Econ214 macroeconomics Chapter 5

1. Chapter 5
Measuring a
Nation’s Production
and Income

2. 5-2
Learning Objectives
1. Explain the circular flow
2. Identify the components of GDP
3. Describe the steps from GDP to income
4. Calculate real and nominal GDP
5. List the phases of the business cycle
6. Discuss the relationship of GDP to welfare

3. 5-3
● macroeconomics
The study of the nation’s economy as a whole;
focuses on the issues of inflation, unemployment,
and economic growth.
● inflation
Sustained increases in the average prices of all
goods and services.
MEASURING A NATION’S
PRODUCTION AND INCOME

4. 5-4
The Circular Flow of Production and Income
FIGURE 5.1
The Circular Flow of Production and Income
The circular flow shows how the production of goods and services
generates income for households and how households purchase goods
and services produced by firms.
5.1 THE “FLIP” SIDES OF MACROECONOMIC
ACTIVITY: PRODUCTION AND INCOME

5. 5-5
● gross domestic product (GDP)
The total market value of final goods and services
produced within an economy in a given year.
● intermediate goods
Goods used in the production process that are not
final goods and services.
5.2 THE PRODUCTION APPROACH:
MEASURING A NATION’S MACROECONOMIC
ACTIVITY USING GROSS DOMESTIC PRODUCT

6. 5-6
● real GDP
A measure of GDP that controls for changes in
prices.
● nominal GDP
The value of GDP in current dollars.
● economic growth
Sustained increases in the real GDP of an economy
over a long period of time.
R E A L - N O M I N A L P R I N C I P L E
What matters to people is the real value of money or income—its
purchasing power—not the face value of money or income.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

7. 5-7
FIGURE 5.2
U.S. Real GDP, 1930–2011
During the Great Depression
in the 1930s, GDP initially fell
and then was relatively flat.
The economy was not
growing much.
However, the economy
began growing rapidly in the
1940s during Word War II
and has grown substantially
since then.
SOURCE: U.S. Department of
Commerce.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

8. 5-8
The Components of GDP
Economists divide GDP into four broad categories, each corresponding to different
types of purchases represented in GDP:
1 Consumption expenditures: purchases by consumers
2 Private investment expenditures: purchases by firms
3 Government purchases: purchases by federal, state, and local
governments
4 Net exports: net purchases by the foreign sector (domestic exports minus
domestic imports)
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

9. 5-9
The Components of GDP
CONSUMPTION EXPENDITURES
● consumption expenditures
Purchases of newly produced goods
and services by households.
PRIVATE INVESTMENT EXPENDITURES
● private investment expenditures
Purchases of newly produced goods
and services by firms.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

10. 5-10
The Components of GDP
PRIVATE INVESTMENT EXPENDITURES
Private investment expenditures in GDP consist of three components:
1 First, there is spending on new plants and equipment during the year.
2 Second, newly produced housing is included in investment spending.
3 Finally, if firms add to their stock of inventories, the increase in
inventories during the current year is included in GDP.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

11. 5-11
The Components of GDP
PRIVATE INVESTMENT EXPENDITURES
● gross investment
Total new investment expenditures.
● depreciation
Reduction in the value of capital goods over a one-
year period due to physical wear and tear and also
to obsolescence; also called capital consumption
allowance.
● net investment
Gross investment minus depreciation.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

12. 5-12
The Components of GDP
GOVERNMENT PURCHASES
● government purchases
Purchases of newly produced goods
and services by local, state, and
federal governments.
● transfer payments
Payments from governments to individuals
that do not correspond to the production of
goods and services. Not included in GDP.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

13. 5-13
The Components of GDP
NET EXPORTS
● import
A good or service produced in a foreign country
and purchased by residents of the home country
(for example, the United States).
● export
A good or service produced in the home country
(for example, the United States) and sold in
another country.
● net exports
Exports minus imports.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

14. 5-14
The Components of GDP
NET EXPORTS
● trade deficit
The excess of imports over exports.
● trade surplus
The excess of exports over imports.
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

15. 5-15
Putting It All Together: The GDP Equation
Y = C + I + G + NX
Y = GDP
C = Consumption
I = Investment
G = Government purchases
NX = net exports
GDP = consumption + investment + government purchases + net exports
where
In other words,
5.2 THE PRODUCTION APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING GROSS
DOMESTIC PRODUCT (cont.)

