Transcript File - Government and Economics

Chapter 12 Economics
Measuring the Nation’s Economic
Performance…or in this case, the Lack of
Performance
People measure how successful they are
economically by the size of their incomes
and by their overall standard of living,
including how much their disposable income
will buy.
The measure of the overall economy in the
United States is measured in much the same
way.
The measurement of the national economy’s
performance is called national income
accounting. The major elements used to
measure the nation’s income and production
are:
Gross domestic product, net national
product, national income, personal income
and disposable income.
National income accounting measures
the nation’s economic performance in
terms of output-Gross Domestic
Product and income Gross National
Product.
Gross domestic product (GDP) is the
total dollar value of all final goods and
services produced during one year.
It tells how much American workers
have produced in that year that is
available for people to purchase. GDP
is one way to measure the nation’s
material standard of living. How can we
measure the strength of the economy?
Economists use the dollar as this
common measure of value. GDP is
always expressed in dollar terms.
• Economists add only the value of final
goods and services to avoid double
counting.
• Example-memory chips for computers
are not added separately, they are
measured with the computer.
Only new goods are counted in
GDP- for example, the sale of a
used car is not counted, a new
battery put in a used car is counted.
• U.S. National Debt Clock : Real Time
Flour that a bakery buys is not counted, if
they use the flour to bake a pie for sale, the
pie is counted. This is called the expenditure
method of measuring GDP, because it
measures what is spent.
GDP is computed by adding products
purchased by consumers, by businesses, by
the government, and net exports (the
difference between exports and imports).
Weaknesses: some of the figures used to
compute GDP are estimates, it omits some
areas of the economy, and it only measures
quantity not quality.
Another way to measure GDP is using
income. National income (NI) is the total
earned by everyone in the economy. Income
that is earned in 4 areas: wages, interest,
rents and profits.
A significant change in GDP, whether up or
down, usually has a significant effect on the stock
market. It's not hard to understand why: a bad
economy usually means lower profits for
companies, which in turn means lower stock
prices. Investors really worry about negative
GDP growth, which is one of the factors
economists use to determine whether an economy
is in a recession.
Personal income (PI) is income received
before paying personal taxes.
PI is NI(national income)minus transfer
payments (assistance payments) and income
that is not available to be spent.
Disposable personal income (DI) is income
left to purchase goods or put in savings
after paying taxes.
GDP does not measure loss of value due to
depreciation, Net Domestic Product
accounts for this loss. Net Domestic
Product accounts for the fact that some
production is only due to depreciation. NDP
takes GDP and subtracts loss of value due
to depreciation.
• Economy Tracker - from CNN.com
• Because Net Domestic Product
(NDP) takes this loss of value
(depreciation) into account, it can be
a better measure of the nation’s
economy.
• Rising and falling prices affect the dollar
value of GDP. The value of money is
usually talked about in terms of its
purchasing power. If your money income
stays the same, but the price of one good
that you buy goes up, you have a
decrease in purchasing power.
• What happens to your purchasing power
if your income goes up, and the price of
goods and services stays the same?
• The faster the rate of inflation, the greater
the drop in purchasing power. Inflation
must be taken into account when
calculating the GDP.
• Deflation is a prolonged decline in the
general price level.
• CPI Inflation Calculator
• During a recession, deflation can have a
negative effect on the economy by dragging
down wages for workers.
Measures of Inflation
• The consumer price index (CPI) is a measure
of the change in price of a specific group of
products and services (a market basket) used
by the average household.
• The producer price index (PPI) measures the
average change in prices that companies
charge the consumer (most of the producer
prices are in mining, manufacturing, and
agriculture)
• The PPI usually rises before the CPI.
• Changes in the Producer Price Indexes
(PPIs) are watched by economists as a
hint that inflation is going to increase or
decrease.
• The GDP price deflator is used to
remove effects of inflation from a GDP
so that different years can be compared in
terms of spending value-this figure is
called the Real GDP.
• The Institute for the Future is a marketing firm
that predicts trends in consumer demand. They
are specifically interested in sophisticated
consumers which they define as having three
of the four following characteristics: 1) one
year of college, 2) works as a manager,
professional, or technician in an informationintensive job, 3) lives in a household with
spending power of more than $50,000, and 4)
has access to high-speed, interactive,
multimedia communication devices at home.
• Sophisticated consumers accounted for
20% of all households in 1980,
• 45% in 1999, and are expected to reach
60% by the year 2020. How might the
above changes in demographics impact
aggregate demand and supply curves?
