GDP is the most widely accepted indicator of economic growth. GDP measures the annual or quarterly change in the production of goods and services in the economy. It is comprised of four sectors:
Our basic equation for GDP is:
GDP = C + I + G + NX
We expand our understanding of demand and supply into the capital market. The price of capital is the interest rate and capital markets are used to determine the equilibrium interest rate. The demand for loanable funds represents those businesses and individuals seeking to borrow money. The supply of loanable funds represents savings by individuals, businesses, and governments (a government budget deficit lowers domestic savings). Increases in the demand for loanable funds will increase the price of money - raise the interest rate, and increases in savings will lower interest rates.
Supply of loanable funds = private savings + public savings + net foreign savings
where:
- Private savings = sum of savings by individuals and businesses.
- Public savings = federal, state and local government. If the federal government runs a budget deficit, then public savings will be negative (if state and local governments in total have a surplus, it is relatively insignificant).
- Net foreign savings = foreign savings entering the domestic economy - domestic savings leaving the country.
In this section we expand our discussion of GDP with some interesting applications. One area that we will look at is a broader definition of GDP. One of the major criticisms of the use of GDP of a measure of economic growth is that it does not account for the depletion of resources. GDP only measures the value of the additional goods and services produced in a given time period. Using these general criteria, higher levels of GDP are desirable since they are leading to the largest gains in wealth and improvements in living standards. But what if economic growth is accompanied by unhealthy levels of pollution and the destruction of a country's resource base? The World Bank has broadened the definition of GDP to include the latter. Producing a good increases a nation's GDP, but the natural resources depleted in order to produce that good take away from that same country's GDP. The World Bank goes on to define genuine investment as a way to develop resources in a desirable method to make sure the gains to society exceed the losses in the form of resource degradation.
Another issue we will address is the paradox that has been found between the presence of natural resources and economic growth. Contrary to what you might expect, countries that are abundant in natural resources actually lag in economic growth rates behind countries that are natural resource scarce in relation to their capital. In this study, the definition of capital includes what is known as human capital; knowledge and skills that we gain during our lifetime. The primary reason is that resource-scarce countries seek to develop diversified industries while resource-abundant countries tend to rely too heavily on the development of resources to generate industry and wealth.
1) Real variable = nominal variable - inflation rate % change in real GDP = % change in nominal GDP - inflation rate |
The labor market determines the equilibrium price of labor - the wage rate, by bringing together the demand for labor by employers and the supply of labor by individuals like ourselves who are in the labor market. The equilibrium wage is determined in the labor market and changes in either the demand or supply of labor will influence the wage rate.
We will define what is the labor force and the unemployment rate. The unemployment rate equals the percentage of the labor force that is seeking work. We will look at the various types of unemployment. Not all people are out of work for the same reason. Some have been laid off because their job has been displaced by automation, others due to the end of a season, some choose to become unemployed and others are the consequences of a decrease in demand for the good or service they produce.
One important item to note is that trying to achieve an unemployment rate of 0% is not possible. Some individuals claim the government prohibits a zero percent unemployment rate in order to keep wages low. In reality, there will always be some voluntary unemployment, although there is some truth to the belief that government policy makers often worry when low unemployment rates are accompanied by rising inflation rates. In these circumstances, they may put the economic brakes on and allow the unemployment rate to creep upwards.
Even in today's high tech economy, labor costs still comprise about 2/3 of all production costs incurred by producers.
Among the tremendous amount of economic data that is released by the government and other organizations, there are three statistics that are considered to be the most important indicators of the overall condition of an economy: the unemployment rate, the inflation rate and the rate of change in the Gross Domestic Product (GDP).
The Consumer Price Index (CPI) is the accepted statistic for measuring inflation in the economy. Inflation simply represents an increase in prices of goods and services that are purchased by consumers. Inflation is generally caused by an increase in demand (demand-pull), where the demand curve for a good shifts outward, driving up prices, or by increases in production costs that cause the supply curve to shift inward (cost-push) also raising prices.
LINK TO MAIN SECTION OF UNIT 1