Pump Primer

Using your textbook:

Define Gross Domestic Product. List at least three categories that are

not listed in GDP.

Unit V: Economics of the Unit V: Economics of the GovernmentGovernment

Unit V: Economics of the Unit V: Economics of the GovernmentGovernment

By Alan J. CarperBy Alan J. CarperBob Jones University Press. 1998Bob Jones University Press. 1998

By Alan J. CarperBy Alan J. CarperBob Jones University Press. 1998Bob Jones University Press. 1998

“ECONOMICS for Christian Schools”“ECONOMICS for Christian Schools”

““Measuring the Wealth of the Measuring the Wealth of the Nation”Nation”““Measuring the Wealth of the Measuring the Wealth of the Nation”Nation”

Chapter 12Chapter 12Chapter 12Chapter 12

ObjectivesObjectives

Define gross domestic productDefine gross domestic product Differentiate between final and Differentiate between final and

intermediate goodsintermediate goods Identify the four categories of Identify the four categories of

expenditures used to tabulate the expenditures used to tabulate the GDPGDP

Explain why the nominal GDP figure Explain why the nominal GDP figure is not entirely accurate and needs is not entirely accurate and needs adjustment to become more usefuladjustment to become more useful

Define trade deficit and trade surplusDefine trade deficit and trade surplus List the reasons that a nation might List the reasons that a nation might

experience a trade deficitexperience a trade deficit Explain the positions of the Explain the positions of the

protectionists and the supporters of protectionists and the supporters of free tradefree trade

ObjectivesObjectives

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

The Two Main Schools of ThoughtThe Two Main Schools of Thought

The two main approaches to The two main approaches to macroeconomics are based on two macroeconomics are based on two schools of thought:schools of thought:

Classical macroeconomicsClassical macroeconomicsKeynesian macroeconomicsKeynesian macroeconomics

(Bade slide 4)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

Classical macroeconomics Classical macroeconomics is a body of is a body of theory about how a market economy works theory about how a market economy works and why it experiences economic growth and why it experiences economic growth and fluctuations.and fluctuations.

The economy will fluctuate, and growth will The economy will fluctuate, and growth will slow down from time to time.slow down from time to time.

But no government remedy can improve But no government remedy can improve the performance of the market.the performance of the market.

The classical view = markets work well and The classical view = markets work well and deliver the best available macroeconomic deliver the best available macroeconomic performance.performance.

(Bade slide 5)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

Classical macroeconomic fell into Classical macroeconomic fell into disrepute during the 1930s, which was a disrepute during the 1930s, which was a decade of high unemployment and decade of high unemployment and stagnant production throughout the stagnant production throughout the world. (i.e., Great Depression)world. (i.e., Great Depression)

Classical macroeconomics predicted that Classical macroeconomics predicted that the Great Depression would end, but gave the Great Depression would end, but gave no method for ending it more quickly.no method for ending it more quickly.

(Bade slide 6)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

Keynesian macroeconomics Keynesian macroeconomics is a body of is a body of theory about how a market economy works theory about how a market economy works that stresses it inherent instability and the that stresses it inherent instability and the need for active government intervention to need for active government intervention to achieve full employment and sustained achieve full employment and sustained economic growth.economic growth.

John Maynard Keynes, in his book “John Maynard Keynes, in his book “The The General Theory of Employment, Interest, and General Theory of Employment, Interest, and MoneyMoney,” began this school of thought.,” began this school of thought.

Keynes’ theory was that too little consumer Keynes’ theory was that too little consumer spending and investment lead to the Great spending and investment lead to the Great Depression.Depression.

(Bade slide 7)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

Keynes’ solution to depression and high Keynes’ solution to depression and high unemployment was increased government unemployment was increased government spending.spending.

But Keynes predicted that his policy aimed at But Keynes predicted that his policy aimed at curing unemployment in the short term might curing unemployment in the short term might increase it in the long term.increase it in the long term.

This prediction became reality during the This prediction became reality during the 1960s and 1970s, when inflation exploded, 1960s and 1970s, when inflation exploded, growth slowed, and unemployment increased.growth slowed, and unemployment increased.

It was time for another challenge to the It was time for another challenge to the mainstream: new macroeconomicsmainstream: new macroeconomics

(Bade slide 8)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

The New MacroeconomicsThe New Macroeconomics New macroeconomics New macroeconomics is a body of theory is a body of theory

about how a market economy works based about how a market economy works based on the view that macro outcomes depend on on the view that macro outcomes depend on micro choicesmicro choices—the choices of rational —the choices of rational individuals and firms interacting in marketsindividuals and firms interacting in markets..

