13-1 L ECTURE LAUNCHER PAGES PAGES

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1 13-1 L ECTURE LAUNCHER When Hurricane Andew blew through Southern Florida it was a disaster, but the GDP recorded it as a $15 billion boon to the economy. What does GDP measure? Under what circumstances would the labor of preparing a meal be included in GDP? PAGES I. National Income Accounting A. The measurement of the national economy s performance is called national income accounting. B. Five major statistics measure the national economy: gross domestic product, net domestic product, national income, personal income, and disposable personal income. Why do you think it is important to measure the nation s economy in a variety of ways? (Answers will vary but should demonstrate an understanding that the economy is very difficult to measure, and that by using many different statistics, economists can get a better picture of the overall economy.) PAGES II. Measuring GDP A. The total dollar value of all final goods produced in a country during a year. B. The GDP value is always expressed in dollars C. The GDP only accounts for final products so that parts are not double counted. D. Only new products are counted: used products are not because they are considered a transfer from one owner to another. E. GDP is computed by adding products purchased by consumers, by businesses, by the government, and net exports (the difference between exports and imports). F. 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. turn Daily Lecture Notes 82

2 13-1 Why do you suppose that Gross Domestic Product does not include used products that were sold that year? (If used products were included in the GDP, then they might be counted more than once. In fact, a new product can be sold as a used product in the same year. And other used products may have been sold more than once that year.) PAGE 347 III. Net Domestic Product A. Accounts for fact that some production is only due to depreciation B. NDP takes GDP and subtracts loss of value due to depreciation C. NDP is a better measure of productivity because it accounts for depreciation. Why is it important to consider depreciation if you want to measure the economy? (This will make the analysis more clear as to whether economy is clearly growing or just maintaining what has already been built or purchased.) PAGES IV. Measurements of Income A. National income (NI) is the total earned by everyone in the economy. B. NI is made up of wages and salaries, income of self-employed people, rental income, corporate profits, and interest on savings and other investments. C. Personal income (PI) is income received before paying personal taxes. D. PI is NI minus transfer payments (assistance payments) and income that is not available to be spent. E. Disposable personal income (DI) is income left to purchase goods or put in savings after paying taxes. How can the national income be misleading in terms of how well people are doing economically? (If there is a large gap between the poorest and wealthiest workers, it will not be evident from the national income. If the majority of workers are not doing well economically, the national income can still be quite high if the wealthiest workers earn enough.) end Daily Lecture Notes 83

3 13-2 L ECTURE LAUNCHER In the 1970s the primary goal of the Federal Reserve was to lower inflation. Interest rates went up. Buttons were distributed that said WIN, an acronym for Whip Inflation Now. What is inflation? Why is it considered harmful and how does it skew GDP figures? PAGE 351 I. The Purchasing Power of Money A. When inflation occurs, the prices of goods and services rise, and the purchasing price of the dollar goes down. B. Purchasing power of a dollar is equal to the real goods and services the dollar can buy. C. Inflation can also be defined as the decline in the purchasing power of money. D. Faster the rate of inflation, greater the drop in purchasing power. E. Inflation must be taken into account when calculating the GDP. F. Deflation is a prolonged decline in the general price level. Why is it important to take inflation into account when calculating the GDP? (Figures that result from inflation don t reflect an increase in production output. Therefore, inflation gives the appearance that production has increased, and can lead to incorrect economic policies.) PAGES II. Measures of Inflation A. 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. B. 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) C. The PPI usually rises before the CPI. D. 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. E. The figure achieved after the GDP price deflator is used is the real GDP. turn Daily Lecture Notes 84

4 13-2 Which do you think is a better indicator of the economy the consumer price index or the producer price index? Why? (Possible response: The consumer price index is better because it reflects what most people are buying, whereas the producer price index mostly reflects costs of mining, manufacturing, and agriculture. The producer price index is better because it helps to predict future changes in economy.) end Daily Lecture Notes 85

