Key Economic Indicators

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1 Chapter 2 Understanding Economics and How it Affects Business All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill Education. Key Economic Indicators Gross Domestic Product (GDP) The Unemployment Rate Inflation and Price Indexes Gross Domestic Product The total value of final* goods and services produced in a country in a given year. *Excludes intermediate goods. 1

GDP Excludes Intermediate Goods Intermediate goods: Goods used to make other goods or services.

Why Intermediate Goods are Excluded from GDP The value of the intermediate goods is already included

The selling price of the car includes the value to the consumer of the 4 tires.

2 GDP Excludes Intermediate Goods Intermediate goods: Goods used to make other goods or services. Example: The tires Ford buys from Bridgestone/Firestone to make its cars and trucks. Why Intermediate Goods are Excluded from GDP The value of the intermediate goods is already included in the value of the $30,503 final goods. The selling price of the car includes the value to the consumer of the 4 tires. If we count them again, we will overstate the amount of new value created this year. Landowners $ Rent $ Businesses $ Wages $ Workers You can use my land I ll work for you Final Goods and Services 2

3 Per capita GDP The country s GDP in a given year divided by its population in that same year. Note: This is the most popular way to measure a country s standard of living. Country 2015 GDP 2015 Population Standard of Living Norway $ 388 billion 5 million $ 77,600 United States $ 17,947 billion 322 million $ 55,736 Sweden $ 493 billion 10 million $ 49,300 Canada $ 1,551 billion 36 million $ 43,083 Germany $ 3,356 billion 81 million $ 41,432 France $ 2,422 billion 64 million $ 37,844 South Korea $ 1,378 billion 50 million $ 27,560 Mexico $ 1,144 billion 127 million $ 9,008 China $ 10,866 billion 1,376 million $ 7,897 Indonesia $ 862 billion 258 million $ 3,341 Philippines $ 292 billion 101 million $ 2,891 Vietnam $ 194 billion 93 million $ 2,086 India $ 2,074 billion 1,311 million $ 1,582 Haiti $ 9 billion 11 million $ 818 North Korea $ 17 billion 25 million $ 680 Afghanistan $ 19 billion 33 million $ 576 Country 2015 GDP 2015 Population Standard of Living Norway $ 388 billion 5 million $ 77,600 United States $ 17,947 billion 322 million $ 55,736 Sweden $ 493 billion 10 million $ 49,300 Canada $ 1,551 billion 36 million $ 43,083 Germany $ 3,356 billion 81 million $ 41,432 France $ 2,422 billion 64 million $ 37,844 South Korea $ 1,378 billion 50 million $ 27,560 Mexico $ 1,144 billion 127 million $ 9,008 China $ 10,866 billion 1,376 million $ 7,897 Indonesia $ 862 billion 258 million $ 3,341 Philippines $ 292 billion 101 million $ 2,891 Vietnam $ 194 billion 93 million $ 2,086 India $ 2,074 billion 1,311 million $ 1,582 Haiti $ 9 billion 11 million $ 818 North Korea $ 17 billion 25 million $ 680 Afghanistan $ 19 billion 33 million $ 576 3

4 CAPITALISM LO 2-2 Capitalism -- All or most of the land, factories and stores are owned by individuals, not the government, and operated for profit. Countries with capitalist foundations: - United States - England - Australia - Canada Photo credit: Luc Beziat/Cultura RM/Alamy STATE CAPITALISM LO 2-2 State Capitalism -- When the state, rather than private owners, run some businesses. Well-known countries practicing state capitalism: China Russia These countries have experienced some success using capitalistic principles, but the future is still uncertain. CAPITALISM S FOUR BASIC RIGHTS LO The right to own private property. 2. The right to own a business and keep all that business s profits. 3. The right to freedom of competition. 4. The right to freedom of choice. Photo credit: Ingram Publishing 4

