AP Macroeconomics UNIT 2 Review

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Unit 2

Economic Indicators and the Business Cycle

standards

UNIT 2: Economic Indicators and the Business Cycle

(12-17% of the Exam)

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2.1: The Circular Flow and GDP

2.2: Limitations of GDP

2.3: Unemployment

2.4: Price Indices and Inflation

2.5: Costs of Inflation

2.6: Real v. Nominal GDP

2.7: Business Cycles

2.1 Circular Flow + GDP

The Circular Flow Model

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Expenditure Approach: add up SPENDING on all final goods/services (CIGXn)

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Income Approach: add up INCOME on all final goods/services (wages, rent, taxes, interest, profits)

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These both will add up to be the same!!

Key Takeaway:

Money flows from one sector to another!

2.1-2.2 GDP

GDP - the dollar value of all final goods and services produced within a country’s borders in one year

What’s NOT included in GDP?

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Intermediate goods: goods/services that go into the production of other goods

Goods from other years: only include values for year being calculated!

Goods made in other countries: ex. Factory for US sold cars that is based in Japan

• Non-market (illegal) goods
• Non-production goods
• Financial: stocks, bonds
• Used goods

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% Change in GDP

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Year 2 GDP - Year 1 GDP

Year 1 GDP

X 100

Income Approach

NI + Adjustments = GDP

NI: National Income

• Wages, rent, interest, profits

Statistical Adjustments:

• Net foreign factor income, statistical discrepancy, depreciation allowance

GDP PER CAPITA

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Best measure of standard of living!

2.1 GDP practice

What part of GDP (CIGXn) would these fall under?

1. $10.00 for movie tickets

2. $5M Increase in defense expenditures

3. $45 for used economics textbook

4. Ford makes new $2M factory

5. $20K Toyota made in Mexico

6. $10K Profit from selling stocks

7. $15K car made in US, sold in Canada

8. $10K Tuition to attend college

9. $120 Social Security payment to Bob

10.Farmer purchases new $100K tractor

1. C
2. G
3. Not included!
4. I
5. Not included!
6. Not included!
7. Xn
8. C
9. Not included!
10. I

Expenditure Approach

C + I + G + Xn = GDP

C: Consumer Spending

I: iNvestment spending

G: Government Spending

X: Net Exports (Exports - Imports)

2.1 GDP practice

What is the GDP of this country?

Expenditure Approach: CIGXn

Income Approach: NI

$304 + $124 + $156 + ($24 - $6)

= $602

$100 + $267 + $75 + $160

= $602

2.3 Unemployment

Unemployment Rate: the percent of people in the LABOR FORCE who are actively looking for a job

THREE TYPES

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Frictional: unemployment between jobs

Structural: lacking the skills necessary, skills are obsolete (i.e. jobs become automated)

Cyclical: due to the natural ups/downs of the economy

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LABOR FORCE

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• Above 16 years old
• Able + willing to work
• Not institutionalized
• Not in the military, full-time school, or retired.

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# unemployed

# in labor force

X 100

Natural Rate of Unemployment: Ideal place for the economy to be, ONLY has frictional/structural employment

2.3 Unemployment

Unemployment Rate: the percent of people in the LABOR FORCE who are actively looking for a job

CRITICISMS

The unemployment rate doesn’t account for the following populations accurately

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• Part-Time workers: unemployment rate assumes everyone to be full time
• Discouraged workers: people who have given up looking for jobs because they can’t find one
• Illegal labor: lots of labor happens without being calculated!
• Race/gender inequalities

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PRACTICE

1. How large is the labor force?
2. How many people are unemployed?
3. What is the population?
4. What is the unemployment rate?
5. Are we at full employment? (Hint: look at the types of unemployment)

2.4 Price Indices (and inflation!)

Inflation - general and overall increase in the price level in an economy

MEASURED BY...

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Market Basket: around 300 goods that are used to calculate changes in price level

Inflation rate: changes in prices within one year

CPI: consumer price index

Market Basket:

To calculate, simply multiply the PRICE from year specified and QUANTITY from base year

CPI:

Price of market basket in question

Price of market basket in base year

X 100

Base year ‘index’ is ALWAYS 100

% change Inflation = Change in CPI/GDP deflator

GDP deflator:

Nominal GDP

Real GDP

X 100

2.4 Price Indices (and inflation!)

CPI vs GDP Deflator

CPI

Only measures the price of goods/services bought by consumers (which means that gov. Expenditures are not included)

GDP Deflator

Measures prices of ALL goods and services

CPI is the most common/used form

However! There are some problems with it

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• Substitution bias: as products in market basket increase, consumers may start buying a substitute
• New products: market basket may not include newer products
• Product quality: CPI does NOT account for improvements in quality

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How might these problems affect CPI?

2.4 Price Indices (and inflation!)

PRACTICE (GDP DEFLATOR)

rGDP = price of base year X quantity of current year

GDP deflator = nominal/real x 100

Year 1 is the base year!

nGDP = price x quantity of current year

2.4 Price Indices (and inflation!)

PRACTICE (CPI)

Market basket = price of current year X quantity of base year

The opposite of how to calculate rGDP!!

Year 1 is the base year!

CPI = market basket of current yr / base yr x 100

2.5-2.6 Costs of Inflation (real v. nominal)

HELPED VS HURT

BORROWERS

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Borrowers are HELPED by unanticipated inflation

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Inflation DECREASES the “worth” that money has, therefore, the money that they are paying back are worth LESS than it originally did

LENDERS

(as well as those with fixed incomes, and savers)

Lenders are HURT by unanticipated inflation

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Since the money being paid back is worth less, lenders are essentially losing that value!

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‘real’ means the calculation is adjusted for inflation

Real GDP: best measure of economic growth, expressed in constant dollars

nominal GDP: expressed in terms of current prices, does not account for inflation

2.7 Business Cycle

Business Cycle: shows the constant upward and downward cycle that our economy is in

Business Cycle

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POINTS

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A: Peak, highest relative points

B: Trough, lowest relative points

Trendline: shows the increase in rGDP over time

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INTERVALS

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Above trendline, sloped downwards: recession

Below trendline, sloped downwards: depression

Below trendline, sloped upwards: recovery

Above trendline, sloped upwards: expansion

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time

rGDP

A

B

A

A

B

B

Questions!