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  Chapters 12- 16
                     Domain Focus


The student will illustrate the means by
  which economic activity is measured.
                     Domain Focus


The student will explain the role and
  functions of the Federal Reserve
                     Domain Focus


The student will explain the role and
  functions of the Federal Reserve
 SSEMA1 The student will illustrate the means by which
              economic activity is measured.

a. Explain that overall levels of income, employment, and prices are
determined by the spending and production decisions of
households, businesses, government, and net exports.
b. Define Gross Domestic Product (GDP), economic growth,
unemployment, Consumer Price Index (CPI), inflation, stagflation,
and aggregate supply and aggregate demand.
c. Explain how economic growth, inflation, and unemployment are
d. Identify structural, cyclical, and frictional unemployment.
e. Define the stages of the business cycle, as well as recession and
f. Describe the difference between the national debt and
government deficits.
• Reminder- Macroeconomics= the study of the
  behavior and the decision making of entire
Circular Flow Model
Gross Domestic Product

• Gross= total

• Domestic= produced anywhere in the 50
  states, by anyone

• Product= final goods and services
What does GDP measure?

 Total amount of final goods and
  services produced in a country
            in one year.

     (Measure of Output)
         Gross Domestic Product
• Gross Domestic Product (GDP)- the dollar value
  of all final goods and services produced within a
  country’s borders in a given year
   – Dollar Value- the total of the selling prices of all goods
     and services produced in a country in one calendar
   – Final Goods and Services- products in the form sold to
      • Intermediate goods- used in the production of final goods
   – Produced within a country’s borders- includes cars
     produced in the U.S. by a Japanese automaker
Are there any cool formulas you
   can give us relating to this
      interesting concept?

                              Expenditure Approach
• C= consumption spending
    (think consumers)
• I= investment spending
    (think businesses investing in themselves)
• G= government spending
• (X-M)= difference between exports and imports
         Expenditure Approach
• Expenditure Approach (output-expenditure
  – Estimate the annual expenditures or amounts spent on
    four categories of final goods and services
     • Consumer goods and services
        – Durable goods- goods that last for a relatively long time
          (refrigerators, cars, etc.)
        – Nondurable goods- goods that last a short period of time (food, light
          bulbs, etc.)
     • Business Goods and services
     • Gov’t goods and services
     • Net exports or imports of goods and services
  – Add together the amounts spent on all four categories
    to arrive at the total expenditures on goods and services
    produced during the year
 Expenditure Approach

            Income Approach
• Income Approach
  – Calculates GDP by adding up all the incomes in the
• Results from the two approaches are
  compared to judge accuracy
               What is counted in GDP?
• FINAL goods
   and services

• Goods/Services produced
  here, even if by a foreign co.
       What is NOT counted?

• Things produced outside the

• Illegal stuff

• Purely financial transactions
           Limitations of GDP
• GDP does not take into account certain
  economic activities
  – NonMarket Activities- goods and services that
    people make or do themselves
  – The underground economy- black market and
    illegal goods, legal informal transactions
  – Negative Externalities- unintended economic side
  – Quality of life
Problems associated with GDP

• Slow to calculate

• Does not count everything
  (it’s an estimate)

• Inflation can distort the figure
     Real vs. Nominal
      Nominal Versus Real GDP
• Nominal GDP- GDP measured in current
• Real GDP- GDP expressed in constant, or
  unchanging prices
              Real and Nominal GDP

       Nominal and Real GDP
            Year 1                                    Year 2                                    Year 3
          Nominal GDP                               Nominal GDP                                Real GDP

