1. Chapter 12

2. Section 1

3.  Economists use a system called national
income accounting to monitor the U.S.
economy.
 They collect macroeconomic statistics, which
the government uses to determine economic
policies.
 The most important data economists
analyze is gross domestic product (GDP),
which is the dollar value of all final goods
and services produced within a country’s
borders in a given year.

4.  Basically, gross
domestic product
tracks exchanges of
money.
 To understand GDP,
you need to
understand which
exchanges are
included in the final
calculations—and
which ones are not.

5.  One method used to
calculate GDP is to
estimate the annual
expenditures on
four categories of
final goods and
services:
 Consumer goods
 Business goods and
services
 Government goods
and services
 Net exports

6.  Another method
calculates GDP by
adding up all the
incomes in the
economy.
 The rationale for this
approach is that when a
firm sells a product or
service, the selling price
minus the dollar value
of goods service
purchased from other
firms represents income
from the firm’s owners
and employees.

7.  Nominal GDP is measured in current
prices.
 To calculate nominal GDP, we use the current
year’s prices to calculate the value of the
current year’s output.
 The problem with nominal GDP is that it does
not account for the rise in prices. Even though
your output might be the same from year to
year, the prices won’t be and nominal GDP
would be different.
 To solve this problem, economists determine
real GDP, which is GDP expressed in constant,
or unchanging, prices.

8.  Nonmarket Activities—GDP does not
measure goods and services that people
make or do themselves.
 The Underground Economy—GDP does not
account for black market activities or
people paid “under the table” without
being taxed
 Negative Externalities—unintended
economic side effects, like pollution, are
not subtracted from GDP
 Quality of Life—a high GDP does not
necessarily mean people are happier

9.  In addition to GDP, economists use other ways to
measure the economy.
 The equations below summarize the formulas for
calculating these other economic measurements.

10.  Aggregate Supply
 Aggregate supply is the total amount of goods
and services in the economy available at all
possible price levels.
 In a nation’s economy, as the prices of most
goods and services change, the price level
changes and firms respond by changing their
output.
 As the price level rises, real GDP, or aggregate
supply rises. As the price level falls, real GDP
falls.

11.  Aggregate Demand
 Aggregate demand is the amount of goods and
services that will be purchased at all possible
price levels.
 As price levels in the economy move up and
down, individuals and firms change how much
they buy—in the opposite direction that
aggregate supply changes.
 Any shift in aggregate supply or aggregate
demand will have an impact on real GDP and the
price level.

12.  Aggregate supply and demand represent supply
and demand on a nationwide level. The far right-
hand chart shows what happens to GDP and price
levels when aggregate demand shifts.

13. Section 2

14.  Business cycles are made up of major
changes in real GDP above or below
normal levels.
 The business cycle
consists of four
phases:
 Expansion
 Peak
 Contraction
 Trough

15.  Periods of economic
growth
 Periods of economic
decline
 Business investments
 Interest rates and
credit
 Consumer
expectations
 External shocks

16.  There are three types of contractions, each
with different characteristics.
 A recession is a prolonged economic contraction
that generally lasts from 6 to 18 months and is
marked by a high unemployment rate.
 A depression is a recession that is especially long
and severe characterized by high unemployment
and low economic output.
 Stagflation is a decline in real GDP combined
with a rise in price level, or inflation.

17.  Business cycles are
affected by four main
economic variables.
 Business Investment
 When the economy is
expanding, business
investment increases,
which in turn increases
GDP and helps maintain
the expansion.
 When firms decide to
decrease spending, the
result is a decrease in
GDP and the price level.

18.  Consumers often use credit to buy new cars, home,
electronics, and vacations. If the interest rates on
these goods rise, consumers are less likely to buy
them.
 The same principle holds true for businesses who are
deciding whether or not to buy new equipment or
make large investments.

19.  If people expect that
the economy is going to
start to contract, they
may reduce spending.
 High consumer
confidence, though, will
lead to people buying
more goods, pushing up
GDP.

20.  Negative external shocks, like war breaking out
in a country where U.S. banks and businesses
have invested heavily, can have a great effect on
business, causing GDP
to decline.
 Positive external
shocks, like the
discovery of large oil
deposits, can lead to
an increase in a
nation’s wealth.

