ch 6 notes

Real GDP

• Real Gross Domestic Product (GDP) – A measure of the value of all newly produced goods and services in a country during some period of time, adjusted for changes in prices over time.

• Note: The adjective “real” means that the GDP has already been adjusted to remove the effects of prices over time.

AP Economics – Chapter 6: Measuring Domestic Output and Ntl’ Income

Shanghai American School: Mr. Dachpian

Real GDP (cont’d)

• Economic growth – An upward trend in real GDP, reflecting an expansion in the economy over time.

• Economic fluctuations – Swings in the real GDP that leads to deviations of the economy from its long term trend.





Figure 17.1 plots the US real GDP measured in billions of chained 2000 dollars, from 1970-2005.

Real GDP (cont’d)

• The straight black line in Figure 17.1 shows the growth trend in the US real GDP through time. Notice that the actual real GDP numbers fluctuate around the trend.

• The vertical shaded bars mark the six recessions experienced by the economy since 1970. Thicker shaded bars represent longer recession periods.



US Real GDP

• A closer look at Figure 17.1 shows that the value of goods and services produced in the US economy almost tripled in value over the last 35 years. During this period, the US economy grew by 3 percent per year.



US Real GDP (cont’d)

• Fact: In 2004, the US real GDP was larger than the economies of Japan (world’s 2nd largest economy at time) and Germany (3rd largest economy at time) combined.

• Figure 17.2 shows that the US economy in 2004 roughly equaled the sum of the GDP of Japan and Germany in 2004, plus the US GDP in 1969.



US Real GDP (cont’d)Figure 17.2



Economic Fluctuations

• Business Cycles – The ups and downs in GDP experienced by an economy.

Phases of Business Cycles1) Peak2) Recession3) Trough4) Recovery



Economic Fluctuations (cont’d)

• Recession – A decline in real GDP that lasts for at least 6 months.

• Peak – The highest point in real GDP before a recession.

• Trough – The lowest point in real GDP at the end of a recession.




• Expansion – The period between the trough of the recession and the next peak, consisting of a general rise in output and employment.

• Recovery – The early part of an economic expansion immediately after a recession.




• Figure 17.3 illustrates the phases of the business cycle around the 2001 recession in the US. One could say that the recession in 2001 was relatively mild, as evidenced by the small drop in the real GDP and a relatively short time span between the peak and the trough.




• Table 17.1 lists and compares the recessions in the US economy from 1920-2001. The shortest period of recession in US history was between July 1990-March 1991. It was followed by the longest period of expansion in US history (120 months). The longest recession since the 1920s was the during the Great Depression, when the economy was in recession for 43 months.



Economic Fluctuations (cont’d)Table 17.1




• Recessions vs. Depressions

• Depressions – A prolonged and deep recession; no formal definition.

• The Great Depression – The depression experienced by the US from August 1929-March 1933. During this period, real GDP fell by 32.6 percent.




• Figure 17.4 illustrates the real GDP (1996 dollars) fluctuations during the 20th century.

• The size of the recessions are small relative to the Great Depression.



Economic Fluctuations (cont’d)Figure 17.4



Business Cycles• Business Cycles are fluctuations in

economic activity.• Peak: period of general prosperity. • Contraction: a slowdown marked by

declining sales and GNP and by an increase in layoffs.

• Trough: a low point. • Expansion: a recovery in which GNP and

employment increase, business invest, and an optimistic outlook prevails.



Unemployment

• Unemployment rate – The percentage of the labor force that is unemployed.

• Labor Force – Workers who are either working (employed) or looking for work (unemployed).

• Unemployed – Workers who are willing to work at a given wage, but cannot find a job.



Unemployment (cont’d)

• Figure 17.5 shows the unemployment rate for the US from 1970-2005. Note that the unemployment rate increases at or around the time the US experiences a recession.

• Figure 17.6 illustrates the unemployment rate throughout the 20th century. Note that the unemployment rate for the US was almost 25 percent during the height of the Great Depression.



Unemployment (cont’d)Figure 17.5



Unemployment (cont’d)

• Figure 17.7 shows the behavior of the unemployment rate after 2001. The recession began in March 2001 and ended in November 2001, but the unemployment rate continued to rise after 2002.



Inflation

• Inflation Rate – The percentage increase in the overall price level over a given period of time, usually one year.

• Figure 17.8 shows the ups and downs in the inflation rate from 1970-2004. Note that the inflation rates usually drop during or immediately after a recession.



Inflation (cont’d)Figure 17.8



Interest Rates

• Interest rate – The amount received per dollar loaned per year, usually expressed as a percentage (e.g., 6 percent) of the total loan.



Interest Rates (cont’d)

Different Types of Interest Rates

1) The mortgage interest rate – The rate on loans to buy a house.

2) Savings deposit interest rate –The rate people get on their savings deposits at banks.




Different Types of Interest Rates, continued:

3) The Treasury bill rate – The interest rate the government pays when it borrows money from people for one year or less.

4) Federal funds rate – The interest rate banks charge each other on very short-term loans.




• Figure 17.9 illustrates the behavior of the interest rates (in this graph, the Fed Funds Rate) from 1970-2004. A closer look shows that interest rates tended to rise just before a recession and then declined during and just after the recession.




Figure 17.9




• The next three figures show the behavior of the other interest rates in the economy. Figure 17.9 A shows the 30 year mortgage rate for the last 10 years., Figure 17.9 B shows the Bank Prime Lending Rate and Figure 17.9 C shows the secondary market rate for the 6 – Month Treasury Bill.



Figure 17.9A30- Year Conventional Mortgage Rate



Figure 17.9BBank Prime Loan Rate



Figure 17.9C6- Month Treasury Bill Rate: Secondary Market

Rate




• Real interest rate – The interest rate minus the expected rate of inflation; it adjusts the nominal interest rate for inflation.

• Nominal interest rate – The interest rate uncorrected for inflation.



Macroeconomic Theory and Policy

• Potential GDP – The economy’s long-term growth trend for real GDP; determined by the available supply of capital, labor, and technology. Real GDP fluctuates above and below the potential GDP.

• Potential GDP of an economy is given by its aggregate supply.

• Aggregate Supply – The total value of all goods and services produced in the economy by the available supply of capital, labor, and technology; also called potential GDP.



Macroeconomic Theory and Policy (cont’d)

• Labor – The number of hours people are available for work in producing goods and services.

• Capital – The factories, improvements to cultivated land, machinery and other tools, equipment, and structures used to produce goods and services.




• Technology – Anything that raises the amount of output that can be produced with a given amount of labor and capital.

• Production function – The relationship that describes output as a function of labor, capital, and technology.




• The Production Function

• Real GDP = F (labor, capital, technology)

• Where: F( ) means that there is some general relationship between these variables.



The Role of Government Policy

• Fiscal Policy – Government policy concerning taxing, spending, and borrowing.

• These policies are intended to mitigate the negative impact on aggregate demand of other factors such as a fall in investor or consumer confidence.



The Role of Government Policy (cont’d)

• Monetary Policy – Government policy concerning the money supply and the control of inflation.

• These policies are also intended to slow down spending (aggregate demand) when the economy is rising too fast, and increase spending (aggregate demand) when the economy is in a recession.



The Role of Government Policy (cont’d)

• Aggregate Demand – The total demand for goods and services by consumers, businesses, government, and foreigners.

• According to the Theory of Economic Fluctuations, changes in the real GDP above and below the potential GDP in the short run, are caused by changes in the aggregate demand.



ch 6 notes

Business

measuring

nominal interest

interest rate

interest rates

real gdp

potential

unemployment

economic fluctuations