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     Unit 3
• The branch of economic theory that deals
  with the economy as a whole.

• Does not deal with small decisions by

• Example: Government; University
  National Income Accounting
• Economic success is based off the amount
  of an income and by the standard of living
  (high or low).

• The measurement of a country’s economic
  health is called the national income
 --Deals with the overall output and income.
• There are 5 major statistics that measure
  the national economy (In order of value):
 1. Gross Domestic Product
 2. Net domestic Product
 3. National Income
 4. Personal Income
 5. Disposable Personal Income
Gross Domestic Product (GDP)
• The total dollar value of all final goods and
  services produced in a nation in a single
 --How many goods were produced and
   available to be bought in 1 year.

• Always measured in dollars ($). This is
  the common measure of value in
Gross Domestic Product (GDP)
• GDP deals only with final products ready
  for sale for the first time

• Deals with the value of the item the
  consumer would buy at the store
 --The value of the whole computer, not the
 --Only for items sold for the first time –
   Used cars sold do not count into GDP
   Gross Domestic Product (GDP)
• GDP can be determined by an equation

• GDP=Consumption (C)+ Investment (I)+ Govt.
  Spending (G)+ [Exports(X)-Imports(M)].

• The way you will usually see it:
• GDP=C+I+G+(X-M)
          Consumption (C)
• All private consumptions in our economy.

• Personal Expenses such as food, rent,
  medical expenses that are bought by
  common people.

• Does not include the buying of a new
• If total consumption is $5 million.

GDP=5 million+I+G+(X-M)
            Investment (I)
• Investments by businesses or households
  into capital.

 --Business Ex.: Buying new machinery
 --Household Ex.: Purchasing a new house

• Only applies to situations when money is
  exchanged for a product/service.
• Investments totaled $6 million

 GDP=5 million+6 Million+G+(X-M)
    Government Spending (G)
• Any money the government spends on
  goods and services.

 --Ex.: Salaries, supplies, military spending.

• Includes all levels of government (federal,
  state, & local)
• Government spending totaled $10 million

GDP=5 million+6 million+10 million+(X-M)
    Exports (M) – Imports (M)
• The answer you get when you do X-M is
  called the Net Exports.
 --It’s the difference between and country’s
  exports and imports

• This could end up being a negative
  number because a country might import
  more than it exports
               Exports (X)
• This is the amount of goods or services a
  country produces and sends out to other

• We export oil from our oilrigs in the oceans
  and from land.
             Imports (M)
• These include any goods or services we
  receive from other countries.

• America receives a large number of
  products from China and Taiwan.
• Be sure exports are first and imports are

• Exports totaled $8 million

• Imports totaled $3 million

• $8 million - $3 million = $5 million
GDP=5 million+6 million+10 million+5 million
• GDP is simply an estimate of the
  economic health of a country

• There are many ways this figure can be
  flawed and untrue.
• There are 5 major statistics that measure
  the national economy (In order of value):
 1. Gross Domestic Product
 2. Net domestic Product
 3. National Income
 4. Personal Income
 5. Disposable Personal Income
  Net Domestic Product (NDP)
• Depreciation is the loss of value due to
  use and wear and tear.

• GDP does not factor in depreciation

• NDP subtracts the amount of depreciation
  from the GDP
• GDP = $26 Million

• NDP = $2 Million


• $26 Million - $2 Million

• Economic health = $24 Million
• There are 5 major statistics that measure
  the national economy (In order of value):
 1. Gross Domestic Product
 2. Net domestic Product
 3. National Income
 4. Personal Income
 5. Disposable Personal Income
            National Income
• Total amount of income earned by everyone in
  the economy

• This is the total of 5 areas:
 1. Wages & salaries
 2. Income of Self-Employed individuals
 3. Rental Income
 4. Corporate Profits
 5. Interest on Savings & other Investments
• There are 5 major statistics that measure
  the national economy (In order of value):
 1. Gross Domestic Product
 2. Net domestic Product
 3. National Income
 4. Personal Income
 5. Disposable Personal Income
          Personal Income
• The total income a person makes before
  all personal taxes are taken out. (Gross
• Examples of income taken out:
 --Insurance, Social Security, Taxes, etc

• Examples of income put in without
  production activity:
 --Unemployment, Medicaid, etc.
• There are 5 major statistics that measure
  the national economy (In order of value):
 1. Gross Domestic Product
 2. Net domestic Product
 3. National Income
 4. Personal Income
 5. Disposable Personal Income
  Disposable Personal Income
• The amount people have left to spend
  after all taxes are taken out (Net Income)

• Good indicator of economic health
  because it shows how much most people
  have of spendable money.
• GDP is an indicator of economic health

• However, we know GDP can sometimes
  be inaccurate because of depreciation

• Another thing that skews GDP is inflation
 --A prolonged rise in the general price level
  of goods & services
• When inflation occurs, it causes the true
  value of currency to go down.