5 FREE MARKETS LO 2-2 Free Market -- Decisions about what and how much to produce are made by the market. Consumers send signals about what they like and how they like it. Price tells companies how much of a product they should produce. If something is wanted but hard to get, the price will rise until more products are available. FREE MARKET BENEFITS and LIMITATIONS LO 2-2 Benefits: It allows for open competition among companies. Provides opportunities for poor people to work their way out of poverty. Limitations: People may start to let greed drive them. Photo credit: ColorBlind Images/Blend Images LLC SOCIALISM LO 2-3 Socialism -- An economic system based on the premise that some basic businesses, like utilities, should be owned by the government in order to more evenly distribute profits among the people. Entrepreneurs run smaller businesses. Citizens are highly taxed. Government is more involved in protecting the environment and the poor. 5

BENEFITS of SOCIALISM LO 2-3 Greater equality of economic outcomes Free education Free healthcare Free childcare Longer vacations Shorter work weeks Generous sick leave Photo credit: Kathy

6 BENEFITS of SOCIALISM LO 2-3 Greater equality of economic outcomes Free education Free healthcare Free childcare Longer vacations Shorter work weeks Generous sick leave Photo credit: Kathy dewitt/alamy NEGATIVES of SOCIALISM LO 2-3 Few incentives for businesspeople to take risks. Brain Drain: Some of a country s best and brightest workers (i.e. doctors, lawyers and business owners) move to capitalistic countries. Fewer inventions and innovations because the reward is not as great as in capitalistic countries, therefore in theory and in some cases slower growth in standard of living. Country 2015 GDP 2015 Population Standard of Living Norway $ 388 billion 5 million $ 77,600 United States $ 17,947 billion 322 million $ 55,736 Sweden $ 493 billion 10 million $ 49,300 Canada $ 1,551 billion 36 million $ 43,083 Germany $ 3,356 billion 81 million $ 41,432 France $ 2,422 billion 64 million $ 37,844 South Korea $ 1,378 billion 50 million $ 27,560 Mexico $ 1,144 billion 127 million $ 9,008 China $ 10,866 billion 1,376 million $ 7,897 Indonesia $ 862 billion 258 million $ 3,341 Philippines $ 292 billion 101 million $ 2,891 Vietnam $ 194 billion 93 million $ 2,086 India $ 2,074 billion 1,311 million $ 1,582 Haiti $ 9 billion 11 million $ 818 North Korea $ 17 billion 25 million $ 680 Afghanistan $ 19 billion 33 million $ 576 6

7 COMMUNISM LO 2-3 Communism -- An economic and political system in which the government makes almost all economic decisions and owns almost all the major factors of production. Prices don t reflect demand which may lead to shortages of items, including food and clothing. Most communist countries today suffer severe economic depression and citizens fear the government. Country 2015 GDP 2015 Population Standard of Living China $ 10,866 billion 1,376 million $ 7,897 India $ 2,074 billion 1,311 million $ 1,582 Country 2015 GDP 2015 Population Standard of Living South Korea $ 1,378 billion 50 million $ 27,560 North Korea $ 17 billion 25 million $ 680 7

South Korea Today North Korea Today MIXED ECONOMIES LO 2-4 Mixed Economies -- Some allocation of resources is made by the market and some by the government.

8 South Korea Today North Korea Today MIXED ECONOMIES LO 2-4 Mixed Economies -- Some allocation of resources is made by the market and some by the government. Neither free-market nor command economies have created sound economic conditions so countries use a mix of the two economic systems. TRENDING TOWARD MIXED ECONOMIES Communist governments are disappearing. Socialist governments are cutting back on social programs, lowering taxes and moving toward capitalism. LO 2-4 Capitalist countries are increasing social programs and moving more toward socialism. Photo credit: Dmitry Rogulin/ITAR-TASS/Newscom 8

Labor Productivity GDP per worker = GDP/# Workers Tightly coupled to standard of living through this formula: GDP = GDP X Workers Person Worker Person

9 Labor Productivity GDP per worker = GDP/# Workers Tightly coupled to standard of living through this formula: GDP = GDP X Workers Person Worker Person Standard of Living Labor Productivity Employment- Population Ratio To increase standard of living, you must increase either labor productivity or the employment-population ratio. What Government Tries to Do Maximize the GDP growth rate while Minimizing harm to the environment and Pursuing other policy goals such as relieving the suffering and improving the living conditions of the American poor protecting our nation from terrorists, catching and punishing criminals, etc. 9

discourage both working people and entrepreneurs from working. Working creates GDP.

