Review of Economic Indicators
Financial Transactions of GDP
Public transfers – government taking money from one group and giving it to another. There is no good that government is buying with this transaction – just money moving around.
Private transfer payments – same idea, but this time it’s people moving money around without a product being included. Like you giving allowance to a child – or getting $20 from your grandmother for your birthday. Now, if the child rakes leaves to earn the allowance – then it isn’t a private transfer – it’s “income” in return for production. In that raking example, we should be adding that allowance in as GDP (although we know it isn’t since we have no way to find that transaction to include it).
Stock market transactions – transactions by the stock market do not increase the amount of capital in the economy, it only changes who owns it.
Secondhand Sales – This would be if you bought a car in January and then sold it in August. This car has been sold before, and the re-sale would not be included because the product was already included as GDP once. Its secondary sale does not represent any new production – just a changing of hands.
Gross Domestic Product - Income Approach vs Expenditure Approach
The Expenditures Approach – this is the approach we use in economics the most –not only is it the easiest (only 4 categories to keep track of)
Personal Consumption Expenditures (-C-) the spending by all households for goods and services
- Durables – products that are expected to last for a while (at least 3 years, but that’s a squishy cut-off). If is a product we expect to use over time, then it’s durable.
- Non-durables – Products that are consumed relatively quickly
- Services – this would include all the things you buy where you don’t get a physical asset or product for it – from medical exams, to tax preparing service to the lawn mowing service.
Gross Private Domestic Investment (Ig) – The amount of spending done by all businesses Positive and Negative Changes in Inventories
We measure production with “Investment” – not sales. Gross Investment (Ig) versus Net Investment (In) – This is defining the difference between the additions to new value (gross investment) and the increase in value (net
Government purchases (G) – The spending by government for goods and services. This does not include the total government budget – since a large portion of the official budget is just transfer payments – and does not represent the purchase of anything. This means that Social Security payments, Unemployment Insurance, Medicare and Medicaid reimbursements etc – are not government “expenditures” the way we use the term in macro economics.
Net exports Xn – the difference between what we sell to the rest of the world (exports) and what we buy from the rest of the world (imports). This is a correction to get expenditure by Americans to match production by Americans. Some of what we produce (and therefore should include in GDP) isn’t bought by Americans – it’s bought by the rest of the world. We have to add that in. Some of what we buy (as households, businesses or government) isn’t produced here, so it shouldn’t count as GDP. This category takes
care of both problems simultaneously.
GDP = C + Ig + G + Xn …
National Income to GDP
From national income to GDP:
Indirect business taxes – taxes collected by businesses for government. This isn’t taxes on businesses – just ones collected by businesses – like sales taxes and excise taxes.
Consumption of Fixed Capital – another term for depreciation
Net Foreign Factor Income – This is subtracting off income earned by foreigners in the country and adding on income earned by citizens abroad
Other National Accounts:
Net Domestic Product – The same measure as GDP but using (In) instead of (Ig) – i.e. we are subtracting out depreciation.
National Income – the difference between GDP and this (which is GNP) is the former is “produced within the country” and the latter is “produced by citizens”
Personal Income – Income received by the citizens – not businesses or government.
Disposable Income – Income citizens can choose how to spend
Nominal GDP vs Real GDP: “nominal” uses prices from the same period as the product was produced to determine GDP, but “real” uses an inflation corrected set of price
GDP Price Index – the measure of the level of prices using a “market basket” of all the goods in the economy.
Dividing Nominal GDP by the Price Index to get Real GDP.
Real GDP = --------------- X 100
Real-World Considerations and Data: There are some complications in determining real GDP – but the book does a pretty good job explaining those, so I won’t repeat them here.
Real GDP vs. Nominal GDP
Consumer Price Index
THE BUSINESS CYCLE
- Peak – the top point of the cycle
- recession / depression – the downward sloping section
- trough – the bottom point
- recovery / expansion / boom – the upward sloping portion.
- Notice that we can be in a recession and still be doing very well (even better than usual) and we can be in a recovery/boom /expansion and still have high unemployment.
- measurement of unemployment
(# unemployed in the labor force)
----------------------------------------- x 100%
(# in the labor force)
Frictional Unemployment – these people are temporarily unemployed due to a variety of reasons – like just graduating and looking for a job, just re-entering the labor force after an absence of any kind, voluntarily quitting your job, being fired for cause from your job, etc.
Structural Unemployment – these people lose their jobs because the economy no longer needs the things they make. It could be that a GM worker is displaced because people move to some other type of transportation or another company is more efficient and takes part of GM’s market share.
Seasonal Unemployment – this is people who do jobs that are not year-round employment. Like looking like Santa – in May.
Cyclical Unemployment – This is a sign of a bad economy. This type of unemployment is due to the business cycle. The downturn in spending means less items are bought – meaning that less goods and services are needed – meaning less workers are needed to supply them.
Natural rate of unemployment – we naturally always have some structural seasonal and frictional unemployment. That unemployment is expected – or at least naturally occurring. Generally in the US we expect unemployment of about 4-6% all the time.
Inflation and Purchasing Power
Nominal and Real Income – nominal income is what the number is on your check stub. Real income is what that income will buy.
The higher the inflation rate, the less that nominal income will buy – i.e. the real income falls as price levels rise.
Who is Hurt by Inflation?
- Fixed income receivers – if a person gets the same dollar amount each month from an annuity, pension or even social security, then as inflation increases, their money doesn’t buy as much as it used to.
- Savers – those who earn interest on savings find that their savings doesn’t increase their purchasing power as fast as it would without inflation.
- Creditors – those who loan money out at a certain rate do not get the expected return on their loan as they intended, because prices are rising and eating away the value of their return.
Who is helped by inflation?
- Flexible Income receivers – their incomes rise with inflation, while others’ incomes do not. By comparison they are better off than fixed income earners.
- Debtors – Let’s say you borrow $100 and agree to pay it back next year with 5% interest. In the mean time, inflation was 10%. If you used to earn $10 per hour, you now get $11 ($10 + 10%). It used to take 10 hours of work to but what cost $100. Now for that same 10 hours of work, you can pay back the loan of $100 plus the $5 of interest and still have $5 left over.
GDP Gap and Okun’s Law – the difference between potential GDP (the GDP we would have had if we were at the natural rate of unemployment) and what we actually achieved.
Actual Real GDP fluctuates with resource availability as well as the business cycle, so it fluctuates more than potential GDP – which fluctuates with resource availability only.
The lower the unemployment rate, the closer Actual GDP will be to Potential GDP – and the smaller the GDP gap will be.
Okun’s law – more a relationship than an actual statistical law: for each 1% of cyclical unemployment (unemployment over 4-6%), the GDP gap will increase by 2%.