16. 5-16
● national income
The total income earned by a
nation’s residents both domestically
and abroad in the production of
goods and services.
Measuring National Income
● gross national product
GDP plus net income earned abroad.
5.3 THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
NATIONAL INCOME

17. 5-17
Measuring National Income
● personal income
Income, including transfer
payments, received by households.
● personal disposable income
Personal income that households
retain after paying income taxes.
5.3 THE INCOME APPROACH: MEASURING A
NATION’S MACROECONOMIC ACTIVITY USING
NATIONAL INCOME (cont.)

18. 5-18
How to Use the GDP Deflator
● GDP deflator
An index that measures how the
prices of goods and services included
in GDP change over time.
Nominal GDP
GDP Deflator = 100
Real GDP
×
● chain-weighted index
A method for calculating changes in
prices that uses an average of base
years from neighboring years.
5.4 A CLOSER EXAMINATION OF
NOMINAL AND REAL GDP (cont.)

19. 5-19
● recession
Commonly defined as six consecutive months
of declining real GDP.
● peak
The date at which a recession starts.
● trough
The date at which output stops falling in a
recession.
● expansion
The period after a trough in the business cycle
during which the economy recovers.
5.5 FLUCTUATIONS IN GDP (cont.)

20. 5-20
chain-weighted index
consumption expenditures
depreciation
depression
economic growth
expansion
export
GDP deflator
government purchases
gross domestic product
(GDP)
gross investment
gross national product
(GNP)
import
inflation
intermediate goods
macroeconomics
national income
net exports
net investment
nominal GDP
peak
personal income
personal disposable income
private investment
expenditures
real GDP
recession
trade deficit
trade surplus
transfer payments
trough
value added
K E Y T E R M S

21. Chapter 6
Unemployment
And Inflation
.

22. 5-22
Learning Objectives
1. Define these concepts: the labor force, the labor
force participation rate, and the unemployment
rate.
2. Distinguish between cyclical, structural, and
frictional unemployment.
3. Describe the costs of unemployment.
4. Discuss how the Consumer Price Index is
calculated.
5. Explain the difference between inflation and the
price level.
6. Summarize the costs of anticipated and
unanticipated inflation.

23. 5-23
● The Unemployed: Individuals who do not
currently have a job but are actively
looking for work.
Actively looking is critical
How Is Unemployment Defined and Measured?
6.1 EXAMINING UNEMPLOYMENT

24. 5-24
● labor force
The total number of workers, both
the employed and the unemployed.
How Is Unemployment Defined and Measured?
● unemployment rate
The percentage of the labor force
that is unemployed.
labor force = employed + unemployed
unemployed
labor force
unemployment rate = 100×
6.1 EXAMINING UNEMPLOYMENT
(cont.)

25. 5-25
● labor force participation rate
The percentage of the population
over 16 years of age that is in the
labor force.
How Is Unemployment Defined and Measured?
labor force
100
population 16 years and older
labor force participation rate = ×
6.1 EXAMINING UNEMPLOYMENT
(cont.)

26. 5-26
How Is Unemployment Defined and Measured?
 FIGURE 6.1
Unemployment Data, March 2012
Approximately 64 percent of the civilian population is in the labor force.
The unemployment rate in March 2012 was 8.2 percent.
SOURCE: Bureau of Labor Statistics, U.S. Department of Labor, 2012.
6.1 EXAMINING UNEMPLOYMENT
(cont.)

27. 5-27
How Is Unemployment Defined and Measured?
 FIGURE 6.2
Unemployment Rates in
Developed Countries
Among the developed
countries, unemployment
rates vary substantially.
SOURCE: The Economist ,
April 7, 2012.
6.1 EXAMINING UNEMPLOYMENT
(cont.)

