GDP measures 2 Things
1. The total Income of everyone in the economy
2. The total expenditure on the economy's output of goods and services
For an economy as a whole income must equal expenditure
Gross Domestic Product
The market value of all final goods and services produced within a country in a given period of time
Gross National Product (GNP)
The market value of all final goods and services produces by a country's permanent residents wherever located in a given time period
GDP equation
GDP= C + I + G + NX
consumption + investment + government +net exports
Consumption
Spending by households on goods and services with the exception of purchases of new housing
Household spending on education is also included in consumption of services
Investment
The purchase of goods that will be used in the future to produce more goods and services
Sum of purchases of capital equipment, inventories, and structures
Includes expenditure on new housing
Government Purchases
Spending on goods and services by local, state, and federal governments
Includes the salaries of government workers as well as expenditure on public works (social security and unemployment is a transfer payment and are not included)
Net Exports
The foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports)
Imports- Exports
Nominal GDP
The production of goods and services valued at current prices
(Price x quantity) + (Price x Quantity)
Uses current prices to place a value on the economy's production of goods and services
Real GDP
The production of goods and services valued at constant prices
Must designate a base year- keep prices constant when figuring out the GDP, but quantity changes
Uses constant base year prices to place a value on the economy's production of goods and servic
GDP Deflator
A measure of the price level- measures the current level of prices relative to the level of prices in the base year
Nominal GDP / Real GDP x 100
GDP deflator in base year is always 100
Inflation Rate
The percentage change in some measure of the price level from one period to the next
(GDP Deflator year 2 - GDP Deflator Year 1) / GDP Deflator Year 1 (x 100)
(CPI year 2 - CPI year 1) / CPI year 1 (x 100)
What is Not included in GDP
Underground Economy- illegal or underground market transactions
Illegal- drugs, counterfeit DVD's, ect.
Underground- getting paid under the table- Legal activities paid for under the table to avoid taxation
Used goods- because used goods aren't new produc
Macroeconomics
The study of economy-wide phenomena, including inflation, unemployment and economic growth
Microeconomics
The study of how households and firms make decisions and how they interact in the market
Consumer Price Index
A measure of the overall cost of goods and services bought by a typical consumer
How is CPI calculated
Fix the basket
Find the Prices
Compute the baskets cost
Choose a base year and compute the index
Consumer Price Index Equation
Price of basket in Current year / Price of basket in base year (x 100)
Producer Price Index
A measure of the cost of a basket of goods and services bought by firms
Problems with CPI
Substitution Bias
The Introduction of new products
Unmeasured quality change
Substitution Bias
Not all prices change proportionally from one period to another. Consumers respond by substituting towards goods that have become relatively less expensive
Introduction of New Products
Takes time for them to be incorporated into basket
Unmeasured Quantity Change
Because quality is hard to measure, CPI has a hard time keeping up with quality changes even though it tries to measure a constant change in quality
Differences between GDP and CPI
GDP deflator reflects the prices of all goods and services produced domestically, whereas CPI reflects the prices of all goods and services bought by consumers
GDP deflator includes production for export
CPI include imports consumed by consumers
CPI measu
Indexation
The automatic correction by law or contract of a dollar amount for the effects of inflation
Cost of Living Allowance (COLA)
A COLA automatically raises the wage when consumer price index rises
Nominal Interest Rate
Usually exceeds the real interest rate
the interest rate not adjusted for inflation, it measures the change in dollar amounts
Real Interest Rate
The interest rate corrected for the effects of inflation
measures the change in purchasing power
How to measure GDP
Income Approach
Expenditure Approach
Fisher Equation
Real Interest Rate = Nominal Interest Rate- Inflation Rate
Income Approach
Add all the components of national income
GDP= Wages + Rent + Interest + Profit
Expenditure Approach
Measures GDP by adding up all the market values of all final goods and services
GDP= Consumption + Investment + Gov. Spending + Net Exports
Unemployment Rate
Percentage of those in the labor force without jobs
Measured by the BLS- survey each month of 60000 households
Cyclical Unemployment
Year to year fluctuations in unemployment around its natural rate- associated with the business cycle
Frictional Unemployment
Unemployment that results because it takes time for workers to search for the jobs that best suit their tasks and skills
Structural Unemployment
Joblessness created by structural changes in labor demand
People who lack marketable skills and whose jobs have become obsolete
Medium of Exchange
An item buyers give when they want to purchase goods or services
Store of Value
Item that people can use to transfer purchasing power from the present to the future
Liquidity
The ease with which an asset can be converted into the economy's medium of exchange
Reserves
Deposits that banks have received but have not loaned
Money Multiplier
The amount of money the banking system generates with each dollar of reserves
Reserve Ratio
The fraction of deposits that banks hold as reserves
Discount Rate
The interest rate on loans the Fed makes to banks
Federal Funds Rate
The short term interest rate that banks charge one another for loans