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Flashcards in Chapter 14 Part 1 Deck (20):

GNP measures the

total value of all goods and services produced by a national economy. For the U.S., this measure would include both goods and services produced domestically as well as overseas by a U.S. company.


Gross Domestic Product has replaced Gross National Product as the most important measure of output and spending within the United States. GDP is the

output of goods and services produced by labor and property located in the United States, without regard to the origin of the producer. For example, a Toyota plant in Columbus, Ohio is part of U.S. GDP. Components of GDP include consumer spending, investments, government spending, and net exports.


The most useful variation of GDP is

real GDP, which is GDP adjusted for inflation using constant dollars. This is considered the key measure of aggregate economic activity. Rising GDP signifies economic growth and potential inflation.


Inflation is a

persistent and appreciable rise in the general level of prices. Inflation occurs when the demand for goods and services in the market increases at a faster rate than the supply of these items. In other words, there is too much money chasing too few goods.


The Consumer Price Index (CPI) is

widely considered the most important measure of inflation. The CPI measures the prices of a fixed basket of goods bought by a typical consumer. If prices, as measured by the CPI, are rising, then the economy is experiencing inflation.


Inflationary periods are typically characterized by rising interest rates. Interest-rate-sensitive stocks, such as those issued by

utilities, react to changes in interest rates. Since utility companies are highly leveraged, it becomes more expensive for these companies to raise money when interest rates increase. Interest charges increase, causing a drain on earnings, resulting in a decline in prices of these securities.


Inflation represents a double whammy for bondholders

interest rates rise, causing the market price of their holdings to fall, while the purchasing poWer of their interest payMents also decreases. lnvestments in gold are also considered a good
hedge against inflation. Inflalionary risk is also referred to as purchasing-power risk


Deflation is a

persistent and appreciable decline in the general level of prices. If the supply of goods and services is greater than the demand for those items, then producers will need lo lower their
prices to compete for the limited demand. If this is the case on a broad scale, deflation will take place.


Deflation should not be confused with disinflation. While deflation is a drop in prices, disinflation is

a reduction in the rate of inflation


Stagflation is a

prolonged period of a high rate of inHation at the same time as a high rate of unemployment. This docs not happen often since high unemployment usually leads to a period of low inflation or even deflation (falling prices) and the possibility of a recession. A period of low unemployment usually leads to rising prices and increased inflation


The business cycle has four phases:

expansion (recovery), peak, contraction (decline), and trough


In the expansion phase, business activity is

growing, production and demand increasing, and employment expanding. Businesses and consumers normally borrow money to expand, causing interest rates to rise.


As the cycle moves into the peak

demand for goods overtakes supply and prices rise, creating inflation. During inflationary times, there is too much money chasing a limited amount of goods. Businesses are able to charge more for their products, causing prices to rise, and reducing the purchasing power of the consumer.


As prices rise, demand slackens, which causes economic activity to decrease. The cycle then enters the contraction phase.

As business activity contracts, employers lay off workers, unemployment increases, and demand slackens. Usually, this causes the rate at which prices are rising (tending toward inflation) to decline (tending toward disinflation). The situation where prices are actually falling in real terms is called deflation. The cycle enters the trough at the bottom of the economy's decline. Eventually, lower prices will stimulate demand and the economy moves into a period of renewed expansion called a recovery.


By definition, a recession occurs when

Real GDP declines for two successive quarters (six months).


A depression occurs when

Real GDP declines for a more prolonged period.


Economists use three types of indicators that provide monthly data on the movement of the economy as the business cycle enters different phases. The three types are

leading, coincident, and lagging economic indicators


Leading economic indicators precede the

upward and downward movements of the business cycle. They may also be used to predict the near-term activity of the economy.


Leading Economic Indicators

The average workweek for production workers in manufacturing; The average weekly initial claims for state unemployment insurance; New orders for consumer goods and materials; Vendor performance (companies receiving slower deliveries from suppliers); Contracts and orders for plant and equipment; New building permits for private housing units; The prices for the S&P 500 Index of common stocks; The Money Supply (M2); The change in credit outstanding for business and consumer borrowing; Interest- rate spreads, 10-year Treasury bonds less federal funds; Index of consumer expectations


Coincident indicators usually

mirror the movements of the business cycle.

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