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Gross Domestic Product (GPD)

total market value of all final goods and serves produced within the borders of a nation in a period of time


Nominal GDP

- measured in “today’s” prices
- measures the value of all final goods and services in prices prevailing at the time of production (current prices)


Real GDP

- measured in “base year” prices
- measures the value of all final goods and services in constant prices.
- It is adjusted to account for changes in the price level.
- Real GDP is the most commonly used measure of economic activity and national output,


Price Index

GDP Deflator - calculates real GDP
It is a price index for all goods and services included in GDP.

Real GDP = (Nominal GDP / GDL deflator ) x 100


Real GDP per Capita and Economic Growth

Real per capital GDP = real GDP / population


Economic growth

the increase in real GDP per capita over time


Business Cycles

1. Expansionary phase - rising economic activity and growth
2. Peak - high point of economic activity
3. Contractionary phase - falling economic activity and growth
4. Trough - low point, the lowest level
5. Recovery phase - increase



- below long term average growth
- two consecutive quarters of falling national output
- negative real economic growth



- a very severe recession
- a relatively long period of stagnation


Economic indicators

1. Leading indicators
2. Lagging indicators
3. Coincident indicators


Leading indicators

Predicting before the fact actually happens
- average new unemployment claims
- building permits for residences
- average length of the workweek
- money supply
- prices of selected stocks
- orders for goods
- prices changes of materials
- index of customer expectations


Lagging indicators

Predicting after the fact happened
- prime rate charged by banks
- average duration of unemployment
- bank loans outstanding


Coincident indicators

Occur at the same time as the economic activity
- industrial production
- manufacturing and trade sales


Reasons for fluctuations

business cycles result from shifts in aggregate demand and/or aggregate supply


Aggregate Demand (AD) Curve

the maximum quantity of all goods and services that households, firms and the government are willing and able to purchase at any given price level


Aggregate Supply (AS) Curve

the maximum quantity of all goods and services producers are willing and able to produce at any given price level
1. Short run aggregate supply curve - upward sloping, Price UP/ Production UP
2. Long run aggregate supply curve - vertical line, potential level of output in the economy, independent of price level, resources available to produce
3. Potential level of output - the level of real GDP that the economy would produce if its resources were fully employed
Real GDP below the potential level of output - recession
Above - expansion


Aggregate demand, aggregate supply and economic fluctuations

business cycles are results of shifts in aggregate demand and short run aggregate supply


Reduction in demand

IF reduced demand, real GDP will decline, leading to a contraction in economic activity and possibly a recession.


Increase in demand

if increased demand, GDP will rise, employment, reduction in excess capacity leading them to increase the size of their workforce


Factors that shift aggregate demand

1. Changes in wealth
a. Increase - aggregate demand shifts to the right
b. Decrease - ag. demand left
2. Changes in Real Interest Rates
a. Increase - reduction in demand
b. Decrease - increase
3. Changes in expectations about the future economic outlook
a. Confident - demand up
b. Uncertain - demand down
4. Changes in Exchange rates
a. Appreciated - expensive foreign demand, aggregate demand down
b. Depreciated - cheap for foreigners, demand up
5. Changes in Government spending
a. Increase - demand up
b. Decrease - down
6. Changes in Consumer Taxes
a. Increase - demand down (shifts to left)
b. Decrease - up


Multiplier effect

an increase in consumer, firm or government speeding produces a multiplied increase int he level of economic activity.
The multiplier effect results from the marginal propensity to consume (MPC)
Multiplier = 1 / (1-MPC)
Change in real GDP = Multiplier = Change in spending


Factors that Shift short run aggregate supply

1. Changes in input prices
a. increase in input prices - shift left
b. decrease in input prices - shift to right
2. Supply shocks
a. plentiful - right
b. curtailed - left


Economic measures

1. Real gross domestic product
2. Unemployment rate
3. Inflation rate
4. Interest rate


The National Income and Product Accounting (NIPA

developed by the US Department of Commerce in order to monitor the health and performance of the US economy.