5 13-3 L ECTURE LAUNCHER 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 How might the above changes in demographics impact aggregate demand and supply curves? PAGES I. Aggregate Demand A. Aggregate demand is the total quantity of goods and service demanded by all people in the economy. B. Aggregate demand is related to the price level or the average of all prices as measured by a price index. C. If the price level goes down, a larger quantity of real domestic output is demanded per year. D. The relationship on the aggregate demand curve occurs because of the effect of inflation on the purchasing power of cash and the relative price of goods and services sold to other countries. 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 the 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.) PAGE 358 II. Aggregate Supply A. Aggregate supply is the quantity of all goods and services being produced. B. If the price goes up and wages do not, overall profits will rise and producers will want to supply more. turn Daily Lecture Notes 86

6 13-3 Why might economists want to measure aggregate supply? (They might want to see if overall production is up or down within the economy. This might be a better indication of the economy than just looking at certain industries because those industries might have difficulties unrelated to the economy.) PAGES III. 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 (where two curves meet). Why is combining aggregate demand with aggregate supply important? (It helps economists to attain the equilibrium price level.) end Daily Lecture Notes 87

7 13-4 L ECTURE LAUNCHER In 1998 Jacob M. Schlesinger, an economics reporter for The Wall Street Journal wrote: Through the mid-1990s, pundits liked to talk of America s perfectly balanced Goldilocks economy. Like the porridge that the girl of fable devoured, it was not too hot and not too cold, but just right... The boom, it seemed, would never end. What is a boom in the business cycle? How do business fluctuations affect the read GDP? PAGES I. Model of the Business Cycle A. Begins with growth that leads to an economic peak, boom, or period of prosperity. B. Real GDP levels off and begins to decline, while business activity slows down (contraction). C. If real GDP doesn t grow for at least 6 months, economy is in a recession (business activity falls at a rapid rate). D. If recession continues to get worse, 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. How can the model of the business cycle help the owner of a company? (The owner can expect ups and downs as the business grows, or slows down. It can also help the owner to think more reasonably during times of boom, and not to stretch assets thin in anticipation of growth.) PAGES II. Ups and Downs of Business A. In real world economy, business cycles are not regular. B. The largest drop in the U.S. economy was following the stock market crash of 1929, which resulted in a severe depression. C. The rise climaxed after World War II. D. In the 1970s and 1980s the economy had small recessions. E. The 1990s began with a recession, but became a time of great economic growth. turn Daily Lecture Notes 88

8 13-4 Why do you think business models show regular cycles even though they are unrepresentative of real world economies? (Models are used to help people understand what is happening or will happen in the economy. The models represent the ideal cycle and can help businesses to strive toward stability. If the models were so irregular, they would not be used to help make any predictions.) end Daily Lecture Notes 89

9 13-5 L ECTURE LAUNCHER Business cycles are difficult for economists to explain, but Jeffery A. Miron, author of The Economics of Seasonal Cycles, says that they might be better understood if we looked more closely at seasonal fluctuations. Since the 1930s macroeconomists have largely focused on business cycles. However, Miron suggests that seasonal and business cycles are driven by similar economic mechanisms and raise many of the same questions for welfare and policy analysis. Why is it difficult to explain business fluctuations? What might it mean to a nation s economy if business fluctuations were more fully understood? PAGES I. Causes of Business Fluctuations A. Business investment companies expanding or scaling back, or companies using innovations in their business practices. B. Government activity taxing and spending policies, and control of money supply in economy. C. External factors non-economy related factors, such as wars or raw material costs D. Psychological factors people s optimistic or pessimistic outlook on future and economy can contribute to increased spending or more saving. Choose two of the factors above. Describe how they could work together to impact the economy. (Answers may vary. Students should be able to explain the interrelationship between any of the two factors. Sample response: External factors can affect psychological factors by causing people to think positively or negatively. For example, a drought might cause people who make farm machinery to think negatively about future prospects, and scale back for the long term rather than just the short time. This psychological reaction will make the external factor seem more important than usual.) turn Daily Lecture Notes 90

10 13-5 PAGES II. Economic Indicators A. 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. B. Economists then turn to indicators to help predict the economy more accurately. C. Often different indicators within a group move in opposite directions. D. It can take a long time before a change in an indicator is felt in the economy. E. Leading indicators seem to lead to a change in overall business activity. F. Coincident indicators change at the same time as the economic changes. G. Lagging indicators change after the economic change has already begun, and help economists determine how drastic and long-lasting this economic phase will be. When might lagging indicators be least helpful? (When the economic change is very short-lived. In fact, the economy might change again before the original change is detected on a lagging indicator.) end Daily Lecture Notes 91