10 How Smart Governments Do That Resist the temptation to micromanage everything. Resist the temptation to build a government office and program for every social problem; because that leads to high tax rates, which discourage both working people and entrepreneurs from working. Working creates GDP. Use fiscal and monetary policy to negotiate a path through the twin dangers of inflation and unemployment. Inflation and Unemployment are the Scylla and Charybdis of Macroeconomic Policy It s Like Operating a Steam Locomotive: More Pressure Gives you More Horsepower 10

Fiscal and Monetary Policy are Used to Keep the Economy at Maximum Safe Pressure When the economy is too cold, GDP will be much lower than its potential level and unemployment will be high.

11 Fiscal and Monetary Policy are Used to Keep the Economy at Maximum Safe Pressure When the economy is too cold, GDP will be much lower than its potential level and unemployment will be high. Use fiscal and/or monetary policy to heat up the economy and put some of those unemployed back to work (all but the last 4%). When the economy is too hot, GDP will be at its potential level, but inflation will continuously accelerate. Use fiscal and/or monetary policy to cool off the economy to stop the inflation. Business Cycle Terminology 11

12 The Unemployment Rate 10% 4% U.S. UNEMPLOYMENT RATE LO 2-5 * As of October The Unemployment Rate 12

UNEMPLOYMENT LO 2-5 Unemployment Rate -- The percentage of civilians at least 16-years-old who are unemployed and tried to find a job within the prior four weeks.

13 UNEMPLOYMENT LO 2-5 Unemployment Rate -- The percentage of civilians at least 16-years-old who are unemployed and tried to find a job within the prior four weeks. Four Types of Unemployment Frictional Structural Cyclical Seasonal Photo credit: Paul Sakuma/ AP Images Frictional Unemployment Individuals who either quit their last job and are currently looking for work, or who are entering the labor market for the first time. Is caused by the inevitable lag between when a qualified person begins a job search and when they start their next job. It s the needle in a haystack problem. Decreasing Frictional Unemployment Electronic job boards like HotJobs.com and Monster.com have permanently decreased the amount of friction in the U.S. labor market. These tools enable qualified job candidates and companies with job openings to find each other faster. The California Employment Development Department (EDD) operates a similar service called CalJOBS. 13

14 Structural Unemployment Caused by a mismatch between the skills the unemployed people in a particular geographic area have and the skills employers in that area are looking for. Decreasing Structural Unemployment The main solution to structural unemployment is job retraining. As some industries grow and others decline, some individuals are going to have to go back to school and acquire new skills in order to become employed again. Both the federal and state governments subsidize retraining for the unemployed in a variety of ways. Seasonal Unemployment Caused by seasonal ups and downs in demand for workers which occur rhythmically each year in certain industries such as farming, fishing, and retail sales. The seasonal component of unemployment affects monthly unemployment figures, but not annual ones. 14

15 Cyclical Unemployment Caused by the tendency of free-market economies to grow their gross domestic product not at a steady rate, but in spurts of extra-rapid growth separated by periods of relatively poor growth, or even decline, in GDP. The only component of unemployment that can be addressed (kept to a minimum) by fiscal and monetary policy. The Unemployment Rate 4% = the natural rate of unemployment = frictional + structural unemployment Anything above 4% = excess unemployment = cyclical unemployment Employers raise salaries and wages to entice qualified workers from their current jobs. Employers do not hire unqualified workers, and it still takes time for qualified workers and employers to find each other, so unemployment stays at 4% (structural plus frictional components). Employers raise their prices to cover their increased labor costs. Employed workers demand higher wages to cover the higher prices they now face. Inflation continuously accelerates. 15

16 Money doesn t make people better off, goods and services do. If money incomes double but you don t make more stuff, prices will simply double, and people will be neither better nor worse off than they were before. Nominal (dollar-denominated) GDP divided by the price index gives you real GDP. Real GDP measures how much actual goods and services you made. Real GDP is a better indicator of welfare levels than nominal GDP. 16

The wages, rent/leases, tax brackets, government benefits and interest rates of some citizens are based upon the CPI.

