in Texas Capital – a cheaper way to build cars is discovered + $ is reinvested in the company for further developments Labor – the population OR could result from an increase in a population’s education/training Entrepreneurs – tend to flourish in areas w/ minimum gov.’t regulation Businesses want to productivity (the efficient use of inputs - referring to capital + labor - to create goods/services). This leads to economic growth. End Section 4

12. Business cycles Largely systematic ups + downs of real GDP. It has 2 phases: a recession is a period during which real GDP declines for 2 quarters in a row (1 quarter = 3 months) + an expansion is a period of recovery from a recession. When the a recession reaches its lowest point, the trough, the period of expansion begins + when a period of expansion reaches its highest point, the peak, the recession begins. If a recession becomes severe enough, it turns into a depression – a state of the economy w/ large numbers of unemployed, shortages, + an excess capacity in manufacturing plants. Ch 14 – Economic Instability

13. or Recession

14. Causes of the business cycle There is no one theory, but there are several factors working together which can help explain changes in the business cycle: Capital expenditures: When the economy is expanding, businesses buy more capital goods (goods used to make consumer goods). When they’ve expanded enough, they stop buying capital goods, causing a loss of jobs for the makers of those goods leading to a recession. Inventory adjustments: Businesses hold on to more inventory when the economy is expanding + cut back during a recession. Innovation + imitation: When a company creates a new product or discovers a more efficient way of doing business, sales go up + the economy expands. Other businesses then follow. Later, there is a slump + economic activity slows. Monetary factors: The FED lowers interest rates during a recession to encourage loans + investments, as the economy improves, interest rates are raised. External shocks: Outside influences (such as drastic changes in the oil market).

15. The Great Depression Farm Foreclosure Rate (1920-1930) During 1920s, US economy appeared to be booming; however, it had flaws: 1. Uneven distribution of wealth (Wealthiest 5% received 33% of income in 1929) Many were too poor to buy much of the goods being produced. 2. Overproduction Because many goods weren’t being sold, factories began laying off workers. Fewer people could buy goods, led to a downward spiral. Farmers were also overproducing w/ help of new scientific methods + machinery (also face world competition). Couldn’t pay off loans + weakened banks .

16. Stock Market Crashes Crowd gathering on Wall Street after the 1929 crash. Wall Street, NYC was the financial capital of the world. Stock prices had soared. By Sept. 1929, some people began to think stock prices were unnaturally + would soon , so they started to sell their stocks until the stock market plummeted. Everyone was selling + no one was buying. “Black Tuesday” – Tues. Oct. 29, 1929, the market crashed.

17. The Great Depression Stocks were worthless + many people were living in poverty. Unemployment as production, prices, + wages . Thousands of businesses failed. Banks closed + 9 mil people lost their savings when banks had no $. Many farmers lost their land b/c they couldn’t pay their mortgage. By 1933, ¼ of American workers were out of work. This prolonged business slump was The Great Depression.

18. American banks began demanding repayment of their overseas loans + American investors withdrew $ from Europe. Congress placed high tariffs on imported goods (so people would buy American goods). Other countries did the same + world trade 65%. Set off a world wide depression felt especially hard in Germany + Austria (due to war debts + dependence on American loans). The Great Depression didn’t end until WWII. End Section 1 Collapse of World Trade Following Smoot-Hawley Tariff of 1930

19. Unemployment The unemployed are people available for work who make a specific effort to find a job during the past month + worked less than 1hr for pay or profit in the last week. The unemployment rate is the # of unemployed individuals divided by the total # of people in the civilian labor force. The unemployment rate tends to dramatically during recessions + then come down slowly afterward. The unemployment rate underestimates employment conditions for 2 reasons: It doesn’t count those who are too discouraged to look for work. It doesn’t count those who are working part-time even if they wish to gain full-time employment.

20. Types of unemployment Frictional – caused by workers who are in b/w jobs. It is short-term + inevitable as people change jobs frequently. Structural – occurs when a fundamental change in the operations of the economy reduces the demand for workers + their skills. (Ex. Changing from a manufacturing economy to one based on computer technology). This is a much more serious type of unemployment + can require a long period of adjustment. Cyclical – occurs due to changes in the business cycle. Seasonal – occurs due to changes in the weather or changes in the demand for certain products (Ex. Construction workers). Technological – occurs when workers are replaced by machines or other technology (Ex. ATMs replacing many bank tellers). End Section 2

21. Is it a frictional, structural, cyclical, seasonal, or technological unemployment? _____________ 1. A constructional company goes out of business when a recession hits _____________ 2. Mr. Chamblee is replaced by a robot _____________ 3. Ashleigh loses her job as a lifeguard at the end of summer _____________ 4. Other countries are able to farm food more efficiently causing many agricultural jobs to go overseas _____________ 5. Fewer teachers are used for summer school as most work is now done on computers _____________ 6. Logan’s maid and butler quit to find another employer who pays them more _____________ 7. A woman quits her job to look for another one after having a baby because they don’t give her the hours she needs _____________ 8. More small businesses start up in Anderson as the economy booms

22. Determining inflation (From last chapter) Inflation is the in the general price level. To determine the rate of inflation, economists create a price index (a series of prices compared over time to measure the change in price). To create a price index, you must have a base year (the year to which all other years’ prices are compared to) + a market basket (a representative selection of commonly purchased goods/services). The price of the market basket is compared over a series of time to the base year which shows how prices have changed.