Expenditure Approach

1. Government purchases of goods and services
2. Gross private domestic investment
3. Personal consumption expenditures
4. Net Exports (exports - imports)


Income Approach

1. Income of proprietors
2. Profits of corporations
3. Interest
4. Rental income
5. Adjustments for net foreign income and misc items
6. Taxes (indirect business taxes)
7. Employee compensation (wages)
8. Depreciation (capital consumption allowance)


Comparison of approaches

Expenditures approach (flow of product) = Income Approach (earnings and costs)


Net Domestic Product

GDP less depreciation (capital consumption allowance)


Gross National Product (GNP)

market value of final goods and services produced by residents of a country in a given time period


Net National Product (NNP)

Gross National Product less economic depreciation


National Income

Net National Product less indirect business taxes


Personal Income

income received by households and non corporate businesses


Disposal Income

personal income less personal taxes


Unemployment rate

measures the ratio of the number of people classified as unemployed to the total labor force.


Labor force

- noninstitutionalized individuals 16 years of age or older who are working or looking for work


Unemployment rate formula

(Number of unemployed / Total labor force) x 100


Types of unemployment

1. Frictional unemployment
2. Structural unemployment
3. Seasonal unemployment
4. Cyclical unemployment


Frictional unemployment

normal unemployment resulting from workers routinely changing jobs or from workers being temporarily laid off.


Structural unemployment

- jobs available in the market do not correspond to the skills of the workforce
- unemployed workers do not live where the jobs are located


Seasonal unemployment

seasonal changes in the demand and supply of labor


Cyclical unemployment

amount of unemployment resulting from declines in real GDP during periods of contraction or recession or in any period when the economy fails to operate at its potential


Natural rate of unemployment

normal rate of unemployment around which the unemployment rate fluctuates due to cyclical unemployment.


Full employment

level of unemployment when there is no cyclical unemployment (there is still some unemployment)

natural rate = full employment



sustained increase in the general prices go goods and services



sustained decrease in the general prices of goods and services


Inflation/Deflation rate

% change in the customer price index (CPI) from one period to the next


Consumer Price Index (CPI)

measure of the overall cost of a fixed basket of goods and services purchased by an average household


Consumer Price Index Formula

Inflation rate = ((CPI this period - CPI last period)/CPI last period) x 100


Causes of inflation and deflation

- caused by shifts in the aggregate demand and short run aggregate supply curves
- shift right aggregate demand - price level rises - inflation
- shift left short run aggregate supply - price level rises - inflation


Demand pull inflation

Caused by increases in aggregate demand
- increases in government spending
- decreases in taxes
- increases in wealth
- increases in the money supply


Cost push inflation

Caused by reduction in short run aggregate supply
- increase in oil price
- increase in nominal wages



caused by shifts in aggregate demand or short run aggregate supply
- shift left in aggregate demand - prices fall
- shift right in short run aggregate supply - prices fall


Inflation and the Value of Money

Inflation has an inverse relationship with “purchasing power” As price level rises, the value of money decline.


Monetary assets and liabilities

fixed in dollar amounts regardless of changes in specific prices or the general price level


Nonmonetary assets and liabilities

value of non monetary assets and non monetary liabilities will fluctuate with inflation and deflation


Holding monetary assets

Inflation - money lose value


Holding monetary liabilities

Inflation - fixed amount of debt good for creditors not good for companies that lend money


The Philips Curve

inverse relationship between the rate of inflation and the unemployment rate


Budget deficits

occurs when a country spends more than it takes in taxes


Financial budget deficits

financed by government borrowing, which affects interest rates. The government could also finance budget deficits by printing new money.


Cyclical budget deficit

caused by temporarily low economic activity.


Structural budget deficit

caused by a structural imbalance between government spending and revenue


Budget Surpluses

occurs when government revenues exceed government spending during the year


Nominal Interest Rate

amount of interest paid measured in current dollars. When the economy experiences inflation, nominal interest rates are not a good measure of how much borrowers really pay or lenders really receive when they take out or make a loan.


Real Interest Rate

the nominal interest rate less the inflation rate

Real interest rate = Nominal interest rate - Inflation rate


Relationship between nominal interest rates and inflation

Nominal interest rates and inflation tend to move together.
When the inflation rate increases, so does the nominal interest rate.

Nominal interest rate = Real interest rate + Inflation



set of liquid assets that are generally accepted in exchange for hoods and services.


