GDP Gross Domestic Product the market value of all final goods and services produced within a country in a year What consumers actually pay final transaction Needs to be produced no used goods If not sold immediately then put in inventory buy it from themselves later when sold subtract from inventory and add to sold Cant be an asset ex Stocks or bonds Even if a foreign country if it is produced in a country it is that country s GDP Real per capita GDP Real GDP population y pop Potential GDP hypothetical number what economy is capable of producing o Higher than real GDP in recession lower when over time o Is an estimate of what GDP would have been if all factors of production ex Labor and capital had been used at their normal rates Measure of capacity and not real production Nominal GDP value of all goods and services measured at current prices when good was produced 09 Real GDP value of all goods and services measured at a constant price level accounts for inflation o 2009 Nominal GDP P1 09 P2 09Q2 09Q1 o Say 2005 for a base year 2009 real GDP P1 05Q1 09 P2 05Q2 09 Measuring GDP The expenditure method calculates GDP by adding up the value of all expenditures on all final goods and services in the economy o Investment spending by businesses on capital goods Most volatile component during recession o Y C I G NX Y GDP C total consumption expenditure I investment expenditure G government purchases NX net exports exports imports C I G NX aggregate expenditure Value added method calculates GDP through income generated at each stage in the process of production Income method calculates GDP through income generated at each state in the process Measures of Price Level P GDP Deflator Measures the current level of prices relative to the level of prices in the base year o 100 for the base year o In that example prices increased about 8 5 from 2005 to 2009 o GDP Deflator Nominal GDP Real GDP x 100 o Inflation between 2 years GDP deflator in later year GDP year GDP deflator in earlier year x 100 o Calculated and published by Bureau of Labor Statistics BLS o Uses Consumer Price Index CPI measures changes in prices of things that an average consumer buys deflator in earlier Tracks changes in the typical household s cost of living Adjusts many contracts for inflation COLAS cost of living adjustment Allows comparison of dollar amounts over time o How is it constructed 1 Survey customers to determine composition of basket 2 Put categories into basket saying what to each food beverage housing apparel transport medical recreation education communication other a Collect prices on items in basket price of basket 3 Choose a base year now on average prices 1982 1984 4 Calculate the CPI in a given month by a CPI cost of basket in that month cost of basket in base period x 100 o Calculating the inflation rate with CPI CPI in later year CPI in earlier year CPI in earlier year x 100 o Why CPI might overstate inflation 1 Substitution bias 2 CPI uses fixed baskets so it cannot reflect cannot reflect consumers ability to substitute towards goods whose relative prices have fallen ex Oranges and tangerines some of the increase in the price of a product may reflect an Increase in quality bias improvement in the product s quality while the rest represents true inflation It is hard to separate the two 3 New product bias include new products whose prices tend to fall rapidly soon after their introduction BLS collects price rate primarily from full price retail stores not taking into account lower price outlets ex Wal Mart the market basket used is not updated frequently so it fails to increasingly consumers buy from discount or lower price online retailers 4 Outlet bias CPI vs GDP Deflator GDP Deflator Includes all goods CPI Includes only goods bought by typical customers Includes imported goods Uses fixed basket of goods Only domestic goods Uses changing basket of goods Disinflation vs Deflation Disinflation when inflation is going down so prices are still increasing just not as quickly Deflation when price levels are going down The Costs of Inflation The inflation fallacy most people think inflation erodes all incomes but inflation is a general increase in prices wages and goods rise together Distributional effect Shoe leather costs holdings try to buy stuff to get rid of money change to foreign currency wastes time some worker s incomes will not keep up with inflation the resources wasted when inflation encourages people to reduce their money o Not much of an issue in the US Menu costs menu catalogs etc to change the price for customers Confusion and inconvenience o Complicates long range planning the costs of changing prices do firms raise or hold off Don t want to buy new inflation change the yardstick we use to measure transactions Tax distortions inflation makes nominal income grow faster than real income o Taxes based on nominal income and some aren t adjusted for inflation people pay more even when their real incomes don t increase Arbitrary redistributions of wealth creditors to debtors Debtors get to repay their debt with money that isn t worth as much o Lower than expected inflation transfers purchasing power from debtors to creditors o High inflation is more variable and less predictable than low inflation o So arbitrary redistributions are frequent when inflation is high higher than expected inflation transfers purchasing power from Real vs Nominal Interest rates Nominal interest rate i Real interest rate r Inflation rate i r r i If forcasting use e expected inflation o i r e Changes in the price level and interest rates As P goes up goes up As goes up e goes up Since i r e as e goes up i goes up P up means i up o Bank wants r 5 and e 3 then they set i at 8 BLS monthly employment survey Labor force o Employed o Unemployed worked even part time in the last week did not work in the last week but did look for a job over the last month Not in labor force did not work in last week or actively look for a job in the last month Unemployment rate Types of unemployment number unemployed number in labor force o Natural rate of unemployment natural in a healthy economy people between jobs people whose skills no longer fit jobs available ex Outdated computer related to business cycle cant find a job deviation of unemployment from natural laws tends to unemployment Frictional Structural skills o Cyclical rate Factors the influence the natural rate o Government policies training programs minimum wage o Unemployment