Transcript Chapter 13- Measuring the Economy`s Performance

Measuring the
Economy’s Performance
National Income
Accounting
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National Income Accounting: the measurement of
the national economy’s performance
Five major statistics measure the national
economy:
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gross domestic product (GDP)
net domestic product (NDP)
national income (NI)
personal income (PI)
disposable personal income (DPI)
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Gross Domestic Product (GDP): total dollar value
of all final goods produced in a country during
a year
This figure tells the amount of goods and
services produced within the country’s borders
and made available for purchase in that year.
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Simply adding up the quantities of different
items produced would not mean much to
measuring the economy.
It is important to know the value of items using
some common metric.
The GDP value is always expressed in dollars.
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The GDP only accounts for final products so
that parts are not double counted.
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For example: GDP does not add the price of
computers and motherboards and memory chips if
those motherboards and memory chips are going to
be installed in computers for sale.
Only new products are counted: used products
are not because they are considered a transfer
from one owner to another.
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GDP is computed by adding products
purchased by consumers (C), by businesses (I),
by the government (G), and net exports (X),
which is the difference between exports and
imports.
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GDP= (C)+(I)+(G)+(X)
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Some of the figures used to compute GDP are
estimates.
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It omits some areas of the economy.
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It only measures quantity not quality.
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Accounts for fact that some production is only
due to depreciation.
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Depreciation: loss of value because of wear and tear
to durable goods and capital goods
Net Domestic Product (NDP): value of the
nation’s total output (GDP) minus the total
value lost through depreciation on equipment
NDP is a better measure of productivity
because it accounts for depreciation.
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Three measurements look at income:
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National Income
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Personal Income
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Disposable Personal Income
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National Income (NI): the total income earned by
everyone in the economy.
NI is equal to the sum of all income resulting
from 5 areas of the economy:
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wages and salaries
income of self-employed people
rental income
corporate profits
interest on savings and other investments.
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Personal income (PI): total income that
individuals receive before paying personal
taxes
PI is National Income minus transfer payments
(assistance payments) and income that is not
available to be spent.
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Transfer Payments: welfare and other supplementary
payments that a state or the federal government
makes to individuals
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Disposable personal income (DI): income left to
purchase goods or put in savings after paying
taxes.
DI is an important indicator of the economy’s
health because it measures the actual amount
of money income people have available to save
and spend.
Correcting Statistics for
Inflation
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When inflation occurs, the prices of goods and
services rise, and the purchasing price of the
dollar goes down.
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Inflation: prolonged rise in the general price level of
goods and services
Purchasing power of a dollar is equal to the
real goods and services the dollar can buy.
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Inflation can also be defined as the decline in the
purchasing power of money.
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Faster the rate of inflation, greater the drop in
purchasing power.
Inflation must be taken into account when
calculating the GDP.
Deflation: a prolonged decline in the general
price level of goods and services
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Deflation rarely happens.
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The government measures inflation in several
ways.
Three of the most commonly used
measurements are:
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Consumer Price Index (CPI)
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Producer Price Index (PPI)
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GDP Price Deflator
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The consumer price index (CPI): measure of the
change in price of a specific group of products
and services used by the average household.
The group of items that are priced are referred
to as a market basket.
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Market Basket: representative group of goods and
services used to compile the consumer price index
The list includes about 80,000 specific goods and
services under general categories.
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The numbers are updated monthly and new
items are added to the list every 10 years.
The Bureau of Labor Statistics is responsible for
updating the list.
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They start with prices from a base year to serve as a
comparison.
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The Producer Price Index (PPI): measures the
average change in prices that companies charge
the consumer for their goods and services
Most of the producer prices are in mining,
manufacturing, and agriculture.
PPIs usually increase before the CPI and are
used as an indicator that inflation is going to
increase.
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GDP Price Deflator: price index that removes the
effect of inflation from GDP so that the overall
economy in one year can be compared to
another year
When the price deflator is applied to the GDP
in any year, the new figure is called the real
GDP.
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Real GDP: GDP that has been adjusted for inflation
by applying the price deflator
Aggregate Demand
and Supply
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The laws of supply and demand can be applied
to the economy as a whole as well as to
individual consumer decisions.
Economist are interested in the demand by all
consumers for all goods and services and the
supply by all producers of all goods and
services.
This requires the use of aggregates.
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Aggregate: summation of all the individual parts in
the economy
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Aggregate Demand: total quantity of goods and
services in the entire economy that all citizens
will demand at any single time
Where consumer demand is related to the price
of one product, aggregate demand is related to
the price level or the average of all prices as
measured by a price index.
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Because there are millions of different prices for all
products, aggregate demand cannot be related to
one price.
