REV - Measuring Economic Performance

Measuring Economic Performance

Gross Domestic Product (GDP)

GDP Expenditures Approach

Expenditures approach: GDP = C + Ig + G + Xn

• C = personal consumption expenditures (durable consumer goods, nondurable consumer goods, consumer expenditures for services)

• Ig= gross private domestic investment (all final purchases of capital by businesses, all construction, changes in inventories)
• G = government purchases (government spending on products and resources)
• Xn= net exports (exports – imports

Some types of transactions do not involve purchasing of a final good or service, so they should not be counted in GDP. These include public transfer payments (social security, welfare, etc), private transfer payments (monetary gifts, etc), security transactions (stocks and bonds), and secondhand sales (they don’t reflect current production).

 

GDP Income Approach

GDP = Compensation of employees + Rents + Interest + Proprietors’ income + Corporate profits (Corporate income taxes + dividends + undistributed corporate profits) + indirect business taxes + depreciation (consumption of fixed capital) + net foreign factor income 

 

GDP Growth

 

 

Nominal vs Real GDP

Nominal GDP is sometimes inaccurate because if there is a lot of inflation, the actual GDP growth isn’t as high as the figures seem to say. Therefore, we have a measure of GDP that is adjusted for inflation: real GDP. This is calculated by the formula 

 

 

Differences in Approaches

• The expenditures approach tells us GDP by telling us how much the final user pays for each thing, giving us the value of the final product.
• The income approach adds all the wage, rent, interest, and profit incomes created in producing the product.

They both add up to the same amount because money spent on a product is received as income by those who helped to make it.

 

Multiple Counting / Value Added

If we were to count the prices of intermediate goods instead of final goods in the expenditures approach, since the value of final goods already includes the value of intermediate goods, it would be counting the same thing multiple times, making GDP seem higher than it really is.

To avoid multiple counting, accountants calculate only the value added by each firm in each stage of the product, instead of just how much each firm sells its product to the next firm. 

 

NDP

GDP includes the money spent for replacing capital goods used by the year’s production, so it somewhat exaggerates the value of the output available. NDP makes allowance for this money spent by subtracting depreciation (consumption of fixed capital) from GDP.

For NDP to grow year to year, the stock of capital must increase. 

 

Types of Income

National Income (NI) - National Income includes all income earned by US-owned resources, whether located at home or abroad. To calculate NI, we must subtract net foreign factor income earned in the United States (since it isn’t US-owned resources) and the indirect business taxes (since government isn’t an economic resource and indirect taxes aren’t a payment to resources.)

Personal Income (PI) - Personal Income includes all income received, whether earned or unearned. This is NI – social security contributions – corporate income taxes – undistributed corporate profits + transfer payments.

Disposable Income (DI) -This is the amount of money households can spend. It is PI minus personal taxes.

 

 

Inflation

CPI

 

Inflation

This is the increasing general level of prices from year to year. The rate of inflation is calculated by the formula

 

If the rate of inflation is less than 3 percent (and greater than 0 percent, of course), it is considered “acceptable”.

 

Types of Inflation

Demand-pull inflation: more spending than the economy’s capacity to produce. The excess demand increases the prices of the limited real output, causing prices to rise.

Cost-Push (Supply-side) inflation: Per-unit production costs (total input cost ÷ units of output) rise, reducing the amount of companies willing to sell products at the current price level. Then, supply decreases, causing the price level to increase. 

 

Wage Price Spiral

As price level rises, labor will demand and get higher nominal wages. Businesses will agree, hoping to get back the money by increasing prices. Then, as prices increase even more, labor will find that it has a reason to demand even more wage increases, but that causes more prices increases, and so on. 

 

Rule of 70

If we divide 70 by the annual rate of inflation, this quotient is the number of years it takes for inflation to double the price level. 

 

Fighting Inflation

We can fight inflation by trying to reduce demand or by trying to prevent a wage-price spiral from getting out of hand. We can use either fiscal or monetary policy (means of doing so is explained later). Fiscal action will result in a budget surplus. 

 

Real vs Nominal Values

A Nominal value is an un-adjusted value. A Real value is a nominal value adjusted for inflation.

 

Therefore, we can’t just look at nominal values when trying to determine the status of the economy. Since lots of inflation can lead to very high nominal values, we can get a false impression that the economy is doing well when the real value is perhaps even decreasing.

 

Inflationary Expectations

The effects of unexpected inflation are:

• It hurts people with fixed nominal incomes, since the money they earn isn’t worth as much anymore.
• It hurts people who save in fixed-value accounts
• It benefits debtors (borrowers) while hurting creditors (lenders).

The effects of inflation can be lessened if people expect it (anticipated inflation), since then they can get a chance to prepare for the damages that the inflation may cause.

For example, a person who has a fixed nominal income can try to adjust it if they know that its value is going to decrease. Many unions have labor contracts with cost-of- living adjustment (COLA) clauses, in which workers’ wages increase if there is inflation.

 

Unemployment

Types of Unemployment

1. Frictional – includes workers who are searching for jobs or waiting to take jobs in the near future. This unemployment is inevitable, since many workers switch to better jobs.
2. Structural – changes over time in consumer demand and technology change the “structure” of total demand for labor. Some skills will not be needed as much or become obsolete, and new skills will appear. This is a mismatch between job seekers’ skills and the skills needed for the job. This is also inevitable because the demand for labor will always change over time as new technologies arise.
3. Cyclical – this type of unemployment is caused by recession. People who are laid off because of decreased overall spending in the economy.

Full Employment

This is NOT zero unemployment, as frictional and structural unemployment are regarded as unavoidable in an economy. Therefore, full employment means no cyclical unemployment, and the full-employment rate is equal to the frictional plus structural rates. It is also called the natural rate of unemployment. 

 

Employment Solutions

In order to decrease cyclical unemployment, we must try to increase overall spending in the economy so businesses find their inventories decreasing and so hire more people. We do this by increasing aggregate demand with fiscal or monetary policy. 

 

Unemployment Calculations

Unemployment means unemployment in the labor force, not the whole population. The labor force is total population – under 16 and/or institutionalized – people not in the labor force. Then, the unemployment rate is 

 

 

Criticism of Unemployment Rate

The unemployment rate has been subject to some criticism, however.

First of all, part-time workers are counted as fully employed; however, some part-time workers are people who can’t get a full-time job because of recession. This tends to understate the unemployment rate.

Also, discouraged workers who are not actively searching for jobs anymore are not counted in the labor force. This understates the unemployment rate, especially in recession. 

GDP Gap

This is the amount by which actual GDP falls short of potential GDP (the GDP that can be attained at the natural rate of unemployment). 

 

 

Watch the videos below for additional information on these topics.

  

 

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