Measuring the Economy’s Performance. National Income Accounting.
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Transcript of Measuring the Economy’s Performance. National Income Accounting.
CHAPTER 13Measuring the
Economy’s Performance
CHAPTER 13SECTION 1
National Income Accounting
National Income Accounting
National Income Accounting: the measurement of the national economy’s performance
Five major statistics measure the national economy: gross domestic product (GDP) net domestic product (NDP) national income (NI) personal income (PI) disposable personal income (DPI)
Measuring GDP
Gross Domestic Product (GDP): total dollar value of all final goods produced in a country during a year
This figure tells the amount of goods and services produced within the country’s borders and made available for purchase in that year.
Measuring Value
Simply adding up the quantities of different items produced would not mean much to measuring the economy.
It is important to know the value of items using some common metric.
The GDP value is always expressed in dollars.
Measuring Final Goods and Services
The GDP only accounts for final products so that parts are not double counted. For example: GDP does not add the price of
computers and motherboards and memory chips if those motherboards and memory chips are going to be installed in computers for sale.
Only new products are counted: used products are not because they are considered a transfer from one owner to another.
Computing GDP
GDP is computed by adding products purchased by consumers (C), by businesses (I), by the government (G), and net exports (X), which is the difference between exports and imports. GDP= (C)+(I)+(G)+(X)
Weaknesses of GDP
Some of the figures used to compute GDP are estimates.
It omits some areas of the economy.
It only measures quantity not quality.
Net Domestic Product
Accounts for fact that some production is only due to depreciation. Depreciation: loss of value because of wear and
tear to durable goods and capital goods
Net Domestic Product (NDP): value of the nation’s total output (GDP) minus the total value lost through depreciation on equipment
NDP is a better measure of productivity because it accounts for depreciation.
Measurement of Income
Three measurements look at income:
National Income
Personal Income
Disposable Personal Income
National Income
National Income (NI): the total income earned by everyone in the economy.
NI is equal to the sum of all income resulting from 5 areas of the economy: wages and salaries income of self-employed people rental income corporate profits interest on savings and other investments.
Personal Income
Personal income (PI): total income that individuals receive before paying personal taxes
PI is National Income minus transfer payments (assistance payments) and income that is not available to be spent. Transfer Payments: welfare and other
supplementary payments that a state or the federal government makes to individuals
Disposable Personal Income
Disposable personal income (DI): income left to purchase goods or put in savings after paying taxes.
DI is an important indicator of the economy’s health because it measures the actual amount of money income people have available to save and spend.
CHAPTER 13SECTION 2
Correcting Statistics for Inflation
The Purchasing Power of Money
When inflation occurs, the prices of goods and services rise, and the purchasing price of the dollar goes down. Inflation: prolonged rise in the general price
level of goods and services
Purchasing power of a dollar is equal to the real goods and services the dollar can buy. Inflation can also be defined as the decline in
the purchasing power of money.
The Purchasing Power of Money
Faster the rate of inflation, greater the drop in purchasing power.
Inflation must be taken into account when calculating the GDP.
Deflation: a prolonged decline in the general price level of goods and services Deflation rarely happens.
Measures of Inflation
The government measures inflation in several ways.
Three of the most commonly used measurements are: Consumer Price Index (CPI)
Producer Price Index (PPI)
GDP Price Deflator
Consumer Price Index
The consumer price index (CPI): measure of the change in price of a specific group of products and services used by the average household.
The group of items that are priced are referred to as a market basket. Market Basket: representative group of goods
and services used to compile the consumer price index
The list includes about 80,000 specific goods and services under general categories.
Consumer Price Index
The numbers are updated monthly and new items are added to the list every 10 years.
The Bureau of Labor Statistics is responsible for updating the list. They start with prices from a base year to
serve as a comparison.
Producer Price Index
The Producer Price Index (PPI): measures the average change in prices that companies charge the consumer for their goods and services
Most of the producer prices are in mining, manufacturing, and agriculture.
PPIs usually increase before the CPI and are used as an indicator that inflation is going to increase.
GDP Price Deflator
GDP Price Deflator: price index that removes the effect of inflation from GDP so that the overall economy in one year can be compared to another year
When the price deflator is applied to the GDP in any year, the new figure is called the real GDP. Real GDP: GDP that has been adjusted for
inflation by applying the price deflator
CHAPTER 13SECTION 3
Aggregate Demand and Supply
Aggregates
The laws of supply and demand can be applied to the economy as a whole as well as to individual consumer decisions.
Economist are interested in the demand by all consumers for all goods and services and the supply by all producers of all goods and services.