28. 5-28
Who Are the Unemployed?
FIGURE 6.4
Selected U.S. Unemployment
Statistics, Unemployment Rates
for March 2012
The incidence of unemployment
differs sharply among demographic
groups.
SOURCE: Bureau of Labor Statistics,
U.S. Department of Labor, 2012.
6.1 EXAMINING UNEMPLOYMENT
(cont.)

29. 5-29
Who Are the Unemployed?
● seasonal unemployment
The component of unemployment
attributed to seasonal factors.
6.1 EXAMINING UNEMPLOYMENT
(cont.)

30. 5-30
Types of Unemployment: Cyclical, Frictional, and Structural
● cyclical unemployment
Unemployment that occurs during
fluctuations in real GDP.
● frictional unemployment
Unemployment that occurs with the
normal workings of the economy, such
as workers taking time to search for
suitable jobs and firms taking time to
search for qualified employees.
● structural unemployment
Unemployment that occurs when there
is a mismatch of skills and jobs.
6.2 CATEGORIES OF UNEMPLOYMENT

31. 5-31
The Natural Rate of Unemployment
● natural rate of unemployment
The level of unemployment at which
there is no cyclical unemployment. It
consists of only frictional and
structural unemployment.
● full employment
The level of unemployment that
occurs when the unemployment rate
is at the natural rate.
6.2 CATEGORIES OF UNEMPLOYMENT
(cont.)

32. 5-32
● unemployment insurance
Payments unemployed people
receive from the government.
6.3 THE COSTS OF UNEMPLOYMENT
SOURCE: Bureau of Labor Statistics, U.S. Department of Labor, 2012.

33. 5-33
The CPI versus the Chain Index for GDP
FIGURE 6.5
Components of the
Consumer Price Index (CPI)
Rent and food and beverages
make up 44 percent of the CPI
basket. The remainder consists
of other goods and services.
SOURCE: Bureau of Labor
Statistics, U.S. Department of
Labor, 2006.
6.4 THE CONSUMER PRICE INDEX AND
THE COST OF LIVING (cont.)

34. 5-34
Problems in Measuring Changes in Prices
● cost-of-living adjustments (COLAs)
Automatic increases in wages or other
payments that are tied to the CPI.
6.4 THE CONSUMER PRICE INDEX AND
THE COST OF LIVING (cont.)

35. 5-35
● inflation rate
The percentage rate of change in
the price level.
inflation rate = percentage rate of change of a price index
6.5 INFLATION

36. 5-36
6.5 INFLATION (cont.)
Historical U.S. Inflation Rates
SOURCES: Scott Derks, The Value of a Dollar 1860–1989 (Farmington Hills, MI: Gale Group, 1993) and
author’s research and estimates.

37. 5-37
The Perils of Deflation
● deflation
Negative inflation or falling prices
of goods and services.
6.5 INFLATION (cont.)

38. 5-38
● anticipated inflation
Inflation that is expected.
● unanticipated inflation
Inflation that is not expected.
6.6 THE COSTS OF INFLATION
Historical U.S. Inflation Rates

39. 5-39
Anticipated Inflation
● menu costs
The costs associated with changing
prices and printing new price lists
when there is inflation.
● shoe-leather costs
Costs of inflation that arise from trying
to reduce holdings of cash.
● hyperinflation
An inflation rate exceeding 50 percent per month.
Unanticipated Inflation
6.6 THE COSTS OF INFLATION (cont.)

40. 5-40
anticipated inflation
Consumer Price Index (CPI)
cost-of-living adjustments (COLAs)
cyclical unemployment
deflation
discouraged workers
frictional unemployment
full employment
hyperinflation
inflation rate
labor force
labor force participation rate
menu costs
natural rate of unemployment
seasonal unemployment
shoe-leather costs
structural unemployment
unanticipated inflation
unemployment insurance
unemployment rate
K E Y T E R M S