Gross Domestic Product Basics GDP The measures were

• • • • • • • • Gross Domestic Product Basics: GDP The measures were created in the 1930’s. Up until the 1990’s GNP was the main federal measure of the economy. Key terms to know: “Gross” = Totals before adjustments (inflation’s effect) “National Product” = Production owned by US companies “Domestic Product” = Production in the US, even if foreign owned GDP is officially measured in “quarters” of years: Quarter 1 = Jan/Feb/Mar Quarter 2 = Apr/May/June Quarter 3 = July/Aug/Sep Quarter 4 = Oct/Nov/Dec The main form used is the “Expenditures” Approach: C + Ig + G + Xn C = Personal Consumption in the economy: (67% of the Economy !!!) The purchases of finished goods and services (but not houses) Ig = Gross Private Business Investment monies: Factory equipment maintenance, New factory equipment, Construction of housing, Unsold inventory of products built in a year G = Government Spending: Government purchases of products and services Xn = Net Foreign Factor of Trade: Exports minus Imports Exports = Dollars in, Imports = Dollars out (Post WWII, Xn has usually been a negative number: Trade Deficit)

Items that DO NOT Count in GDP: Used goods/Second-Hand goods Gifts or “Transfers” (Private or Public) (note COLAs) Stock/Equity/Securities purchases (places like the NYSE, NASDAQ) Unreported business activities conducted in “cash” (unreported tips. . . ) Illegal activities (underground markets) Financial transactions between banks and businesses “Intermediate goods” (no double counting) (see “value added”) “Non market” activities like volunteer and family work

Business Cycle Is the economy getting better or worse?

Micro vs. Macro • Microeconomics: The study of personal, or small finances. – Individuals, families or businesses • Macroeconomics: The study of economic systems on a large scale – National or Global economies

Gross Domestic Product • Def. The total value, in dollars, of all final goods and services produced within the nation each year • Abbreviated as the GDP

What does the GDP tell us? • If the GDP is larger than last year the economy is expanding (getting bigger) • If the GDP is smaller, the economy is shrinking (getting smaller)

Business Cycle • The Business Cycle allows people to understand the direction the economy (GDP) is going (growing or shrinking) and plan accordingly. • The economy follows the Business Cycle regularly.

Phases of the Business Cycle Expansion (Growing) Peak (Top) Contraction (Shrinking) Trough (Bottom)

Business Cycle Peak ion ns pa Ex sio pa n Ex n io n tio ac ct ra ntr Trough nt Co Co n Peak

Expansion • During a period of expansion: – Wages increase – Low unemployment – People are optimistic and spending money – High demand for goods – Businesses start – Easy to get a bank loan – Businesses make profits and stock prices increase

Peak • When the economic cycle peaks: – The economy stops growing (reached the top) – GDP reaches maximum – Businesses can’t produce any more or hire more people – Cycle begins to contract

Contraction • During a period of contraction: – Businesses cut back production and layoff people – Unemployment increases – Number of jobs decline – People are pessimistic (negative) and stop spending money – Banks stop lending money

Trough • When the economic cycle reaches a trough: – Economy “bottoms-out” (reaches lowest point) – High unemployment and low spending – Stock prices drop But, when we hit bottom, no where to go but up! UNLESS….

Recession/Depression • A prolonged contraction is called a recession (contraction for over 6 months) • A recession of more than one year is called a depression

• Who decides when we’re in a recession? – National Bureau of Economic Research traditionally declares recessions – Private research organization, not a federal agency • Recession dates from peak of business

Post-World War II Recessions* *The February 1945–October 1945 recession began before the war ended in August 1945. Note: These recessions were of varying duration and severity.

Another Look at Expansions and Recessions Can you find a pattern? Neither can economists! That’s why recessions are hard to predict.

What keeps the Business Cycle Going? • 4 variables cause changes in the Business Cycle: 1. Business Investment When the economy is expanding, sales and profit keep rising, so companies invest in new plants and equipment, creating new jobs and more expansion. In contraction, the opposite is true

What Keeps the Business Cycle Going? 2. Interest Rates and Credit Low interest rates, companies make new investments, adding jobs. When interest rates climb, investment dries up and less job growth 3. Consumer Expectations Forecasts of an expanding economy fuels more spending, while fear of a recession decreases consumer spending

What keeps the Business Cycle Going? 4. External Shocks, such as disruptions of the oil supply, wars, or natural disasters greatly influence the output of the economy Ex. 1992 -2000 was the longest period of expansion in U. S. history. Early in 2001, signs of contraction appeared, though the Bush administration denied it. The Sept. 11 th 2001 terrorist attacks quickly caused the business cycle to shift into a contraction.

Business Cycle Theories • Endogenous theories: – Innovation theory: innovation leads to saturation. – Psychological theory: alternating optimism and pessimism – Inventory cycle theory: inventory and demand not in sync – Monetary theory: changes in money supply by Federal Reserve – Underconsumption theory: or overproduction

Business Cycle Theories • Exogenous theories: – The external demand shock theory: effect of foreign economies – War theory: war stimulates economy; peace leads to recession – The price shock theory: fluctuations in oil prices

Who Cares? ? ? • Why should you care about the business cycle and economy? • Lots of reasons!

“Don’t quit that job!” • If the economy is going into a contraction, jobs will become more scarce. If you quit, you may not find another job! • But, if the economy is in a period of expansion, jobs are readily available. It may be a good time to switch careers.

“Should I make a big purchase? ” • Only if you know that you won’t lose your job in a contraction. So, buy your house during an expansion. HOWEVER, • When the economy starts to slow down (contraction), interest rates will decrease. Wait to buy a house until the rates drop to a low point, if you are sure you won’t lose your job.