Unit 2: Macroeconomics: Gross Domestic Product, Inflation, and Unemployment
In macroeconomics we study the total output an economy generates. Economists use gross domestic product (GDP), the monetary value of all final goods and services produced within a country's borders in one year, to measure a country's total output. Macroeconomics tend to use real GDP, rather than nominal GDP, for their comparisons since real GDP removes the effect of inflation. Measuring growth in current dollars (which does not account for inflation), rather than constant dollars, might indicate a false sense of economic growth or decline.
Governments focus on three key indicators of economic growth: an increase in real GDP over time, full employment, and price level stability. In unit 5, we explore how governments form, implement, and evaluate their fiscal and monetary policies to achieve these three goals. In this unit we uncover scenarios and philosophical debates about government's role in a market-based economy. We examine whether GDP is an accurate measure of societal well-being, quality of life, and the standard of living.
Completing this unit should take you approximately 10 hours.Upon successful completion of this unit, you will be able to:
- define and distinguish nominal gross domestic product and real gross domestic product;
- identify the components of the business cycle and track real GDP over time;
- define inflation and track it over time;
- compute inflation by calculating the price of a basket of goods and the corresponding price index;
- distinguish between the various types of price indexes in the economy compute real variables using the corresponding price index;
- define unemployment and discuss how economists measure it;
- distinguish between frictional, structural, and cyclical unemployment and their impacts on the economy's production;
- analyze and apply the concepts of natural rate of unemployment and full employment;
- identify and analyze the four elements of GDP - Consumption, Investment, Government Purchases and Net Exports;
- compare the expenditure and the income approaches to the measurement of GDP; and
- analyze the problems associated with using GDP as a measure of well-being.
2.1: Defining GDP and the Business Cycle
Read this chapter and attempt the "Try It" exercises. Also, complete the concept problems and the numerical problems at the end of the chapter. In the first section of this chapter, you will read about the definition of Gross Domestic Product and some of the issues around measuring it. You will also learn about the 4 phases of the business cycle. As you will see, the economy goes through naturally alternating periods of economic growth and recession. You will review certain sections of this chapter later in the unit.
- Watch these three videos to analyze the definition of Gross Domestic product and the ways in which this definition avoids double-counting and the effects of price changes.
- Watch these two videos to explore the components of the business cycle. As you will see, the business cycle is largely driven by the emotions of the market participants. Bouts of optimism can spur demand and increase economic activity whereas negative expectations can precipitate economic decline.
- Explore the Bureau of Economic Analysis website to find out current real time measures of economic indicators such as GDP, unemployment, inflation, etc.
2.2: Inflation, Nominal GDP, and Real GDP
- Review section 2 of the Macroeconomics chapter assigned in Unit 2.1, which defines and discusses the concept of Inflation. Learn what hyperinflation and deflation are and identify the method of calculating inflation. Pay attention to the meaning and calculation of the term "Price Index" and the way it is used to calculate inflation.
- The following 3 episodes from Dr. McGlasson's Macroeconomics Modules video series explore inflation, the price indexes, and the way real variables such as real income and real GDP are derived.
- Watch these two videos, which show the distinction between real GDP and nominal GDP and introduce the GDP deflator, which is the price index calculated on all goods and services that are included in GDP.
- Watch this lecture about calculating real GDP with a deflator. This is one among many approaches to removing the effect of inflation from nominal or current values. Watch for other approaches, some of which draw from a base broader or narrower relative to that under current consideration.
- Read this article, which discusses how inflation can distort the allocation of resources and adversely affect economic efficiency.
- Inflation is the rise in the general price level in the country. One of the measures of inflation in the U.S. is the Consumer Price Index (CPI). Find the official published CPI levels on the Bureau of Labor Statistics site below. Pay attention to the way food and energy prices contribute to the overall price level.
- The following video introduces inflation, defined as an increase in the price level over time. The video shows how inflation is calculated using the consumer price index (CPI).
- Watch this lecture, which discusses hyperinflation. Hyperinflation is defined as inflation rates in excess of 200 percent for a period of one year or longer.
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- Receive a grade
Take this quiz to see how well you understand nominal GDP, real GDP, and growth rates.
- This assessment does not count towards your grade. It is just for practice!
