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 information-intensive 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 power-inflation 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.