23. Patterns of inflation Inflation tends to faster during expansion periods of the business cycle + during recessions. Deflation (a in the general price level – opposite of inflation) occurs only very rarely. In the US, deflation has occurred only after WWI + again during the Great Depression.

24. Causes of inflation The demand-pull theory: all sectors of the economy try to buy more goods + services than the economy can produce causing shortages + prices. Another explanation blames the federal gov.’t’s deficit spending (similar to the demand-pull theory). A 3rd explanation blames the rising cost of inputs (including labor wages) which forces manufacturers to prices. A 4th explanation says inflation is caused by a never-ending cycle of wage + price increases that is hard to stop. The most popular explanation is excessive monetary growth. This happens when the gov.’t increases the $ supply faster than the growth of real GDP. In other words, the amount of $ in circulation is increasing more than the amount of goods created.

25. Consequences of inflation The dollar buys less. Particularly difficult for people living on a fixed income (like retired people). It changes spending habits which disrupts the economy (ex. Fewer people may be able to buy things like cars – causing some businesses to shut down). It alters the distribution of income + during long inflationary periods, it hurts lenders more than borrowers. End Section 3

26. Distribution of income Reasons for income inequality: Education Wealth (inherited or saved) Discrimination Ability Monopoly power (some groups/professions may control who or how many enter it) Reasons why the income gap is growing (the rich are getting richer + the poor are getting poorer): Structural changes from a goods based economy to a service based economy (services can be worth a lot or very little) Growing gap in education Declining unionism to negotiate wages Increasing # of single parent families

27. Antipoverty programs Welfare – economic + social programs that provide regular assistance from the gov.’t or private agencies b/c of need. Income assistance – direct cash assistance General assistance – non-cash assistance (Ex. food stamps, Medicaid) Social service programs – vary from state to state (include things like foster care, job training, family planning, etc…) Tax credits Enterprise zones – areas where companies can locate free of some tax laws (intended to help bring jobs to needy areas) Workfare programs – requires those receiving welfare to provide some labor in exchange (usually community service) End Section 4

28. Ch 15 and 16 Quiz

29. The Federal Reserve System (“The Fed”) Created in 1913 to act as the central bank of the US. What does it do? Provides financial services to the gov.’t Regulates financial institutions Maintains the payments system Enforces consumer protection laws Conducts monetary policy Ch 15 – The Fed and Monetary Policy

30. Structure of the Fed Ben Bernanke Chairman of the Fed It’s privately owned by its member banks (commercial banks that are members of, + hold stock in the Fed). Individual banks may or may not belong to the Fed. The Board of Governors sets the general policies for the Fed + its member banks to follow, conducts some aspects of monetary policy, + makes a report each year to Congress. The Board has 7 members appointed by the president + confirmed by the Senate. They serve 14 yr terms that are staggered w/ a new member being appointed every 2 yrs. The Chairman of the Fed is one of the 7 Governors who reports to Congress twice a year. 12 Federal Reserve District Banks serve the same function for member banks that those banks serve for the public (loaning $, holding deposits, etc…).

31. Regulatory responsibilities Regulates + monitors the $ its members hold in reserve. Serves as a responsible banking practice + to control the $ supply. Supervises + regulates foreign banks w/in the US + the international operations of US member banks. Has other regulatory responsibilities as well…

32. Other services Clearing checks The District Federal Reserve System Bank takes $ from the account of the person who’s written the check + transferring it into the bank of the person who’s cashed the check. Enforcing consumer legislation Requires lenders to explain purchases made on credit – ex. down payment, the # + size of monthly payments, + the total amount of interest paid over the life of the loan, etc… Maintaining currency + coins Puts new $ into circulation + destroys mutilated currency. Providing financial services to the gov.’t Serves as the federal gov.’t’s bank – ex. maintains accounts for the IRS. End Section 1

33. Monetary policy The expansion or contraction of the $ supply in order to influence the cost + the availability of credit (including loans). The fractional reserve system requires banks to keep a fraction of their deposits in their banks. The legal reserves are the $ that the banks hold in their vaults + at the Federal Reserve district banks. The reserve requirement is the rule that says what percentage of every deposit must be set aside as legal reserves. It is usually around 10%. Excess reserves are any extra $ a bank has over the reserve requirement + may be lent to others by the bank. This $ is either invested or loaned out + banks make a profit from the interest on those loans.