• $1 bill does not equal $1

• The Purchasing Power has dropped
 --The real goods & services money can buy
 --This determines the true value of money
• This affects GDP because there will be an
  increase in the amount of GDP, but there may
  not be an increase of outputs

• Ex.: A Dr. Pepper cost $1.25 last year;
       This year Dr. Pepper cost $2.00.

• The GDP will be higher, but the amount of goods
  sold will stay the same, so this does not show a
  true rise in economic health
• Inflation has to be factored in to accurately
  measure a nation’s economic health

• Deflation: A prolonged decline in the
  general price level of goods & services

• Affects the value of GDP, but rarely
         Inflation Measures
• The government uses 3 different ways to
  measure inflation:

 1. Consumer Price Index (CPI)
 2. Producer Price Index (PPI)
 3. GDP Price Deflator
  Consumer Price Index (CPI)
• A measure of the change in price of a
  specific group of goods & services that the
  average household uses.

• Done once a month by the government

• The specific group of goods & services are
  known as the market basket
    Consumer Price Index (CPI)

 A market basket includes approximately
80,000 specific goods & services in general
--Food                 --Education
--Housing              --Recreation
--Transportation       --Medical Care
--Apparel              --Personal Care
   Consumer Price Index (CPI)
• About every 10 years the market basket is
  updated to include new products

• The Bureau of Labor Statistics (BLS) compiles
  the list monthly and compares the prices to a
  base year

• The base year has a value of 100.0
 --The value of CPI shows the change in value
  since the base year
  Consumer Price Index (CPI)
• Example:

 Base Year value is set at 100.0

 If the new value taken by the BLS is 155.7
 the average price of goods has risen
 55.7% since the base year
   Producer Price Index (PPI)
• Groups together several indexes &
  averages the change in prices the U.S.
  has charged their customers for goods &
 --Usually includes mining, manufacturing, &
   Producer Price Index (PPI)
• PPI will usually change before CPI
  because PPI is measured from goods not
  sold to common people yet.

• PPI is closely watched as a hint of whether
  CPI or inflation will rise.
         GDP Price Deflator
• This indicator removes the effects of
  inflation from GDP so the overall economy
  can be compared from year to year.

• The new figure, with inflation taken out is
  known as the “Real GDP”
        GDP Price Deflator
• Equation:

Current GDP / Price Deflator (CPI) x 100

              = Real GDP
        GDP Price Deflator
• Current GDP = $500 Billion
• CPI = 105

$500 / 105 x 100 = $476 Billion
Real GDP = $476 Billion

• This can be compared to previous years to
  determine how much GDP has rose or fell
• Economists look at how the laws of supply
  & demand apply to the economy as a
  whole, not just to individual businesses

• Aggregates: Summing up of all individual
  parts in the economy.
 --Aggregate Demand
 --Aggregate Supply
          Aggregate Demand
• Total quantity of goods & services in the whole
  economy that all citizens will demand at a single

• Law of demand relates the amount demanded to
  the price

• There are too many different products in an
  economy; cannot relate aggregate demand to
        Aggregate Demand
• Aggregate Demand is related to the price
  level of all products.

• Found by measuring from a price index.

• We can use the GDP Price Deflator & find
  Real GDP (Real Domestic Output) &
  compare that to the price level.
                Aggregate Demand
• When we compare Real GDP against
  price levels we can discover the
  Aggregate Demand Curve

  Price Level

                   Real GDP
        Aggregate Demand
• Both the individual demand curve & the
  aggregate demand curve have inverse

• In aggregate demand when the price level
  drops, a larger level of real domestic
  output is demanded
    Aggregate Demand Curve
• There are 2 reasons for the Aggregate
  Demand Curve to have an inverse

 1. Real purchasing power of your cash
 2. Relative price of goods & services sold
    to other countries
     Real Purchasing Power
• Remember Purchasing Power is the true
  value of your money

• Inflation decreases Purchasing Power &
  Deflation increases Purchasing Power

• When price level drops, Purchasing power
  will rise & vice versa.
       Real Purchasing Power
• It appears you have more money because you
  can buy more than you could before.

• Price level drop results in an increase in the
  domestic output level
  Relative Prices of Goods Sold to
          Other Countries
• When the price level drops, our goods
  become better deals because they are
  now cheaper

• Therefore, foreign countries are more
  willing to purchase our goods & services
          Aggregate Supply
• Just like Aggregate Demand, Aggregate
  Supply is measured against the price level
  & the real domestic output

• When price level rises, the producers will
  offer more to be output, and therefore
  aggregate supply will rise
             Aggregate Supply
• Aggregate Supply shows a direct, or
  positive, relationship with price level &
  domestic output

      Price Level

                    Real Domestic Output
      Equilibrium Price Level
• When the Aggregate Demand &
  Aggregate Supply are put on the same
  graph, the equilibrium price level can be

• Similar to the equilibrium price with the
  supply & demand curves
         Equilibrium Price Level
• The point where to two graphs cross is the
  equilibrium price level

