Class Lecture Notes Measuring the Macroeconomy
Professor Shari Lyman, Ph.D.
GDP Measures
GDP is Gross Domestic Product
GDP is the value of all new final goods and services produced within a country’s borders by its
own citizens or foreign citizens in a given time period.
GNP is Gross National Product
GNP is the value of all new final goods and services produced by a country’s citizens within the
country’s borders or in foreign lands in a given time period. d
http://www.diffen.com/difference/GDP_vs_GNP
Intermediate goods are used to produce other goods. For example, when Pizza Hut buys cheese
to produce pizzas, the cheese is an intermediate good.
Final goods are purchased by the end user. When the Lyman household purchases cheese,
the cheese is a final good.
GDP is represented by the variable Y in macroeconomic calculations.
The formula for GDP is:
Y=Consumption(C)+Investment(I)+Government Expenditures(G)+Net Exports(X-M).
Consumption (durable and non-durable goods and services for individual household
consumption)
Investment (Consumption of new physical capital and new housing such as factories, machines,
tools, transportation systems, new houses, etc.) Investment is purchased using financial capital
instruments.
Government expenditures (all Federal, State, and Local government purchases from paper clips
to aircraft carriers).
Net Exports (Trade Balance=Exports-Imports)
Macroeconomic Measures introduces the student to 3 different methods of measuring GDP:
1.the incomes approach (simplified circular flow model-resource flow approach)
2.the expenditures approach (simplified circular flow model (D) money flow approach)
3.the output approach (simplified circular flow model (S) product flow approach).
Incomes Approach (Input/resource approach)
GDP (also known as national income which is indicated by Y) is equal to the inputs used in the
production process. d The inputs include:
land in the form of rent
labor in the form of wages
capital in the form of interest
entrepreneurship in the form of profit.
Y = rent + wages + interest + profit.
Expenditures Approach (Demand side approach)
GDP (also known as aggregate demand (AD) which is indicated by Y) is equal to the total output
demanded in the economy. d The outputs include:
consumption
investment
government expenditures
net exports
Y=Consumption(C)+Investment(I)+Government Expenditures(G)+Net Exports(X-M)
Output Approach (Supply side approach)
GDP (also known as national output which is indicated by Y) is equal to the outputs supplied to
the economy. d The outputs include:
household goods (durable and nondurable goods and services)
investment goods (new housing and capital)
government (durable and nondurable goods and services)
net exports (goods for export minus goods imported)
Y = Household (C) + Firm and HH (I) + (G) + Net Exports (X-M)
The Keynesian Consumption (Spending) Multiplier
The Keynesian Consumption Multiplier is based on the assumption that for each additional
dollar a household receives some portion of that dollar will be spent on the consumption of
goods and services and some portion will be saved:
To calculate the Multipliers, one must understand the marginal propensity to consume (mpc)
and the marginal propensity to save (mps).
For each additional dollar one receives, one will consume with a portion and save a portion.
mpc + mps = 1
mpc + mps cannot equal more than 1 or less than 1, it must equal 1.
MK = 1/mps
Given that 1 is mps + mpc. d This is a math identity.
We can restate MK = 1/(mps) to the following:
MK = 1/[(1 - mpc)]
Therefore, given mps or mpc, one can calculate the MK.
Once the MK is calculated, one can determine the effects of policy on the overall economy in
that the initial change in one of the GDP variables (C, I, G, or X-IM) will generate a greater
change in GDP:
Change in Y = MK [change in C, change in I, change in G, or change in (X-IM)]
The Keynesian Tax Multiplier
The Keynesian Tax Multiplier uses the notion that taxes affect Y through C using the same
ideas of mps and mpc.
MT = -[(mpc)/(mps)]
Therefore, given mps or mpc, one can calculate the MT.
Once the MT is calculated, one can determine the effects of policy on the overall economy in
that the initial change in taxes will generate a greater change in GDP:
Change in Y = MT (change in T)
Business Cycle
Business cycle is defined as the alternating periods of economic expansion and economic
recession.
The business cycle is made up of expansionary (growth, inflationary, upswings, positive) periods
in which:
1. d The overall price levels are increasing (inflation)
For healthy economic growth, the inflation should be creeping inflation.
2. d The unemployment levels are decreasing.
3. d The national output (GDP) is increasing.
The growth period will reach its highest point (peak), then the business cycle will enter a
downturn.
The business cycle is made up of contractionary (slowdowns, downturn, recessionary, negative)
periods in which
1. d The overall price levels are decreasing (deflation)
2. d The unemployment levels are increasing.
3. d The national output (GDP) is decreasing.
The slowdown period will bottom out at its lowest point (trough), then the business cycle will
enter an upturn.
Unemployment
Unemployed is defined as:
actively seeking paid work
not currently engaged in paid work
at least age 16
Employment is working full or part time as a paid worker.
Unemployment rate is the percentage of the labor force that is not working, but actively seeking
work.