    Suppose an economy‘s entire              In the second year, the economy’s        To correct for an increase in
    output is cars and trucks.               output does not increase, but the        prices, economists establish a set
                                             prices of the cars and trucks do:        of constant prices by choosing
    This year the economy produces:                                                   one year as a base year. When
                                            10 cars at $16,000 each = $160,000        they calculate real GDP for other
   10 cars at $15,000 each = $150,000                                                 years, they use the prices
                                         + 10 trucks at $21,000 each = $210,000
+ 10 trucks at $20,000 each = $200,000                                                from the base year. So we
                                                              Total = $370,000
                     Total = $350,000                                                 calculate the real GDP for Year 2
                                             This new GDP figure of $370,000          using the prices from Year 1:
    Since we have used the current           is misleading. GDP rises because        10 cars at $15,000 each = $150,000
    year’s prices to express the             of an increase in prices.            + 10 trucks at $20,000 each = $200,000
    current year’s output, the result        Economists prefer to have a
                                             measure of GDP that is not                                Total = $350,000
    is a nominal GDP of $350,000.
                                             affected by changes in prices. So        Real GDP for Year 2, therefore,
                                             they calculate real GDP.                 is $350,000
            Economic Growth
• Economic growth is measured by finding real
  GDP per capita (real GDP divided by the total
• Real GDP per capita is considered the best
  measure of a nation’s standard of living.
• The basic measure of a nation’s economic
  growth rate is the percentage change of real
  GDP over a given period of time
               Per Capita GDP

GDP divided by a country’s population
 Other Income and Output Measures
• GDP is the primary measure of output
• Gross National Product (GNP)- the annual
  income earned by U.S. owned firms and U.S.
  – Depreciation (the loss of the value of capital
    equipment that results from normal wear and
    tear) is not taken into account
               Aggregate Supply
 Aggregate Supply- the total amount of goods and
  services in the economy available at all possible price
   Economists add up the total supply of goods and services
    produced for sale in the economy (GDP)
   Calculate the price level (the average of all prices in the
 As the prices of most goods and services change, the
  price level changes.
 Firms respond by changing their output (real GDP)
   Prices rise- production increases
   Prices fall- production decreases
Aggregate Supply
           Aggregate Demand
• Aggregate Demand- the amount of goods and
  services in the economy that will be
  purchased at all possible price levels
  – Lower price levels means greater purchasing
    power for households; falling prices increase
    wealth and demand
  – Higher price levels causes purchasing power to
    decline; reduction in the quantity of goods and
    services demanded
Aggregate Demand
           AS/AD Equilibrium
• Aggregate Supply/Aggregate Demand
  Equilibrium= AS/AD Equilibrium
• Any shift in aggregate supply or aggregate
  demand will have an impact on real GDP and
  on the price level
   Aggregate Demand and Aggregate Supply Lesson
Factors that shift an AD Curve

                                 • Changes in
                                    –   Consumer Spending
                                    –   Investment Spending
                                    –   Government Spending
                                    –   Net Export Spending
                                 • Increases in Aggregate
                                   Demand increase real GDP
                                   and the price level
                                 • Decreases in Aggregate
                                   Demand decrease real GDP
                                   and price level
  Aggregate Demand and Aggregate Supply Lesson
Factors that shift an AS Curve

• Changes in
   – The prices of inputs (land,
     labor, capital, and
   – Productivity
   – Technology
   – Government Regulations
• Increases in Aggregate Supply
  increase real GDP and lower
  the price level
• Decreases in Aggregate Supply
  decrease real GDP and raise
  the price level
             Business Cycles
• Business Cycles- a period of macroeconomic
  expansion followed by a period of contraction
• Business cycles are not minor ups and downs-
  they are major changes in real GDP above or
  below normal levels
      Business Cycle

