Chapter 11 GDP, Unemployment, Inflation and Business Cycles

1. Chapter 11GDP, Unemployment, Inflation and Business Cycles

2. Economy - Structure of economic life and activity in an area • Macroeconomics – study of the whole economy, theories, predictions, events and policies

3. Macroeconomic “Body” and the Human Body • Cells perform functions linked to the operation of the body • Cells die off and are replaced • Blood circulates thru the body providing nutrients • Economic units perform different functions to operate the whole economy • Units die off and are replaced • Money circulates thru the economy providing incentives • Expectations • If you expect to feel better then you will • Economic expectations and action fuel results • Indicators • Temperature, pulse rate, blood pressure • Unemployment rate, inflation rate, capacity utilization • In both economics and medicine there are differences of opinion • Medical people have labs and controlled experiments. Economists only have the one patient: U.S. • Knowledge in both improves over time as each views the performance and results of their patients

4. Gross Domestic Product (GDP) – market value of all final goods produced in a year in a country (not financial transactions) • Final goods vs intermediate goods • Expenditures vs income

5. Expenditures :GDP = C+I+G+Xn • Consumption (C) 65% • Investment (I) 15% • I = In + Ir • In = Net (new) investment • Ir = Replacement investment • Government Purchases (not transfer payments) (G) 20% • Net Exports (Xn) = Exports (X) – Imports (Im) 0%

6. Income: GDI = GDP • Wages and salaries – 72% • Rent – 9% • Interest – 10% • Profits – 9

7. Circular Flow • Real GDP = Nominal GDP adjusted for inflation • Real Per Capita GDP = Real GDP/Population

8. Shortcomings • Doesn’t include home production • Value of a years worth of home production is $134,121 • Doesn’t measure quality or leisure • Doesn’t reflect purpose – alcohol, tobacco and guns • Doesn’t include the underground economy • Illegal activities • Tax avoidance • Environmental damage • Doesn’t include second hand sales, transfer payments and financial transactions

9. Unemployment – people looking for a job but can’t find one • Types • Frictional – between jobs or new entrants • Lack of information • Structural – skills and available jobs don’t match • Lack of Skills • Cyclical – due to business cycles • Contractions – lack of demand • Seasonal – due to seasons • Measures • Labor Force = employed + unemployed • Unemployment Rate = Unemployed/Labor Force • CNAP = Civilian Noninstitutionalized Adult Population • Discouraged worker has stopped looking for a job • Labor Force Participation Rate = Labor Force/CNAP

10. Inflation – increase in the average price level • Purchasing Power – amount of real goods that can be purchased • Price Index • Market Basket – representative goods and services • Base Year – cost of those goods in year 1 • Price Index – cost of goods in a future year as a percentage of the base year • PI = Cost of Today Basket/Cost of Base Year Basket x 100 • CPI – specific group • Problem • Consumers don’t always buy the same thing • People buy different things • New goods are introduced • GDP Deflator – measures all new goods • Types • Anticipated – expected inflation • Unanticipated – unexpected inflation • Creditors lose and debtors gain • COLAs – cost of living adjustments • Real Interest Rate = Nominal Interest Rate – Anticipated Inflation Rate • Deflation – decline in the average level of prices

11. Economic Growth – Long term increase in the GDP

12. Business Cycles (fluctuations) • Phases • Peak – highest level of economic activity • Contraction – GDP is declining • Recession – declining GDP for 6 months • Depression – major slowdown • Trough – lowest level of economic activity • Expansion – increasing GDP • Reasons • External shocks – come from outside the borders • War • OPEC Oil price increases • 911 • Internal shocks • Weather • Labor unions go on strike • Business investment – IPO’s of the 1990’s • Innovation and inventions – new and better products and ways of producing them • Government spending and taxation • Money supply • Spending by Households and Businesses