34. Major tools of the monetary policy 1. Reserve Requirements - The Fed is usually reluctant to use this tool b/c the others tend to work better. 2. Open Market Operations - buying/selling of gov.’t securities (stocks + bonds). - The most commonly used tool. 3. Discount Rate – the interest the Fed charges on loans to financial institutions. - They take out loans to cover a higher # of seasonal loans to their customers or to cover a shortage in their reserve requirements. How these tools are used depends on whether the Fed is operating under a easy money policy or a tight money policy.

35. Easy $ policy the Fed wants to stimulate the economy by encouraging people to spend, invest, + take out loans. Reserve requirements – to encourage spending, investing, + loaning, the Fed would the reserve requirement so more $ would be out in circulation. Open market operations – to put more $ in circulation the Fed buys securities. Discount rate – is to encourage financial institutions to take out loans (so that they can loan more $ to their customers + put more $ in circulation).

36. Tight $ policy the Fed wants to restrict the $ in circulation – to help prevent inflation – by discouraging spending, investing, + loans. Reserve requirements – to discourage spending, investing, + loaning, the Fed would the reserve requirement so less $ would be out in circulation. Open market operations – to $ in circulation the Fed sells securities. Discount rate – is to discourage financial institutions from taking out loans (so that they can loan less $ to their customers, so that less $ is in circulation).

37. Moral suasion The use of persuasion (such as announcements, press releases, articles, + testimony before Congress). A minor monetary policy tool of the Fed’s. Bankers try to predict what the Fed is preparing to do w/ the monetary policy + will often react based on information released by the Fed. End Section 2

38. Impact of monetary policy Other monetary policy issues Short-term – affects interest rates (the price of credit). Long-term – affects the general level of prices. Having too much $ in circulation leads to inflation. Known as the Quantity Theory of $. Timing – effects of changes in the monetary policy can take months or years to be felt. Makes it difficult to know how well it’s working. Burden – may affect some industries more than others (especially those sensitive to the need for loans like cars + houses). Future spending habits – if people take out more loans today they’ll have less $ to spend in the future. Also, expectations of future inflation lead to people spending more $ now. End Section 3

39. Economic instability Can take the form of a recession, high unemployment, +/or inflation. Stagflation is a period of stagnant (no growth) economic growth combined w/ inflation. Costs of economic instability include: loss of production (leading to a loss of tax $), uncertainty among producers + consumers, wasted resources, political instability, higher crime rates, etc… End Section 1 Ch 16 – Achieving Economic Stability

40. Macroeconomic equilibrium Aggregate supply is the total value of goods + services that all firms would produce in a specific period of time at various price levels. If the period was exactly 1 yr, + if production took place w/in a country’s borders, then aggregate supply would be the same as GDP. Aggregate demand is the total quantity of goods + services demanded at different price levels. Macroeconomic equilibrium is the level of real GDP consistent w/ a given price level. In other words, it is where total production + demand are at the same price. On a graph, it is where aggregate supply + aggregate demand intersect. End Section 2

41. Achieving economic stability: demand-side policies Federal policies designed to or total demand in the economy. Fiscal policy – the gov.’t’s attempt to stabilize the economy through taxing + gov.’t spending. Ex: In a recession, the gov.’t would need to spend more $ to stimulate the economy. Automatic stabilizers are programs that automatically trigger benefits if changes in the economy threaten income. - Ex. Unemployment insurance, Entitlement programs (like welfare), + the income tax.

42. Achieving economic stability: supply-side economics Policies designed to stimulate output + lower unemployment by production instead of demand. Also known as “Reaganomics” or the “Trickle-down theory” – benefits that start w/ companies lead to greater profits + more jobs, so the benefits trickle down to individuals. The gov.’t’s role is much smaller. the # of gov.’t agencies Deregulation – fewer regulations promote production. taxes – especially on businesses. Supply-side economics tend to promote economic growth more than stability.

43. Achieving economic stability: monetary policies Focuses on stabilizing the economy by controlling the $ supply – this is what we covered earlier w/ the Fed in Ch 15. This method is often favored b/c both demand + supply-side economics can be difficult to enact due to political bickering in Congress. End Section 3

44. Fiscal policy (The gov.’t’s attempt to stabilize the economy through taxing + gov.’t spending) It involves planning a budget that has either surpluses or deficits that are intended to maintain a steady level of total spending in the economy. 3 types: Discretionary – policy that someone must CHOOSE to implement. Passive – does not require new or special action to go into effect (ex. unemployment, social security, etc…). Structural – plans + programs put in operation to strengthen the economy in the long run (ex. Health care, banking laws, etc…).

45. Reasons for differing opinions among economists Different beliefs about what is important (one might believe unemployment is the more important problem while another might say inflation, etc…). Different times – economists, like all people, are shaped by the time period they grew up in. End Section 4