17 CONSUMER PRICE INDEX LO 2-5 Consumer Price Index (CPI) -- Monthly statistics that measure the pace of inflation or deflation. The government computes the costs of goods and services (housing, food, apparel, medical care, etc.) to see if they are going up or down. The wages, rent/leases, tax brackets, government benefits and interest rates of some citizens are based upon the CPI. INFLATION LO 2-5 Inflation -- The general rise in the prices of goods and services over time. Disinflation -- When the price increases are slowing (inflation rate declining). Deflation -- Prices are declining because too few dollars are chasing too many goods. 17

18 260 U.S. CPI (1983 = 100) Percentage Change Nominal GDP per capita $ 21,667 $ 21,883 A Consumer Price Index B Real GDP per capita C D E Percentage Change Nominal GDP per capita $ 21,667 $ 21, % Consumer Price Index % Real GDP per capita $ 21,667 $ 10, % Modern Macroeconomic Policy The purpose of modern macroeconomic policy is to dampen the amplitude of the business cycle. 18

Modern Macroeconomic Policy Modern Macroeconomic

Modern Macroeconomic Policy Fiscal Policy Government

19 Modern Macroeconomic Policy Modern Macroeconomic Policy Notice that the trend line gets steeper when you dampen the amplitude of the cycle. That s because you have less deadweight loss. Modern Macroeconomic Policy Fiscal Policy Government spending Taxes Monetary Policy Control of interest rates and the money supply 19

FISCAL POLICY LO 2-6 Fiscal Policy -- The federal government s efforts to keep the economy stable by increasing or decreasing taxes or government spending.

20 FISCAL POLICY LO 2-6 Fiscal Policy -- The federal government s efforts to keep the economy stable by increasing or decreasing taxes or government spending. Tools of Fiscal Policy: Taxation Government Spending Basic method: If unemployment is greater than 5.2%, put your foot on the gas. If inflation is above 4%, put your foot on the brake. Fiscal Policy Government spending Taxes Gas pedal Increase it Decrease them Brake Decrease it Increase them Generally speaking, we don t have inflation and unemployment at the same time Unemployment 4%; inflation above 4% and accelerating Unemployment = 10%; inflation -3% to 0.25% 20

21 Monetary Policy The management of the money supply and interest rates by the Federal Reserve Bank The Federal Reserve Bank is sometimes called The Fed for short, but don t misunderstand: by The Fed, we don t mean the federal government. While technically a federal government agency, the Federal Reserve bank is highly independent from the other branches of the federal government. Monetary Policy When the economy is near a peak inflation is above 4% Real gdp per capita is growing at 2% or more per year, and unemployment is at or near 4% the Fed will raise interest rates This will cause businesses and consumers to curtail their debtfinanced spending. This will cool off the economy and control inflation. Fiscal and Monetary Policy Goals Inflation is steady at around 2% Unemployment is steady at between 4% and 5.2% Real GDP per capita is growing at 2% or higher 21

22 Monetary Policy When the economy is in recession unemployment is substantially above 4% inflation is below 2%, possible negative gdp is growing at less than 1%, possibly negative the Fed will lower interest rates This will cause businesses and consumers to increase their debt-financed spending. This will heat up the economy and reduce unemployment. 22

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Business Cycle Macroeconomics The Great Depression was the springboard for modern macroeconomics. Macroeconomics Macroeconomics is the study of aggregate economic behavior, of the economy as a whole.