Chapter 12: Introduction to GDP, Growth, and Instability

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PART FIVE Macroeconomic Measurement, Models, and Fiscal Policy

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Chapter 12: Introduction to GDP, Growth, and Instability

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Gross Domestic Product Gross domestic product (GDP) is the total market value of all final goods and services produced annually within the U.S., whether by U.S. or foreign-supplied resources. GDP is determined by the Bureau of Economic Analysis (BEA), an agency of the Commerce Department, and is the primary measure of the economy’s performance.

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Gross Domestic ProductGDP is a monetary measure. It compares the relative value of goods and services produced in different year. To avoid counting components that are bought and sold multiple times, GDP includes on the market value of final goods and ignores intermediate goods altogether.

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Gross Domestic ProductSecondhand goods are also excluded from GDP since they do not contribute to current production. These goods were previously counted in the year they were produced.

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Measuring GDPThe four categories of expenditures that provide a measure of the market value of total output in a particular year include: Personal consumption expenditure (C) Gross Private Domestic Investment (Ig) Government Purchases (G) Net Exports (Xn)

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Personal consumption expenditure (C)All expenditures by households on durable consumer goods, nondurable consumer goods and consumer expenditure for services are included in personal consumption expenditure.

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Gross Private Domestic Investment (Ig)Gross private domestic investment includes (1) all final purchases of machinery, equipment, and tools by business enterprises, (2) all construction, and (3) changes in inventories.

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Measuring GDPGovernment purchases includes spending for products that government consumes in providing public services and expenditure for social capital. Net exports are exports minus imports. Adding It Up: GDP = C + Ig + G + NX

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Nominal GDP versus Real GDPIt is difficult to compare values over time without correcting them for inflation or deflation. The monetary value of GDP changes from year to year either due to changes in prices and output. Nominal GDP, or unadjusted GDP, is gross domestic product in terms of the price level at the time of measurement.

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Nominal GDP versus Real GDPTo compare the market value of the quantity of goods and services produced from year to year, an adjustment to inflate GDP when prices rise or deflate GDP when prices fall is required.

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Nominal GDP versus Real GDPReal GDP, or adjusted GDP, is gross domestic product measured in terms of the price level in a base period (or reference year). It is a GDP that has been deflated or inflated to reflect changes in the price level.

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Economic Growth An expansion of real GDP (or real GDP per capita) over time is economic growth. It is calculated as a percentage rate of growth per quarter or per year. Real GDP per capita (or output per person) is found by dividing real GDP by the size of the population.

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Economic GrowthEconomic growth is an economic goal of government since it raises the standards of living in society and lessens the burden of scarcity. Two fundamental ways society can increase its real output and income are: by increasing its inputs of resources by increasing the productivity of those inputs

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Business CyclesBusiness cycles are recurring increases and decreases in the level of economic activity over periods of time. The four phases of a business cycle are recession, trough, expansion and peak. Individual cycles vary substantially in duration and intensity.

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Business Cycles

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Business CyclesThe two primary phases are recession and expansion. A recession is a period of declining real GDP, accompanied by lower income and higher unemployment. An expansion is a generalized increase in output, income, and business activity. The twin problems that arise from business cycles are unemployment and inflation.

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UnemploymentThe Bureau of Labor Statistics (BLS) is charged with reporting unemployment figures, such as the number of persons employed, the unemployment rate, and the number of persons in the labor force. Data is based on a monthly nationwide random survey of some 60,000 households.

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Measurement of UnemploymentThe total U.S. population is divided into three groups. People under 16 years of age and those who are institutionalized Adults that are “not in the labor force”; those who are potential workers but are not employed and not seeking work Adults who are in the labor force; those who are either employed or unemployed and seeking work

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Measurement of Unemployment

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Measurement of Unemployment The unemployment rate is the percentage of the labor force unemployed. Unemployment rate = x 100 unemployed labor force

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Types of UnemploymentThe three types of unemployment are frictional, cyclical, and structural. Frictional Unemployment, consisting of search unemployment and wait unemployment, is unemployment that is associated with people searching for jobs or waiting to take jobs in the near future. Cyclical Unemployment is unemployment that is associated with the recessionary phase of a business cycle.

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Types of UnemploymentStructural Unemployment is unemployment that is associated with a mismatch between available jobs and the skills or locations of those unemployed. Changes over time in consumer demand and in technology alter the “structure” of the total demand for labor, causing this type of unemployment.

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Definition of Full EmploymentFull employment occurs when the economy experience only frictional and structural unemployment; there is no cyclical unemployment. The level of real GDP that would occur if there was full employment is called potential output.

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Economic Cost of UnemploymentForgone output is the basic economic cost of unemployment. If actual GDP is above or below potential GDP, the result is a GDP gap. When actual GDP is less than potential GDP, there is a negative GDP gap accompanied with a higher unemployment rate and foregone income.GDP gap = actual GDP – potential GDP

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InflationInflation is a rise in the general level of prices in an economy. When there is inflation, each dollar of income buys fewer goods and services; the purchasing power of money declines.

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Last Updated: 8th March 2018

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