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Circular Flow & GDP
How the U.S. Economy works
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Branches of Economics• Microeconomics --studies economic behavior &
decision making of small units: individuals, families, businesses
• Macroeconomics --studies economic behavior &
decision making of entire economies
Analyzing Sony’s $100 price cut for PS3
Analyzing how a federal income tax cut has affected unemployment
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Key Concept: Circular Flow
• Describes how goods, services and money flow through a free market economy
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Circular FlowPRODUCERS CONSUMERS
Factor Market
Product Market
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Circular FlowPRODUCERS CONSUMERS
Factor Market (Factors of Production)--land, labor, capital, education/skills are
exchanged
Product MarketWhere goods & services sold
The U.S. Free Market EconomyThe U.S. Free Market Economy
labor
Wages/paycheck
Make productsPay for products
Boeing cuts 1000 jobs
Income tax rebate $700Interest rates go up
Price of oil goes down
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Measuring the Circular Flow: GDP
• The total dollar value of economic output of the circular flow is called Gross Domestic Product (GDP)
• Dollar Value of all FINAL new goods & services produced in USA over one year
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GDP = C + I + G + (X-M)
How to Calculate GDP
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GDP is a very IMPERFECT measure—it does NOT
Measure:
Leisure time v. hours worked
What is produced—shoes, guns, toys count the same
How happy or content people are
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GDP Growth Rate
• Instead we use the percentage growth rate (measured quarterly and annually)– Example: GDP grew last year at a +2.2% rate last quarter
GDP #s are hard for our minds to grapple with:GDP increased from $13.2 trillion to $13.5 trillion; DOES NOT COMPUTE!
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GDP growth: Speed Limits
• Too fast: If GDP grows above 5.0%, the economy may experience inflation– Prices rise
• Too slow: If GDP grows below 2%, not enough jobs are created– Unemployment rate increases
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Gross Domestic Product (GDP) Growth Rate
• Slowest ever -13.0% (1932)
• Fastest ever +18.5% (1942)
• Historical average: +2.5%-3.0%
Recent GDP Growth Rates: 1Q 2008: +0.9%2Q 2008 +2.8% 3Q 2008 -0.5%4Q 2008 -6.5%
1Q 2009: -6.4%
2Q 2008 -0.7%3Q 2008 +2.2%