This requires the use of aggregates. Aggregate: summation of all the individual
parts in the economy
Aggregate Demand
Aggregate Demand: total quantity of goods and services in the entire economy that all citizens will demand at any single time
Where consumer demand is related to the price of one product, aggregate demand is related to the price level or the average of all prices as measured by a price index. Because there are millions of different prices for
all products, aggregate demand cannot be related to one price.
Aggregate Demand
If the price level goes down, a larger quantity of real domestic output is demanded per year.
There are two reasons for this inverse relationship: Purchasing power of money
Relative prices of goods and services sold to other countries.
Aggregate Demand
Purchasing Power Inflation causes the purchasing power to
decrease. Deflation causes purchasing power to
increase. Therefore, when price level goes down, the
purchasing power of any cash held will increase.
Relative Prices When price level goes down in the United
States, our goods become relatively better deals for foreigners who want to buy them.
Foreigners would them demand more of our goods and services.
Aggregate Demand
Aggregate Supply
Aggregate Supply: real domestic output of producers based on the rise and fall of the price level
If the price level goes up and wages do not, overall profits will rise and producers will want to supply more.
Aggregate Supply
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).
If price levels and output remain the same, there will be neither inflation nor deflation.
CHAPTER 13SECTION 4Business Fluctuations
The Business Cycle
Some years inflation, unemployment, world trade, or taxes are high; other years they are not.
There are fluctuations in virtually all aspects of our economy.
Business Fluctuations: ups and downs in an economy
Business Cycle: irregular changes in the level of total output measured by real GDP
Model of the Business Cycle
The Business Cycle
Begins with growth that leads to an economic peak, boom, or period of prosperity. Peak/Boom: period of prosperity in a business
cycle in which economic activity is at its highest point
Economies also experience contraction, where real GDP levels off and begins to decline, while business activity slows down. Contraction: part of the business cycle during
which economic activity is slowing down
The Business Cycle
If real GDP doesn’t grow for at least 6 months, economy is in a recession.
If recession continues to get worse, economy goes into a depression. Depression: major slowdown of economic
activity
The Business Cycle
The downward direction of economy levels off in a trough and real GDP stops going down. Trough: lowest part of the business cycle in
which the downward spiral of the economy levels off
Business activity increases and economy begins expansion or recovery.
Ups and Downs of a Business
In real world economy, business cycles are not regular.
The largest drop in the U.S. economy was following the stock market crash of 1929, which resulted in a severe depression.
The rise climaxed after World War II.
Ups and Downs of a Business
In the 1970s and 1980s the economy had small recessions.
The 1990s began with a recession but became a time of great economic growth.
CHAPTER 13SECTION 5Causes and Indicators
of Business Fluctuations
Causes of Business Fluctuations
For many years economists believed that business fluctuations occurred in regular cycles.
Today economists tend to link business fluctuations to 4 main forces: Business Investment Government Activity External Factors Psychological Fators
Business Investment
Some economists believe that business decisions are the key to business fluctuations.
Business investment involves companies expanding or scaling back, or companies using innovations in their business practices. Innovation: inventions and new production
techniques
When businesses anticipate a downturn in the economy, they cut back their investments and inventories.
Government Activity
A number of economists believe that the changing policies of the federal government are a major reason for business cycles.
Government activity involves taxing and spending policies, and control of money supply in economy.
External Factors
Factors outside a nation's economy also influence the business cycle.
External factors are non-economy related factors, such as wars or raw material costs.
The impact of wars results from the increase in government spending during wartime.
New sources of raw materials may lower operating costs for certain industries.
Psychological Factors
Psychological factors are people’s optimistic or pessimistic outlook on the future and the economy and can contribute to increased spending or more saving.
Economic Indicators
Business leaders are faced with the dilemma of trying to predict what will happen to the economy in the coming months or years.
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.
Economic Indicators
Economists then turn to indicators to help predict the economy more accurately. Economic Indicators: statistics that measure
variables in the economy
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.
Economic Indicators
Economic indicators can be placed into 3 groups: Leading Indicators
Coincident Indicators
Lagging Indicators
Economic Indicators
Leading Indicators: statistics that point to what will happen in the economy They seem to lead to a change in overall
business activity- whether it is an upward or a downward trend.
The Commerce Department keeps track of numerous leading indicators.
Example: Weekly initial claims for unemployment
insurance New orders for consumer goods Stock prices
Economic Indicators
Coincident Indicators: economic indicators that usually change at the same time as changes in overall business activity They indicate a downswing or upswing has
begun.
Examples: Personal income minus transfer payments Rate of industrial production Sales of manufacturers, wholesalers, and
retailers
Economic Indicators
Lagging Indicators: indicators that seem to lag behind changes in overall business activity It could be months after the start of a
downturn before businesses begin to reduce borrowing.
Lagging indicators give economists clues as to the duration of the phase of the business cycles
Examples: Averate length of unemployment Size of manufacturing and trade inventories Change in CPI for services