If unemployment is increasing, it is demonstrated as a downturn on the business cycle and a
shift inward to the left of the aggregate demand curve. when accompanied by decreasing prices
and decreasing GDP. This type of unemployment can be resolved using traditional
contractionary fiscal and/or monetary policies.
Labor Force is the sum of the employed and the unemployed workers in the economy.
Discouraged worker is someone who is available for paid labor, but has given up looking for
work.
Labor Force Participation Rate is the percentage of the working age population in the labor force.
The Three Main Categories of Unemployment
Frictional Unemployment is short term unemployment arising from the process of matching
workers with jobs. d This is a household level (microeconomic) unemployment that is considered
very temporary.
Structural Unemployment is a persistent mismatch between skill sets and characteristics of
workers and the job requirements. This is a household level (microeconomic) unemployment that
is considered more permanent requiring retraining, re-skilling, and re-education of the labor unit.
However, if this type of obsolescence occurs on a large scale in a specific industry or group of
industries, then it may become a regional or national level (macroeconomic) unemployment that
requires government funding for education and training programs.
Natural Rate of Unemployment (Full-Employment Unemployment) is the sum of frictional
unemployment and structural unemployment. This is due to the natural changes in a dynamic
developing and growing economy.
Cyclical unemployment occurs when the macroeconomy enters a recessionary phase on the
business cycle due to a decrease in aggregate demand. This type of unemployment indicates
the economy is suffering loss in output. According to Keynes, this is when expansionary fiscal
and/or monetary policies would benefit an economy by stimulating demand to which supply can
respond positively.
Inflation
Inflation is a general increase in the overall price level.
The Three Main Categories of Inflation
Creeping inflation is a low-level, steady increase in overall price level that demonstrates a
steady, healthy growing economy. In the US economy, creeping inflation generally is considered
any inflation between 0% and 3%. This type of inflation allows for growth in the resource market
and the product market at a rate that can be accommodated with increases in demand and
supply, as well as slight increases in prices, including wages.
http://useconomy.about.com/od/inflationfaq/tp/Types-of-Inflation.htm
Galloping inflation is a fast-paced inflation at a rate of 10% or greater for the US economy.
This type of inflation is disruptive to both consumers and producers since prices are not easily
maintained or predicted.
http://useconomy.about.com/od/inflationfaq/tp/Types-of-Inflation.htm
Hyperinflation is a rapid increase in price levels at a rate of 50% or more. This is a very
destabilizing type of inflation that may create instability in the economy and the political system.
This type of inflation creates a vacuum in the social-political-economic system as seen during
the US Civil War, during the 1920s in Germany, in many Latin American countries in the 1980s,
and during 2004-2009 in Zimbabwe.
“Hyperinflation is when the prices of most goods and services skyrocket, usually more than
50% a month. It usually starts when a country's Federal government begins printing money to
pay for fiscal spending. As the money supply increases, prices creep up as in regular inflation.
However, instead of tightening the money supply to lower inflation, the government keeps
printing more money to pay for spending. Once consumers realize what is happening, they
expect inflation. This causes them to buy more now to avoid paying a higher price later. This
boosts demand, causing inflation to spiral out of control. The only winners in hyperinflation are
those who borrowed before the hyperinflation. They find that higher prices makes their debt
worth less by comparison, until it is virtually wiped out.”
http://useconomy.about.com/od/inflationfaq/tp/Types-of-Inflation.htm
Hyperinflation may create a political vacuum in which leadership crumbles and new leaders such
as Adolf Hitler are able become the champion of stability and a good economy regardless of
their other dangerous rhetoric and violence.
Two Causes of Inflation
Demand-Pull Inflation is a general increase in the overall price level due to an increase in
aggregate demand.
This type of inflation is demonstrated by an outward shift to the right of the Aggregate Demand
curve. d In small increments, it demonstrates creeping inflation which indicates a healthy, growing
economy. In larger increments, it may demonstrate galloping or hyperinflation which are
destabilizing to the economy.
Also, this type of inflation is demonstrated by the expansionary phase on the business cycle.
This type of inflation, if considered creeping inflation, is an indicator of a healthy, growing
economy due to the increases in price levels, decreases in unemployment, and the increases in
GDP.
If this type of inflation becomes a problem, it can be resolved using traditional contractionary
fiscal and/or monetary policies.
Cost-Push Inflation is a general increase in the overall price level due to a decrease in
aggregate supply.
This type of inflation is demonstrated by an inward shift to the left of the Aggregate Supply curve
due to an increase in price and/or decrease in availability of a significant input (resource) into
the production process.
This type of inflation cannot be demonstrated on the business cycle.
This type of inflation is an indicator of an economy experiencing loss and economic challenges
that cannot be resolved with traditional fiscal and/or monetary expansionary or contractionary
policies due to the increases in price levels, increases in unemployment, and the decreases in
GDP.
This type of inflation cannot be resolved using traditional fiscal and monetary policy tools. Cost-
Push Inflation can result in stagflation in which the government must step outside the realm of
economic policies and use diplomacy, political policies, military actions, and other resolutions.
http://useconomy.about.com/od/inflationfaq/tp/Types-of-Inflation.htm