  Price Level                                Equilibrium Price Level

                Real Domestic Output (Real GDP)
       Equilibrium Price Level
• At the equilibrium price level the average
  price of all goods is at a perfect place

• If price levels rise above the equilibrium
  price level, inflation has occurred

• If price levels fall below the equilibrium
  price level, deflation has occurred.
       Business Fluctuations
• Inflation will change from year to year

• Other things such as unemployment or
  taxes will also change from year to year

• The ups & downs of an economy are
  known as business fluctuations.
       Business Fluctuations
• These Business Fluctuations are part of
  the Business Cycle

• Business Cycle: Irregular changes in the
  level of total output that is measured by
  Real GDP
                 Business Cycle
• In economics, there is a model of this
  business cycle.
            Peak or


      Growth                Trough
           Business Cycle
• At the beginning there is a large amount of
  expansion & growth in the economy

• The economy rises to high levels

• This rise leads to an economic boom, or
 --A period of prosperity. Highest point.
            Business Cycle
• Eventually the peak levels out and a
  contraction occurs, where the economy
  will begin to fall.

• This fall can be short or it can be a deep
  fall which could eventually lead to a
 --Recession: No economic growth for 6
           Business Cycle
• If a recession is deep enough, a
  depression will occur.

• Many people will be out of work, & many
  businesses will close down

• At some point the economy hits a trough,
  or the lowest point, and settles off.
             Business Cycle
• After a trough is hit, the economy slowly begins
  to rise back up

• This new rise is known as recovery.

• New businesses open & new jobs are available.

• This continues until a peak, then the cycle starts
                 Business Cycle

            Peak or


      Growth                Trough
           Business Cycle
• The business cycle is not always as
  simple as the graph shows

• However, the troughs & peaks are very
    American Business Cycle
• America was in a period of a peak during
  the 1920’s
 --The time was called the “Roaring 20’s”

• In October, 1929, the stock market
  crashed and there was a serious
  recession which led to the Great
    American Business Cycle
• During the Great Depression, millions lost
  their jobs, banks closed down, and many
  businesses shut down.

• During World War II the economy lifted
  back up to a high peak

• The economy did well until the 1980’s
  when it another small recession started
     American Business Cycle
• The economy did well during the 1990’s

• The attacks on Sept. 11, 2001 caused a
  severe recession in America

• We are still feeling the recession currently.

• Slowly, we are coming out of the
Causes & Indicators of Fluctuations
• Economists have tried to find ways to
  predict business cycles & fluctuations

• There are too many unpredictable factors
  that can cause change in an economic

• There are some causes that have been
  determined to contribute to business
        Causes of Fluctuations
• Economists link 4 main things to business

 1.   Business Investment
 2.   Government Activity
 3.   External Factors
 4.   Psychological Factors
        Business Investment
• Business will invest in labor or capital in an
  effort to increase the productivity of its

• Businesses create new jobs & income for
  consumer spending

• Innovations: Inventions or new production
        Business Investment
• Innovations are used by firms to increase

• Other firms must begin to use an
  innovation to keep competitive

• If there is a downturn, businesses cut
  down on investments, which could lead to
        Government Activity
• The spending trends of government
  affects the economy in 2 ways:

 1. Policies on Taxes & Spending

 2. Control over the supply of money in an
          External Factors
• There are forces that occur outside the
  country that can have an economic force.

• Wars can impact a nation’s economy

• Oil supply can affect the economy also
       Psychological Factors
• There may be events that cause people to
  spend less or more.

• Attacks on Sept. 11, 2001 had a large
  psychological effect on the country & its
        Economic Indicators
• Economists use different measures to try
  to predict what is coming and to determine
  what is already here

• Economic Indicators: Statistics that
  measure variables in the economy.

 Ex.: Stock Market
          Leading Indicators
• Indicators that point to what will possibly
  happen in the future.

• Can predict an upward or downward trend

 Ex.: Stock Market & Interest Rates
         Lagging Indicators
• These are indicators that take longer to
  happen than overall business activity
 Ex.: Banks begin closing, but interest rates
      on loans do not change for 6 months

• Gives clues to the duration of phases in
  the business cycle
          Federal Reserve
• Central Banking System of the U.S.

• Created in 1913 by the Federal Reserve

• Both a public & private bank
           Federal Reserve
• It was originally intended just to address
  banking issues

• Its purpose has expanded since then
           Federal Reserve
• Currently its job includes:
 1. Address the problem of banking panics
 2. Central Bank of U.S.
 3. Balance private banks & government
 4. Manage the U.S. money supply
 5. Maintain economic stability
 6. Provides financial services to large units
 7. Strengthen U.S. standing in the world
           Federal Reserve
• It is criticized as having too much power.

• Some believe we do not need a
  centralized bank because it gives
  government an additional power of the
  people in the economy
• Common Taxes:
 --Personal Income: Percentage of income
 --Social Insurance: Tax to fund Social
 --Estate: Tax on property owned by a person who
           has passed away.
 --Inheritance: Tax on inherited property
 --Sales: Tax on purchases
 --Property: Tax on owned property

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