Module 10The Circular Flow and Gross Domestic Product

•KRUGMAN'S•MACROECONOMICS for AP*

Margaret Ray and David Anderson

What you will learnin this Module:• How economists use aggregate measures to

track the performance of the economy

• The circular flow diagram of the economy

• What gross domestic product, or GDP, is and the three ways of calculating it

• National Income and Product Accounts

• Reliability

The National Accounts

The Simple Circular-Flow Diagram

The Expanded Circular-Flow Diagram

Gross Domestic Product

• Final goods and services

• Intermediate goods and services

• GDP

• Value of all goods and services produced (value added approach)

• Aggregate Spending (C + I + G + XN)

• Total Factor Income

The Components of GDP

What's Included

Domestically produced final goods and services, including capital goods, new construction of structures, and

changes to inventories

Not Included

Intermediate goods and services

Inputs

Used goods

Stocks & Bonds

Foreign produced goods & services

ModuleInterpretingReal GrossDomestic Product

•KRUGMAN'S•MACROECONOMICS for AP*

11

Margaret Ray and David Anderson

What you will learnin this Module:• The difference between real GDP and

nominal GDP

• Why real GDP is the appropriate measure of real economic activity

What GDP Tells Us

• Economic Size

• Comparison

Relative size of country indicates relative size of Gross Domestic Product

• Inflation’s effect on GDP

• Aggregate Output

Real GDP: A Measure of Aggergate Output

Calculating Real GDPYear Tons of

CornPrice per

TonTons of

SoybeansPrice

per TonNominal

GDPReal GDP Base Year

= 2007

2007 100 $100 80 $50 (100*$100) +

(80*$50) = $14,000

$14,000

2008 110 $110 80 $100 (110*$110) +

(80*$50) = $20,100

(110*$100) + (80*

$50) = $15,000

What Real GDP Doesn’t Measure

• Real GDP v. GDP per capita

• Living Standards

• Limitations of Real GDP per capita

ModuleThe Meaningand Calculation of Unemployment

•KRUGMAN'S•MACROECONOMICS for AP*

12

Margaret Ray and David Anderson

What you will learnin this Module:• How unemployment is measured

• How the unemployment rate is calculated

• The significance of the unemployment rate for the economy

• The relationship between the unemployment rate and economic growth

Defining and Measuring Unemployment

•Labor Force Participation Rate

•Unemployment Rate

•Employed

•Unemployed

•Labor Force

The Significance of the Unemployment Rate

• Indicator of employment opportunity

• Overstating the true level of unemployment

• Understating the true level of unemployment

• discouraged workers

• marginally attached workers

• underemployed

The Significance of the Unemployment Rate

Growth and Unemployment

• Recessions and unemployment

• Economic expansions and unemployment

• Except

• Relationship between economic growth and unemployment

ModuleThe Meaningand Calculation of Unemployment

•KRUGMAN'S•MACROECONOMICS for AP*

13

Margaret Ray and David Anderson

What you will learnin this Module:• The three different types of unemployment

and their causes

• The factors that determine the natural rate of unemployment

Job Creation and Job Destruction

•4.5 million jobs destroyed in a ‘good’ month

•Structural changes in the economy

Frictional Unemployment

• Job Search

• Frictional Unemployment

• Duration

• periods of low unemployment

• periods of high unemployment

Structural Unemployment

• Persistent Surplus

• Structural Unemployment

• Minimum Wages

• Labor Unions

• Efficiency Wages

• Side Effects of Public Policy

Structural Unemployment

The Natural Rate of Unemployment

• Natural Rate of Unemployment

Natural unemployment = Frictional unemployment + Structural unemployment

• Cyclical Unemployment

Actual unemployment = Natural unemployment + Cyclical unemployment

Changes in the Natural Rate of Unemployment

• Natural rate of unemployment changes

• Changes in Labor Force Characteristics

• Changes in Labor Market Institutions

• Changes in Government Policies

ModuleInflation:An Overview

•KRUGMAN'S•MACROECONOMICS for AP*

14

Margaret Ray and David Anderson

What you will learnin this Module:• The economic costs of inflation

• How inflation creates winners and losers

• Why policy makers try to maintain a stable rate of inflation

• The difference between real and nominal values of income, wages, and interest rates

• The problems of deflation and disinflation

The Level of Prices Doesn’t Matter...

•Misconception

•It’s all relative

•Real Wage

•Real Income

...But the Rate of Change of Prices Does

Price level in year 2 - Price level in year 1Price level in year 1

X 100

• Inflation Rate

Inflation rate =

•Shoe-Leather Costs

•Hyperinflation

•Menu Costs

•Unit-of-Account Costs

Winners and Losers from Inflation

• Nominal contracts

• Nominal interest rate v. real interest rate

Inflation is Easy; Disinflation is Hard

• Disinflation

• The cost of disinflation

• Policy response to inflation

ModuleThe Measurementand Calculation of Inflation•KRUGMAN'S•MACROECONOMICS for AP*

15

Margaret Ray and David Anderson

What you will learnin this Module:• How the inflation rate is measured

• What a price index is and how it is calculated

• The importance of the consumer price index and other price indexes

• Aggregate Price Level

Price Indexes and the Aggregate Price Level

Market Baskets and Price Indexes

•Market Basket

Market Baskets and Price Indexes

•Price Index

Price Index in given year =Cost of market basket in a given year

Cost of market basket in base year X 100

Inflation Rate =Price index in year 2 - Price index in year 1

Price index in year 1 X 100

The Consumer Price Index

•Consumer Price Index (CPI)

•What is it?

Other Price Measures

• Producer Price Index (PPI)

• GDP deflator

• Coincidence of inflation measures