New classicalNew classical macroeconomics incorporates macroeconomics incorporates the ideas of classical economists that the ideas of classical economists that markets work and markets work and new Keynesiannew Keynesian macroeconomics that markets adjust slowly. macroeconomics that markets adjust slowly.

(Bade slide 9)

MACROECONOMIC APPROACHES AND MACROECONOMIC APPROACHES AND PATHWAYSPATHWAYS

The key difference between the two new The key difference between the two new schools is in their view of how quickly price schools is in their view of how quickly price and wages adjust in the face of excess and wages adjust in the face of excess demand or excess supply.demand or excess supply.

But this difference is tiny, and a consensus is But this difference is tiny, and a consensus is emerging.emerging.

The Road AheadThe Road Ahead We follow the new consensus and begin with We follow the new consensus and begin with

an explanation of what determines real GDP an explanation of what determines real GDP and employment and the pace of economic and employment and the pace of economic growth.growth.

(Bade slide 10)

Gross Domestic ProductGross Domestic Product

““One person’s spending is anotherOne person’s spending is anotherperson’s income.”person’s income.”

Gross Domestic Gross Domestic ProductProduct The The grossgross domestic productdomestic product, or , or GDPGDP, ,

is commonly used to measure is commonly used to measure economic growth. economic growth.

The GDP in the dollar value at The GDP in the dollar value at market prices of all final goods and market prices of all final goods and services produced in the economy services produced in the economy during a stated period. during a stated period.

Final goods are goods intended for Final goods are goods intended for the final user. the final user. For example, gasoline is a final good; For example, gasoline is a final good;

but crude oil, from which gasoline and but crude oil, from which gasoline and other products are derived, is not.other products are derived, is not.

(NCEE slide 26)

GDP also “aims to be a full count of the GDP also “aims to be a full count of the value of everything that is produced.” value of everything that is produced.”

Includes only those items that are Includes only those items that are traded in U.S. markets.traded in U.S. markets. GDP does GDP does notnot include: include:

sale of used goods (used cars) sale of used goods (used cars) sale of intermediate goods sale of intermediate goods illegal transactions illegal transactions purely financial transactions purely financial transactions (A financial transaction (A financial transaction

does not involve production of a good or service. It is a transfer does not involve production of a good or service. It is a transfer of assets.) of assets.)

do-it-yourself activities do-it-yourself activities imports (goods made outside of U.S.) imports (goods made outside of U.S.)

Gross Domestic Gross Domestic ProductProduct

How GDP is MeasuredHow GDP is MeasuredHow GDP is MeasuredHow GDP is Measured

Business Investment:Business Investment:

a. Gross private domestic investment a. Gross private domestic investment (GPDI), or business investment(GPDI), or business investment

- - sum of all business spending on sum of all business spending on capital capital investment and unplanned investment and unplanned inventories.inventories.

Government SpendingGovernment Spending- Federal, state and local governments - Federal, state and local governments

purchase purchase approx. $1 of every $5 worth of approx. $1 of every $5 worth of products and products and services services

Business Investment:Business Investment:

a. Gross private domestic investment a. Gross private domestic investment (GPDI), or business investment(GPDI), or business investment

- - sum of all business spending on sum of all business spending on capital capital investment and unplanned investment and unplanned inventories.inventories.

Government SpendingGovernment Spending- Federal, state and local governments - Federal, state and local governments

purchase purchase approx. $1 of every $5 worth of approx. $1 of every $5 worth of products and products and services services

(Carper, 170-171)

How GDP is MeasuredHow GDP is MeasuredHow GDP is MeasuredHow GDP is Measured

Net ExportsNet Exports

a. Exports a. Exports (products sold to other countries)(products sold to other countries)

b. Imports b. Imports products purchased from other countriesproducts purchased from other countries

includes net income from assets abroadincludes net income from assets abroad

Net ExportsNet Exports

a. Exports a. Exports (products sold to other countries)(products sold to other countries)

b. Imports b. Imports products purchased from other countriesproducts purchased from other countries

includes net income from assets abroadincludes net income from assets abroad

(Carper, 172)

HouseholdsHouseholds

GovernmentGovernment

FirmsFirms

The Financial The Financial MarketMarket

The Output MarketThe Output Market

The Input MarketThe Input Market

Rest of WorldRest of World

$$

II XXMM

TT GG

TT TRTR

IncomesIncomesExpendituresExpenditures

CC IIGG

NXNX

Government borrowscrowding out both

consumptionand Investment.

Expansionary policyreduces government

revenues

Expansionary policyadds extra flowsof government

spending

C=Consumption SpendingC=Consumption SpendingI=Investment SpendingI=Investment SpendingG=Government SpendingG=Government SpendingNX=Net exports (Exports minus Imports)NX=Net exports (Exports minus Imports)

T=TaxesT=TaxesTR=Government Transfer TR=Government Transfer PaymentsPaymentsS=SavingsS=Savings

Macroeconomic GoalsMacroeconomic Goals

Activity 11Activity 11

by Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education,

New York, N.Y.