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If the price level goes down, a larger quantity
of real domestic output is demanded per year.
There are two reasons for this inverse
relationship:
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Purchasing power of money
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Relative prices of goods and services sold to other
countries.
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Purchasing Power
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Inflation causes the purchasing power to decrease.
Deflation causes purchasing power to increase.
Therefore, when price level goes down, the
purchasing power of any cash held will increase.
Relative Prices
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When price level goes down in the United States, our
goods become relatively better deals for foreigners
who want to buy them.
Foreigners would then demand more of our goods
and services.
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Aggregate Supply: real domestic output of
producers based on the rise and fall of the price
level
If the price level goes up and wages do not,
overall profits will rise and producers will
want to supply more.
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If you combine the aggregate supply curve and
the aggregate demand curve, you can find the
equilibrium price and quantity (where two
curves meet).
If price levels and output remain the same,
there will be neither inflation nor deflation.
Business Fluctuations
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Some years inflation, unemployment, world
trade, or taxes are high; other years they are
not.
There are fluctuations in virtually all aspects of
our economy.
Business Fluctuations: ups and downs in an
economy
Business Cycle: irregular changes in the level of
total output measured by real GDP
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Begins with growth that leads to an economic
peak, boom, or period of prosperity.
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Peak/Boom: period of prosperity in a business cycle in
which economic activity is at its highest point
Economies also experience contraction, where
real GDP levels off and begins to decline, while
business activity slows down.
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Contraction: part of the business cycle during which
economic activity is slowing down
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If real GDP doesn’t grow for at least 6 months,
economy is in a recession.
If recession continues to get worse, economy
goes into a depression.
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Depression: major slowdown of economic activity
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The downward direction of economy levels off
in a trough and real GDP stops going down.
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Trough: lowest part of the business cycle in which the
downward spiral of the economy levels off
Business activity increases and economy begins
expansion or recovery.
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In real world economy, business cycles are not
regular.
The largest drop in the U.S. economy was
following the stock market crash of 1929, which
resulted in a severe depression.
The rise climaxed after World War II.
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In the 1970s and 1980s the economy had small
recessions.
The 1990s began with a recession but became a
time of great economic growth.
Causes and Indicators of
Business Fluctuations
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For many years economists believed that
business fluctuations occurred in regular
cycles.
Today economists tend to link business
fluctuations to 4 main forces:
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Business Investment
Government Activity
External Factors
Psychological Factors
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Some economists believe that business decisions
are the key to business fluctuations.
Business investment involves companies
expanding or scaling back, or companies using
innovations in their business practices.
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Innovation: inventions and new production techniques
When businesses anticipate a downturn in the
economy, they cut back their investments and
inventories.
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A number of economists believe that the
changing policies of the federal government are
a major reason for business cycles.
Government activity involves taxing and
spending policies, and control of money supply
in economy.
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Factors outside a nation's economy also influence
the business cycle.
External factors are non-economy related factors,
such as wars or raw material costs.
The impact of wars results from the increase in
government spending during wartime.
New sources of raw materials may lower operating
costs for certain industries.
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Psychological factors are people’s optimistic or
pessimistic outlook on the future and the
economy and can contribute to increased
spending or more saving.
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Business leaders are faced with the dilemma of
trying to predict what will happen to the
economy in the coming months or years.
Economists and the government create
forecasts to try and aid in predicting the future
of the economy.
They are usually too broad to be helpful.
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Economists then turn to indicators to help
predict the economy more accurately.
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Economic Indicators: statistics that measure variables
in the economy
Often different indicators within a group move
in opposite directions.
It can take a long time before a change in an
indicator is felt in the economy.
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Economic indicators can be placed into 3
groups:
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Leading Indicators
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Coincident Indicators
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Lagging Indicators
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Leading Indicators: statistics that point to what
will happen in the economy
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They seem to lead to a change in overall business
activity- whether it is an upward or a downward
trend.
The Commerce Department keeps track of numerous
leading indicators.
Example:
 Weekly initial claims for unemployment insurance
 New orders for consumer goods
 Stock prices
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Coincident Indicators: economic indicators that
usually change at the same time as changes in
overall business activity
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They indicate a downswing or upswing has begun.
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Examples:
 Personal income minus transfer payments
 Rate of industrial production
 Sales of manufacturers, wholesalers, and retailers
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Lagging Indicators: indicators that seem to lag
behind changes in overall business activity
It could be months after the start of a downturn
before businesses begin to reduce borrowing.
 Lagging indicators give economists clues as to the
duration of the phase of the business cycles
 Examples:
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 Average length of unemployment
 Size of manufacturing and trade inventories
 Change in CPI for services