- You will see the correct answers when you submit your answers. Use this to help you study for the final exam!
- You can take this assessment as many times as you want, whenever you want.
2.3: Unemployment
- Review these sections from the Macroeconomics chapter assigned in Unit 2.1, which define and discuss the concept of unemployment. As you will find out, there are specific characteristics that have to be present for for someone to be considered "unemployed". The mere fact of a person not having a job is not sufficient for that determination. Read this section of the text to find out more.
- These episodes from Dr. McGlasson's Macroeconomics Modules video series give you a different angle on the meaning of unemployment and the main types of unemployment: frictional, structural, and cyclical.
- Learn about the meaning of "natural rate of unemployment". As it turns out, our goal is not to achieve 0% unemployment - that is impossible, but a certain rate of low unemployment (aka "the natural rate of unemployment") is not only possible but desirable.
- Read this article to learn about some of the shortcomings of the available unemployment statistics and some alternative metrics to see a more full picture.
As you saw, we can measure unemployment in many ways. This article gives a few additional measures of unemployment that were not discussed in the textbook. In the United States, we use six measures of unemployment. The table and numbers in this resource come from the Bureau of Labor Statistics, the federal agency that monitors and reports on unemployment. After you read this resource, you will confirm your understanding of the BLS unemployment categories in a quiz. You will need to reference the figures on this page as you take the quiz, so be sure to come back to it.
- In the U.S., unemployment statistics is collected and compiled by the Bureau of Labor Statistics of the Department of Labor. The unemployment reports are published monthly and available on the following web site. Explore the website and identify the current level of unemployment in the U.S. How does it compare to the natural rate of unemployment?
- Receive a grade
Take this quiz to see how well you understand the six measures of unemployment used by the Bureau of Labor Statistics.
- This assessment does not count towards your grade. It is just for practice!
- You will see the correct answers when you submit your answers. Use this to help you study for the final exam!
- You can take this assessment as many times as you want, whenever you want.
- Read this article, which includes data from the United States Bureau of Labor Statistics, to learn how to calculate the unemployment rate.
2.4: GDP Components: Consumption, Investment, Government Purchases, and Net Exports
- Read this chapter, to learn about measuring domestic output, and attempt the "Try It" exercises. The material in this chapter concentrates on the four components of GDP: consumption, investment, government purchases, and net exports. Pay attention to the definition of these components as it may differ from your expectations. For example, note that Investment does not refer to the common knowledge definition of investment as in the trading of stock and bonds. Instead, the Investment component refers mainly to the purchase of physical machinery and equipment needed in the production of goods and services. You will revisit certain sections of the chapter later in this unit.
- Watch these two videos which discuss the components of GDP and the income and expenditure approaches to measuring GDP.
Read this chapter for an overview of the concepts that are associated with the business cycle. The business cycle provides information on the causes and characteristics of the economic problems associated with unemployment and inflation. Be sure to complete the assessment in this subunit that accompanies this reading.
Download and examine this table, which contains statistics on various components of the GDP from 2013 to 2015 broken down by quarter. Observe how the United States has gone through growth and contraction at various points during this time period.
Each quarter the BEA produces an estimate of the annual GDP for that year. As the year progresses their estimate of the GDP becomes better and more refined. The fourth quarter estimate is the best estimate, although that number is modified in the following year, as "actual" numbers become available for the previous year. For the fourth quarter of 2014, the GDP is given as "17,615.9." The numbers in this table are expressed in Billions of US Dollars. What it means in words is 17 trillion, 615 billion, 900 million dollars. The US GDP today is heading for 18 trillion dollars.
When you search for this information, you will see slight differences from the numbers reported on various sites to that of the BEA. This slight difference happens because other sites reconcile/modify quarterly estimates to arrive at an annual estimate of GDP, while the BEA just reports quarterly estimates of the annual GDP.
2.5: Problems Using GDP as a Measure of Well-Being
- Review section 3 of the Macroeconomics chapter assigned in 2.1. Learn about the shortcomings of GDP as a measure of well-being. As we will see, GDP is an imperfect measure of happiness as it focuses exclusively on the material well-being of a country's citizens. Factors such as the quality of healthcare, education, and the environment, are not explicitly covered by GDP.
Unit 2 Discussion
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