Before using GDP to measure output growth, Before using GDP to measure output growth, we must first adjust GDP for price changes.we must first adjust GDP for price changes.

Let’s say GDP in Year 1 is $1,000 and in Let’s say GDP in Year 1 is $1,000 and in Year 2 it is $1,100. Does this mean the Year 2 it is $1,100. Does this mean the economy has grown 10 percent between economy has grown 10 percent between Year 1 and Year 2?Year 1 and Year 2? Not necessarily. If prices have risen, part of the Not necessarily. If prices have risen, part of the

increase in GDP in Year 2 will merely represent increase in GDP in Year 2 will merely represent the increase in prices. the increase in prices.

We call GDP that has been adjusted for price We call GDP that has been adjusted for price changes changes real GDP. real GDP. If it isn’t adjusted for price If it isn’t adjusted for price changes, we call itchanges, we call it nominal GDP nominal GDP..

To compute real GDP in a given year, use the To compute real GDP in a given year, use the following formula:following formula:Real GDP in Year 1 = (nominal GDP x 100) / price index

Part C: Measuring Short-Run Economic GrowthPart C: Measuring Short-Run Economic Growth

To computer real output growth in GDP from To computer real output growth in GDP from one year to another; one year to another; Subtract real GDP from one year to another;Subtract real GDP from one year to another;

Subtract real GDP for Year 2 from real GDP in Year 1. Subtract real GDP for Year 2 from real GDP in Year 1. Divide the answer (the change in real GDP from Divide the answer (the change in real GDP from

the previous year) by real GDP in Year 1. the previous year) by real GDP in Year 1. The result, multiplied by 100, is the percentage The result, multiplied by 100, is the percentage

growth in real GDP from year 1 to Year 2. growth in real GDP from year 1 to Year 2. (If real GDP declines from Year 1 to Year 2, the answer (If real GDP declines from Year 1 to Year 2, the answer

will be a negative percentage.) will be a negative percentage.) Here’s the formula:Here’s the formula:

Output growth =

(real GDP in Year 2 – real GDP in Year 1) real GDP in Year

1

x 100

Example: If real GDP in Year 1 = $1,000 and in Year 2 = $1,028, then the output growth rate from Year 1 to Year 2 is 2.8%: (1,028 – 1,000)/1,000 = .028, which we multiply by 100 in order to express the result as a percentage (2.8%).

To understand the impact of output To understand the impact of output changes, we usually look at real GDP changes, we usually look at real GDP per capita. per capita. To do so, we divide the real GDP of any To do so, we divide the real GDP of any

period by a country’s average population period by a country’s average population during the same period. during the same period.

This procedure enables us to determine This procedure enables us to determine how much of the output growth of a how much of the output growth of a country simply went to supply the country simply went to supply the increase in population and how much of increase in population and how much of the growth represented improvements in the growth represented improvements in the stand of living of the entire the stand of living of the entire population. population.

In this example, the average standard of living fell even though In this example, the average standard of living fell even though output growth was positive. Developing countries with positive output growth was positive. Developing countries with positive output growth but high rates of population growth often output growth but high rates of population growth often experience this condition.experience this condition.

Year 1

Real GDP per capita =

Year 1 real GDPPopulation in Year

1

= $1,00010

0

= $10

Year 2

Real GDP per capita =

$1,02811

0

= $9.30

Example, let’s say the population in Year 1 Example, let’s say the population in Year 1 was 100 and in Year 2 it was 110. What was was 100 and in Year 2 it was 110. What was the real GDP per capita in Years 1 and 2?the real GDP per capita in Years 1 and 2?

Nominal and Real GDPNominal and Real GDP

Nominal GDPNominal GDP Price IndexPrice Index Population Population

Year 3 $5,000 125 11

Year 4 $6,600 150 12

8. What is the real GDP in Year 3? _____________________________

9. What is the real GDP in Year 4? _____________________________

10.What is the real GDP per capita in Year 3? ____________________

11.What is the real GDP per capita in Year 4? ____________________

12.What is the rate of real output growth between Years 3 and 4?

__________________________________________

13. What is the rate of real output growth per capita between Years 3 and 4?

__________________________________________

(Hint: Use per-capita data in the output growth rate formula.)