      Phases of a Business Cycle
1. Expansion- a period of economic growth as
   measured by a rise in real GDP
  – Economic Growth- a steady, long-term increase in
    real GDP
  – Plentiful jobs, a falling unemployment rate, and
    business prosperity
2. Peak- the height of an economic expansion,
   when real GDP stops rising
      Phases of a Business Cycle
3. Contraction- a period of economic decline
    marked by falling real GDP
   Unemployment rate rises
   Recession- a prolonged economic contraction-
    generally lasts from 6 to 18 months
   Depression- a recession that is especially long and
    severe; high unemployment and low factory output
   Stagflation- a decline in real GDP combined with a rise
    in the price level
4. Trough- the lowest point in an economic
    contraction, when real GDP stops falling
    What affects Business Cycles?
• Business cycles are affected by 4 main variables
  1. Business Investment
    •   When the economy is expanding businesses invest heavily in
        new plants and equipment
    •   When firms decide they have expanded enough or demand
        falls they cut back on investment spending
  2. Interest Rates and Credit
    •   When interest rates are low households and firms borrow
        more money
    •   When interest rates climb, investments and job growth dries
   What affects Business Cycles?
3. Consumer Expectations
  – Fears of a weakening economy can cause
    consumer confidence to fall- people begin saving
    their money; the opposite is also true
4. External Shocks
     • Negative External Shocks- Disruptions in the oil supply,
       wars that interrupt normal trade relations, droughts
       that severely reduce crop harvests
     • Positive External Shocks- discovery of a large deposit of
       oil or minerals, a perfect growing season
      Business Cycle Forecasting
• Leading Indicators- key economic variables
  that economists use to predict a new phase of
  a business cycle
  – Stock Market
  – Interest Rates
  – Manufacturers new orders of capital goods
  Business Cycles in American History
• The Great Depression- the most severe
  economic downturn in the history of industrial
• John Maynard Keynes- The General Theory of
  Employment, Interest, and Money
  – Economies could fall into long-lasting contractions
  – Government intervention might be needed to pull
    an economy out of a depression
Am I Unemployed?
1. Structural
2. Cyclical
3. Frictional
            Types of Unemployment
Frictional Unemployment
• Occurs when people change jobs, get laid off from their current jobs, take
    some time to find the right job after they finish their schooling, or take
    time off from working for a variety of other reasons
Structural Unemployment
• Occurs when workers' skills do not match the jobs that are available.
    Technological advances are one cause of structural unemployment
Seasonal Unemployment (DO NOT NEED TO KNOW for EOCT)
• Occurs when industries slow or shut down for a season or make seasonal
    shifts in their production schedules
Cyclical Unemployment
• Unemployment that rises during economic downturns and falls when the
    economy improves
Structural Unemployment
Cyclical Unemployment
Frictional Unemployment
       What is “unemployed”?
• People available for work who made a specific
  effort to find work in the past month and who
  during the most recent survey week, worked
  less than one hour for pay or profit.
• Also people who worked in a family business
  without pay for less than 15 hours a week.
How is unemployment measured?
• It’s an important indicator of the health of the
• Bureau of Labor statistics polls sample of population
  to determine how many are employed and
• Unemployment rate is the percentage of nation’s
  labor force that is unemployed.
• It is only a national average – it’s doesn’t reflect
  regional trends.
           Full Employment
• The level of employment reached when there
  is no cyclical unemployment (no one out of
  work because of downturn in the economy –
  everyone who wants a job has one)
• 4-6% unemployment is “normal”.
• Figures don’t count those who have become
  frustrated and stopped looking for work (have
  to have looked for work in the past 4 weeks)
• If you have a part time job you are considered
  employed even if you would rather have a full
  time job – took this one because it’s all you
  could find.
      The Effects of Rising Prices
• Inflation- a general increase in prices
• Purchasing power- the ability to purchase
  goods and services, is decreased by rising
• Price level - the relative cost of goods and
  services in the entire economy at a given point
  in time
             Degrees of Inflation
• Creeping inflation
   – Range of 1-3%
• Galloping inflation
   – Can go as high as 100-300%
• Hyperinflation
   – Out of control
   – In range of 500%
   – Doesn’t happen often – last stage before monetary
     collapse. (WW II – Hungary and Germany)
             Causes of Inflation
• The Quantity Theory- too much money in the
  economy leads to inflation; inflation can be tamed by
  increasing the money supply at the same rate that
  the economy is growing.
• The Cost-Push Theory- inflation occurs when
  producers raise prices in order to meet increased
   – Leads to wage-price spiral- the process by which
     rising wages cause higher prices and higher prices
     cause higher wages
           Causes of Inflation
• The Demand-Pull Theory- inflation occurs when
  demand for goods and services exceeds
  existing supplies
• Wage-price spiral – self-perpetuating spiral –
  higher prices force workers to ask for higher
  wages. Producers try to recover this by raising
  prices, which forces workers to ask for higher
                   Effects of Inflation
• Purchasing Power
   – The dollar will not buy the same amount of goods that
     it did in years past.
• Interest Rates
   – When a bank's interest rate matches the inflation rate,
     savers break even. When a bank's interest rate is
     lower than the inflation rate, savers lose money.
• Income
   – If wage increases match the inflation rate, a worker's
     real income stays the same. If income is fixed income,
     or income that does not increase even when prices go
     up, the economic effects of inflation can be harmful.
               Price Indexes
• Price Index- a measurement that shows how the
  average price of a standard group of goods
  change over time
• Consumer Price Index (CPI)- a price index
  determined by measuring the price of a standard
  group of goods meant to represent the “market
  basket” of a typical urban consumer
  – Market Basket- a representative collection of goods
    and services
  – Inflation Rate- the percentage of change in price level
    over time
               Calculating the CPI
• Price index = cost today             X 100
               cost in base year
Price index is current value of a “basket” of goods and service divided
   by cost of same basket in base year and then multiplied by 100.
- Mixed basket of goods used because prices can go up or down for
   reasons that have nothing to do with inflation.
- Having a large group of representative items helps eliminate the
   effect of some product’s price dropping while others tend to be on
   the rise.
- Base year can be any year.
- Price index for the base year will always be 100.
- Index values over 100 indicate inflation.
- Index values under 100 indicate deflation.
                 Calculating Inflation
• To determine the inflation rate
  from one year to the next:
   – Take the CPI for year A and
      subtract the CPI for year B
   – Multiply by 100
Debt v. Deficit
Questions for You
  • What is the national debt?
  • What caused the national debt?
  • Where does the government get the
    money when it wants to spend more
    than it takes in?
  • What is a budget deficit?
  • What is a budget surplus?
    Budget Deficits and the National
Balanced Budget- a budget in which revenues
 are equal to spending
The federal budget is almost never balanced
Budget Surplus- a situation in which the
 government takes in more than it spends
Budget Deficit- a situation in which the
 government spends more than it takes in
           The National Debt