Money supply

stock of all liquid assets available for transactions in the economy at any given point in time



money that is used for purchases of goods and services (coins, currency, checkable deposits)



M1 plus liquide assets that can’t be used as a medium of exchange but that ban be converted easily into checkable deposits or other components of M1 (savings accounts, mutual fund accounts etc)



M2 plus time certificates of deposits in excess of $100000


Monetary policy and the money supply

use of the money supply to stabilize the economy


The Federal Reserve controls the money supply by

1. Open market operations
a. Increase in the Money supply
b. decrease in the money supply
2. Changes in the discounts rates
3. Changes in the required Reserve Ratio


Demand for money is inversely related to interest rates

interest rates are determined by the supply of and demand for money


Supply of money is fixed at a given point in time

the supply of money is determined by the Federal Reserve and is fixed at any given point in time at the level set by the Federal Reserve


Expansionary monetary policy

- increase in the monetary supply
- interest rates fall
- reduce the cost of capital
- increase in aggregate demand shift to the right
- real GDP rise, unemployment falls, price level rise


Contractionary monetary policy

- decrease in the money supply
- interest rates increase
- reduced investments and spending
- decrease in aggregate demand shift to the left
- unemployment rate rises, prices fall


Will cause inflation

Aggregate demand increase
Aggregate supply decrease


Full employment

no cyclical unemployment only natural unemployment


Cyclical unemployment results from



Cost push inflation

- inflation caused by a shift left in aggregate supply
- increase in input costs will cause the aggregate supply curve to shift left


The discount rate set by the Federal Reserve

the rate established by the feds for short term loans the fed makes to member banks


The Fed increases the money supply

1. Federal open market committee purchasing or selling government securities
2. Raising or lowering the discount rate
3. Changing the reserve ratio


The Fed implements an expansionary monetary policy

- purchase additional US Government securities
- lower the discount rate


To decrease the money supply, the Fed

- sells government securities on the open market
- increase the discount rate
- increase the required reserve ratio


To increase the money supply, the Fed

- buy government securities in the open market
- lower the discount rate
- lower the required reserve ratio


Increase in the money supply leads to

- decline in interest rates
- increase in investment
- increase in aggregate demand
- aggregate demand shifts to the right


An increase in the discount rate would cause

- the money supply to decrease
- interest rates to rise


Reduction in inflation

- decrease in aggregate demand
- increase in aggregate supply


nominal interest rate is 8%
inflation rate is 6%
Real rate of interest?



The inflation rate measures

the rate of increase in the overall price level in the economy



a combination of rising unemployment and a rising price level


The relationship between nominal interest rates and inflation

Nominal Interest rate = Real Interest Rate + Inflation

The overall price level is rising, nominal interest rates are rising too


CPI - Customer Price Index

- measures the costs of a market basket of specific goods commonly purchased by customers.
- it measures consumer buying power and is not distorted by items generally bought by industry


GDP calculation under expenditure approach

Total expenditures in the domestic economy are added up
+ government purchases of goods and services
+ gross private domestic investment
+ personal consumption expenditures
+ net exports - imports


GDP calculation under income approach

Total value of resources costs and incomes generated during the measurement period

+ income of proprietors
+ profits of corporations
+ interest
+ rental income
+ adjustments for net foreign income
+ taxes
+ employee compensation
+ depreciation


Causes of demand pull inflation

- increases in aggregate demand
- increases government spending
- decreases in taxes
- increases in wealth
- increases in consumer confidence
- increases in the money supply


Causes of cost push inflation

- reductions in short run aggregate supply
- increase in oil prices
- increase in nominal wages


Nominal GDP

measures the value of all final goods and services produced within the borders of a nation in terms of current dollars


Real GDP

measures the value of all final goods and services produced within the borders of a nation in terms of constant prices


Gross Domestic Product GDP

total market value of all final goods and services produced within the borders of a nation in a particular period.


Federal Reserve can increase money supply

1. Open market operations: purchase government securities on the open market
2. Changes in the discount rate: lower the discount rate
3. Changes in the required reserve ratio: lower the required reserve ratio


Business cycle

1. Expansionary phase: rising growth in economic activity
2. Peak: high point
3. Contractionary phase: declining growth in economic activity
4. Trough: low point of economic activity



a period during which real GDP is falling for at least two consecutive quarters.
Falling real output and rising unemployment


Business cycle

- the rise and fall of economic activity relative to its long term growth trend.
- Business cycles vary in duration and severity



- severe recession
- long period of falling real GDP and high rates unemployment


Business cycles result from

shifts in aggregate demand and aggregate supply


Factors that shift aggregate demand

- wealth
- real interest rates
- expectations about the future economic outlook
- exchange rates
- government spending
- costumer taxes


Factors that shirt short run aggregate supply

changes in input resource prices supply stock