• Aggregate Demand
• When we look at the economy as a
whole, we are looking at aggregates-the
summation of all the individual parts of
the economy. This is called the aggregate
supply and aggregate demand.
• Aggregate demand is the total quantity of
goods and services demanded by all
people in the economy. The measure of
aggregate demand is based on real
domestic output. Aggregate demand is
related to the price level or the average of
all prices as measured by a price index.
If the price level goes down, a larger
quantity of real domestic output is
demanded per year.
• Aggregate demand and price also have an
inverse relationship-just like regular demand.
• At least 2 factors cause this inverse
relationship: A. real purchasing powerinflation causes the purchasing power of your
cash to go down-when price level goes down,
the purchasing power of cash goes up.
• B. the relative price of goods and services in
other countries-greater foreign demand as
price goes down-if the price is down in the US,
the new lower price also looks good to the
foreigners who buy our products.
• Why is an aggregate demand curve a more
realistic predictor than a “regular” demand
curve? (The aggregate demand curve shows
demand as it is related to the price level
average of all prices. Because it is based on a
price index it is also related to the value of the
dollar. A “regular” demand curve does not
account for changes in price due to inflation or
deflation.)
• Aggregate Supply is the quantity of all goods and
services being produced.
• If the price goes up and wages do not, overall profits
will rise and producers will want to supply more.
• Putting Aggregate Demand and Aggregate Supply
Together
• If you combine the aggregate supply curve and the
aggregate demand curve, you can find the equilibrium
price and quantity demanded (where two curves meet).
This will give the equilibrium general price level and
national output (real domestic output.)
• John Maynard Keynes-economist, originated
Keynesian economics which supports the
liberal use of government spending and taxing
to help the nation’s economy.
• Model of the Business Cycle
• A. Begins with growth that leads to an economic
peak, boom, or period of prosperity.
• B. Then, Real GDP levels off and begins to decline,
this slow down is called a (contraction).
• C. If real GDP doesn’t grow for at least 6 months (2
quarters) the economy is in a recession (business
activity falls at a rapid rate).
• D. If recession continues to get worse, the economy
goes into a depression.
• E. The downward direction of economy levels off in a
trough (lowest point in the cycle) and real GDP stops
going down.
• F. Business activity increases and economy begins
expansion or recovery.
• II. Ups and Downs of Business
• A. In real world economy, business cycles are not
regular.
• B. The largest and longest drop in the U.S. economy
was following the stock market crash of 1929, which
resulted in a severe global depression.
• The US involvement in World War II helped
pull the US out of the depression.
• C. In the 1970s and 1980s the economy had
small, recurring recessions. Another economic
downfall occurred in 1987 with a small Stock
Market crash.
• D. The 1990s started in recession, but became
a time of great economic growth.
• 4 Causes of Business Fluctuations:
• 1. Business investment-if businesses are not
expecting a bright economic forecast, they will halt
production-when they halt production, people are laid
off, which only furthers the bleak outlook...
• 2. Government activity-Government affects business
activity in 2 ways: 1.taxing and spending policies 2.
control of money supply in economy(the Federal
Reserve Board)
• 3. External factors-non-economy related factors,
such as wars or raw material costs
• 4. Psychological factors-Consumer confidence in the
economy can contribute to increased spending or
more saving.
• Economic Indicators
• 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. Economists
then turn to indicators to help predict the economy
more accurately. An indicator is anything that
can be used to predict future financial or
economic trends.
• 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.
• Three types of indicators:
• 1. Leading indicators seem to lead to a change
in overall business activity. These types of
indicators signal future events. Think of how
the amber traffic light indicates the coming of
the red light. In the world of finance, leading
indicators work the same way but are less
accurate than the street light.
• 2. Coincident indicators change at the same time as
the economy changes.
• Coincident - These indicators occur at approximately
the same time as the conditions they signify. In our
traffic light example, the green light would be a
coincidental indicator of the associated pedestrian
walk signal. Rather than predicting future events,
these types of indicators change at the same time as
the economy or stock market. Personal income is a
coincidental indicator for the economy: high personal
income rates will coincide with a strong economy.
• 3. Lagging indicators change after the economic
change has already begun, and help economists
determine how drastic and long-lasting this economic
phase will be.
• Lagging - A lagging indicator is one that follows an
event. Back to our traffic light example: the amber
light is a lagging indicator for the green light because
amber trails green. The importance of a lagging
indicator is its ability to confirm that a pattern is
occurring or about to occur. Unemployment is one of
the most popular lagging indicators. If the
unemployment rate is rising, it indicates that the
economy has been doing poorly.