• National Debt- the total amount of
  money the federal government owes to
  –The U.S. government is viewed as
    stable and trustworthy and can borrow
    money at a low interest rate
    The difference between DEFICITS
                and DEBT

• Deficit- the amount of money the
  government borrows for one budget
• Debt- the sum of all government borrow
  up to that time that has not been repaid
 SSEMA3 The student will explain how the government uses
fiscal policy to promote price stability, full employment, and
                      economic growth.
a. Define fiscal policy.
b. Explain the government’s taxing and
  spending decisions.
Fiscal Policy
       Fiscal Policy
Actions taken by the Federal
Government to influence the
 economy (business cycles).
  How do they do it?

Taxation (revenue)

Spending (expenditures)

  -transfer payments-

If the economy needs a “boost” the Federal
   Government might:

           _______________ taxes.

         _______________ spending.

If the economy needs to be “cooled off” the
   Federal Government might:

           _______________ taxes.

         _______________ spending.
      Understanding Fiscal Policy

Fiscal policies are used to achieve economic
 growth, full employment, and price stability.
Federal Budget- a plan for the federal
 government’s revenues and spending for the
 coming year
  › Lists expected income
  › Shows how much money will be spent
       Understanding Fiscal Policy

• Fiscal Year- a twelve-month period that can
  begin on any date (October 1-September 30
  for the Federal Government)
     Fiscal Policy and the Economy

• Expansionary Policies- fiscal policies, like
  higher spending and tax cuts, that encourage
  economic growth
  – Used to raise the level of output in the economy
  – Encourage growth
  – Government spending increases aggregate
     Fiscal Policy and the Economy