$4,000 [(100 x $5,000) / 125]$4,400 [(100 x $6,600) / 150] $364 ($4,000 /

11)$367 ($4,400 / 12)

10% [($4,400 – 4,000) / 4,000] x 100

0.82% [($367 – 364) / 364] x 100

Foreign TradeForeign TradeForeign TradeForeign Trade

Reasons for Trade Deficits:Reasons for Trade Deficits:

1. Domestic Inability to Produce1. Domestic Inability to Produce

2. Better Quality of Foreign 2. Better Quality of Foreign GoodsGoods

3. Cheaper Foreign Materials3. Cheaper Foreign Materials

4. Lower Foreign Wages4. Lower Foreign Wages

5. Lower Foreign Capital Costs5. Lower Foreign Capital Costs

6. Foreign Government Subsidies6. Foreign Government Subsidies

Reasons for Trade Deficits:Reasons for Trade Deficits:

1. Domestic Inability to Produce1. Domestic Inability to Produce

2. Better Quality of Foreign 2. Better Quality of Foreign GoodsGoods

3. Cheaper Foreign Materials3. Cheaper Foreign Materials

4. Lower Foreign Wages4. Lower Foreign Wages

5. Lower Foreign Capital Costs5. Lower Foreign Capital Costs

6. Foreign Government Subsidies6. Foreign Government Subsidies

(Carper, 176-178)

Foreign TradeForeign TradeForeign TradeForeign Trade

Trade Policy, Protectionism, and Free TradeTrade Policy, Protectionism, and Free Trade

1. Protectionists1. Protectionists

2. Free Trade2. Free Trade

Trade Policy, Protectionism, and Free TradeTrade Policy, Protectionism, and Free Trade

1. Protectionists1. Protectionists

2. Free Trade2. Free Trade

(Carper, 180)

John Stuart Mill (1806-1873)John Stuart Mill (1806-1873)John Stuart Mill (1806-1873)John Stuart Mill (1806-1873)

Economic PhilosopherEconomic Philosopher ““Analyzed contemporary economic thought”Analyzed contemporary economic thought” ““Advanced the idea that society did not have the ability to Advanced the idea that society did not have the ability to

alter its economic production capabilities, but did have the alter its economic production capabilities, but did have the ability to alter the way it distributed its economic products.”ability to alter the way it distributed its economic products.”

Major work, “Major work, “The Principles of Political Economy”The Principles of Political Economy” Government should control the distribution of wealthGovernment should control the distribution of wealth Individual freedomIndividual freedom Social reforms Social reforms

Shorter work hoursShorter work hours Tax reformTax reform

Laid foundation for advancements in economicsLaid foundation for advancements in economics

Economic PhilosopherEconomic Philosopher ““Analyzed contemporary economic thought”Analyzed contemporary economic thought” ““Advanced the idea that society did not have the ability to Advanced the idea that society did not have the ability to

alter its economic production capabilities, but did have the alter its economic production capabilities, but did have the ability to alter the way it distributed its economic products.”ability to alter the way it distributed its economic products.”

Major work, “Major work, “The Principles of Political Economy”The Principles of Political Economy” Government should control the distribution of wealthGovernment should control the distribution of wealth Individual freedomIndividual freedom Social reforms Social reforms

Shorter work hoursShorter work hours Tax reformTax reform

Laid foundation for advancements in economicsLaid foundation for advancements in economics

(Carper, 180)

GNP ActivityGNP Activity

With a partner complete the GNP With a partner complete the GNP Activity.Activity.

Works CitedWorks CitedWorks CitedWorks CitedBade, Robin and Michael Parkin. Bade, Robin and Michael Parkin. Foundations of Foundations of

Economics. Economics. Pearson Education, Inc.: Boston, 2004.Pearson Education, Inc.: Boston, 2004.

Bade, Robin and Michael Parkin. Bade, Robin and Michael Parkin. Essential Essential Foundations of Economics.Foundations of Economics. Power Point Power Point presentation. presentation.

Carper, Alan. Carper, Alan. Economics for Christian SchoolsEconomics for Christian Schools. . Greenville: Bob Jones University Press, 1998. Greenville: Bob Jones University Press, 1998.

"The New King James Version." Logos Bible "The New King James Version." Logos Bible Software. Software. CD_ROM. ed.CD_ROM. ed. 20042004..

Bade, Robin and Michael Parkin. Bade, Robin and Michael Parkin. Foundations of Foundations of Economics. Economics. Pearson Education, Inc.: Boston, 2004.Pearson Education, Inc.: Boston, 2004.

Bade, Robin and Michael Parkin. Bade, Robin and Michael Parkin. Essential Essential Foundations of Economics.Foundations of Economics. Power Point Power Point presentation. presentation.

Carper, Alan. Carper, Alan. Economics for Christian SchoolsEconomics for Christian Schools. . Greenville: Bob Jones University Press, 1998. Greenville: Bob Jones University Press, 1998.

"The New King James Version." Logos Bible "The New King James Version." Logos Bible Software. Software. CD_ROM. ed.CD_ROM. ed. 20042004..