21.  To predict the next phase of a business cycle,
forecasters must anticipate movements in
real GDP before they occur.
 Economists use leading indicators to help
them make these predictions.
 The stock market is a leading indicator.
 Today, the stock market turns sharply downward
before a recession.

22.  Before the 1930s, many economists believed
that when an economy declined, it would
recover quickly on its own.
 The Great Depression changed this belief and
led economists to consider the idea that
modern market economies could fall into
long-lasting contractions.
 Not until World War II, more than a decade
later, did the economy achieve full recovery.

23.  Declining GDP and high unemployment
were two major signs of the Great
Depression, the longest recession in U.S.
history.
 In what year did the Great Depression hit its
trough?
 How long
did it take
GDP to
return to its
pre-
Depression
peak?

24.  OPEC Embargo
 In the 1970s, the United States experienced an
external shock when the price of gasoline and
heating fuels skyrocketed as a result of the OPEC
embargo on oil shipped to the United States.
 The U.S. economy also experienced a
recession in the early 1980s and another
brief one in 1991, followed by a period of
steady economic growth.
 The attacks of 9/11 led to another sharp
drop in consumer spending in many service
industries.

25.  The economy began to grow slowly in
2001 and was surging by late 2003 with
GDP growing at a rate of 7.5 percent over
three months.
 However, growth slowed again as a result
of high gas prices in 2006.
 The sub-prime mortgage crisis caused further
decline in 2007.
 2008 and 2009 marked a recession in the
economy, but by the end of 2009, a rebound
occurred.

26. Section 3

27.  The economy grows through
 An increase in capital deepening
 A higher savings rate
 A population that grows along with capital
growth
 Government intervention
 Technological progress

28.  The basic measure of
a nation’s economic
growth rate is the
percentage of change
in real GDP over a
period of time.
 Economists prefer a
measuring system
that takes population
growth into account.
For this, they rely on
real GDP per capita.

29.  GDP measures the standard of living but it
cannot be used to measure people’s
quality
of life.
 In addition, GDP tells us nothing about
how output is distributed across the
population.
 While real GDP per capita tells us little about
individuals it does give us a starting point for
measuring a nation’s quality of life.
 In general, though, nations with a high GDP per
capita experience a greater quality of life.

30.  A nation with a large
amount of physical
capital will experience
economic growth.
 The process of increasing
the amount of capital per
worker, known as capital
deepening, is one of the
most important sources
of growth in modern
economies.

31.  If the amount of money
people save increases,
then more investment
funds are available to
businesses.
 These funds can then be
used for capital
investment and expand
the stock of capital in the
business sector.

32.  If the population grows while the supply of
capital remains constant, the amount of
capital per worker will shrink, which is the
opposite of capital deepening.
 This process leads to lower standards of living.
 On the other hand, a nation with low
population growth and expanding capital
stock will experience significant capital
deepening.

33.  If government raises taxes, households will
have less money. People will reduce saving,
thus reducing the money available to
businesses for investment.
 However, if government invests the extra tax
revenues in public goods, like infrastructure,
this will increase investment, resulting in
capital deepening.

34.  Foreign trade can result in a trade deficit,
a situation in which the value of goods a
country imports is higher than the value
of goods it exports.
 If these imports consist of investment goods,
running a trade deficit can foster capital
deepening.
 When the funds are used for long-term
investment, capital deepening can offset the
negatives of a trade deficit by helping
generate economic growth, helping a country
pay back the money it borrowed in the first
place.

35.  Technological progress is a key source of
economic growth.
 It can result from new scientific
knowledge, new inventions, and new
production methods
 Measuring technological progress can be
done by determining how much growth in
output comes from increases in capital
and how much comes from increases in
labor.
 Any remaining growth in output must come
from technological progress.

36.  Causes of technological progress include:
 Scientific research
 Innovation
 New products increase output and boost GDP and
profits
 Scale of the market
 Larger markets provide more incentives for
innovation
 Education and experience
 Increases human capital
 Natural resources
 Increased natural resources use can create a need
for new technology