• Contractionary Policies- fiscal policies, like
  lower spending and higher taxes, that reduce
  economic growth
  – Used when demand exceeds supply to slow the
    growth of the economy (GDP)
  – Used to slow or prevent inflation
  – Leads to a decrease in aggregate demand which
    leads to lower prices
           Limits of Fiscal Policy

• The government cannot change spending for
• Difficult to know the current state of the
  economy (GDP)
• Even more difficult to predict future economic
           Keynesian Economics

 John Maynard Keynes- The General Theory of
  Employment, Interest, and Money
  › Comprehensive explanation of economic forces
  › Told economists and politicians how to get out of
    economic crises and how to avoid them
  › Focused on the economy as a whole
  › Productive Capacity- the maximum output that an
    economy can produce without big increases in
  › Demand-Side Economics- the idea that government
    spending and tax cuts help an economy by raising
         Keynesian Economics

› Keynesian Economics- a form of demand-side
  economics that encourages government action to
  increase or decrease demand and output
› Fiscal policy should be used to fight periods of
  recession/depression and periods of inflation
› Advocated the use of expansionary and
  contractionary fiscal policies
› Multiplier Effect- the idea that every one dollar
  of government spending creates more than one
  dollar in economic activity
 SSEMA2 The student will explain the role and
   functions of the Federal Reserve System.

a. Describe the organization of the Federal
   Reserve System.
b. Define monetary policy.
c. Describe how the Federal Reserve uses the
   tools of monetary policy to promote price
   stability, full employment, and economic
     Federal Reserve Act of 1913
• Created the Federal Reserve System
• Composed of 12 independent regional banks
• Could lend money to other banks in times of
 Structure of Federal Reserve System
• Board of Governors- the seven-member
  board that oversees the Federal Reserve
  – Appointed for staggered 14 year terms (keeps
    members from being pressured politically)
  – President picks a chair for a 4 year term from the
    board of governors
    Structure of the Federal Reserve
• Federal Reserve Districts- the twelve banking
  districts created by the Federal Reserve Act (one
  Federal Reserve Bank is located in each district)
• All nationally charted banks are required to join the
• Member banks own shares in the Fed and therefore
  gives the system of high degree of political
Monetary Policy
Monetary Policy DVD
         Monetary Policy
  The actions the Federal Reserve
(Central Bank) takes to influence the
level of GDP and the rate of inflation
           in the economy.
         How Do They Do It?
• Tools of the FED
  1. Open Market Operations
  2. Discount Rate (Fed to Banks)
  3. Federal Funds Rate (bank to bank
  4. Reserve Requirements
     Tools of the Federal Reserve
• Open Market Operations- the buying and selling
  of government securities to alter the money supply
   – Bond Purchases - In order to increase the money
     supply, the Federal Reserve Bank of New York buys
     government securities on the open market.
   – Bond Sales- When the Fed sells bonds, it takes
     money out of the money supply.
• Discount Rate (Federal Reserve to Bank)- the
  interest rate that banks pay to borrow money
  from the Federal Reserve
    Tools of the Federal Reserve
• Federal Funds Rate (bank to bank)- the
  interest rate that banks pay to borrow money
  from each other

• Reserve Requirement- the amount of money
  that a bank must keep on hand; set by the
  Federal Reserve
Fiscal and Monetary Policy Tools

Fiscal and Monetary Policy Tools

                          Fiscal policy tools       Monetary policy tools

                                                 1. open market operations:
                      1. increasing government      bond purchases
                         spending                2. decreasing the discount
                      2. cutting taxes              rate
                                                 3. decreasing reserve

                                                 1. open market operations:
                    1. decreasing government        bond sales
  Contractionary                                 2. increasing the discount
      tools         2. raising taxes                rate
                                                 3. increasing reserve
If the economy needs a “boost” the Federal
   Reserve might:

_______________ bonds.
_______________ interest rates.
_______________ reserve requirements.
If the economy needs to be “cooled off” the
   Federal Reserve might:

_______________ bonds.
_______________ interest rates.
_______________ reserve requirements.

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