💶AP Macroeconomics Unit 2 – Economic Indicators and the Business Cycle

Key Economic Indicators

• Gross Domestic Product (GDP) measures the total value of all goods and services produced within a country's borders over a specific period (usually a year)
• Inflation rate indicates the rate at which the general price level of goods and services is rising, and consequently, the purchasing power of currency is falling
  • Measured by the Consumer Price Index (CPI) and the Producer Price Index (PPI)
• Unemployment rate represents the percentage of the labor force that is currently without a job but actively seeking employment
• Interest rates influence borrowing and lending activities, affecting consumer spending and business investment
  • The Federal Reserve sets the federal funds rate, which influences other interest rates in the economy
• Consumer confidence index gauges the level of optimism that consumers have about the state of the economy and their personal financial situation
• Stock market indices (Dow Jones Industrial Average, S&P 500) reflect investor sentiment and expectations about the future performance of the economy
• Trade balance measures the difference between a country's exports and imports, indicating its international competitiveness

Understanding the Business Cycle

• The business cycle refers to the fluctuations in economic activity that an economy experiences over time, consisting of expansions and contractions
• Expansion phase characterized by increasing GDP, low unemployment, and rising consumer confidence
  • Businesses invest more, hire additional workers, and increase production to meet growing demand
• Peak marks the highest point of the expansion phase, where economic activity reaches its maximum level
• Contraction phase (recession) occurs when economic activity declines, GDP falls, unemployment rises, and consumer confidence decreases
  • Businesses reduce investment, lay off workers, and decrease production in response to falling demand
• Trough represents the lowest point of the contraction phase, where economic activity reaches its minimum level
• Recovery phase begins after the trough, as economic activity starts to increase again, leading to a new expansion phase
• Policymakers (governments and central banks) attempt to smooth out the business cycle by implementing fiscal and monetary policies to stimulate the economy during recessions and control inflation during expansions

Measuring Economic Performance

• Economic performance assessed through various indicators, providing insights into the health and stability of an economy
• Real GDP growth rate measures the percentage change in a country's inflation-adjusted GDP over time, indicating the economy's overall growth
  • Calculated as: $\frac{Real GDP_t - Real GDP_{t-1}}{Real GDP_{t-1}} \times 100$
• Nominal GDP includes the effects of inflation, while real GDP adjusts for inflation to provide a more accurate measure of economic growth
• GDP per capita divides a country's GDP by its population, offering a measure of the average standard of living
• Productivity measures the efficiency of production, calculated as output per unit of input (labor, capital, or both)
  • Increases in productivity can lead to higher economic growth and improved living standards
• Gross National Product (GNP) measures the total value of goods and services produced by a country's citizens, regardless of their location
• Gross National Income (GNI) is the sum of a nation's GDP and the net income received from overseas investments minus payments made to foreign investors

GDP and Its Components

• GDP consists of four main components: consumption, investment, government spending, and net exports
• Consumption (C) includes spending by households on goods and services, such as food, clothing, housing, and healthcare
  • Largest component of GDP in most economies
• Investment (I) refers to spending by businesses on capital goods, such as machinery, equipment, and buildings, as well as changes in inventories
  • Gross private domestic investment includes residential and non-residential fixed investment, as well as inventory investment
• Government spending (G) encompasses expenditures by federal, state, and local governments on goods and services, such as defense, infrastructure, and education
  • Transfer payments (Social Security, welfare) not included in GDP as they do not represent the production of goods or services
• Net exports (NX) represent the difference between a country's exports and imports of goods and services
  • Positive net exports (trade surplus) contribute to GDP growth, while negative net exports (trade deficit) reduce GDP
• The expenditure approach to calculating GDP: $GDP = C + I + G + NX$
• The income approach to calculating GDP: $GDP = Compensation of employees + Rent + Interest + Proprietors' income + Corporate profits + Indirect business taxes + Depreciation + Net foreign factor income$

Inflation and Price Indices

• Inflation is a sustained increase in the general price level of goods and services in an economy over time
• Deflation occurs when the general price level decreases over time
• Consumer Price Index (CPI) measures the average change in prices paid by urban consumers for a basket of goods and services
  • The basket is fixed in the short term and updated periodically to reflect changes in consumer spending habits
• Producer Price Index (PPI) measures the average change in prices received by domestic producers for their output
• GDP deflator is a price index that measures the average price of all goods and services included in GDP
  • Calculated as: $GDP deflator = \frac{Nominal GDP}{Real GDP} \times 100$
• Hyperinflation is an extremely high and accelerating inflation rate, often exceeding 50% per month
  • Can lead to a breakdown of the monetary system and severe economic disruption (Venezuela, Zimbabwe)
• Cost-push inflation occurs when production costs increase, leading to higher prices for goods and services
• Demand-pull inflation happens when aggregate demand grows faster than aggregate supply, causing prices to rise

Employment and Unemployment

• The labor force includes all individuals aged 16 and above who are either employed or actively seeking employment
• Employed persons are those who have a job or have been temporarily absent from their job (illness, vacation)
• Unemployed persons are those who are jobless, have actively looked for work in the past four weeks, and are currently available for work
• Unemployment rate is the percentage of the labor force that is unemployed
  • Calculated as: $Unemployment rate = \frac{Number of unemployed}{Labor force} \times 100$
• Frictional unemployment occurs when workers are temporarily unemployed while searching for a new job or transitioning between jobs
• Structural unemployment happens when there is a mismatch between the skills of the unemployed and the skills required for available jobs
  • Often the result of technological change or shifts in the economy
• Cyclical unemployment is the result of fluctuations in the business cycle, increasing during recessions and decreasing during expansions
• Natural rate of unemployment is the sum of frictional and structural unemployment, representing the minimum level of unemployment in an economy
• Discouraged workers are those who have stopped looking for work because they believe no jobs are available for them
  • Not included in the official unemployment rate

Government's Role in Economic Stability

• Governments use fiscal policy to influence the economy by adjusting government spending and taxation
• Expansionary fiscal policy involves increasing government spending or reducing taxes to stimulate economic growth during a recession
  • Increases aggregate demand, leading to higher GDP and lower unemployment
• Contractionary fiscal policy involves decreasing government spending or increasing taxes to control inflation during an expansion
  • Reduces aggregate demand, leading to lower GDP and higher unemployment
• Automatic stabilizers are government programs that automatically adjust to changes in the economy, helping to reduce the severity of recessions and control inflation
  • Examples include progressive income taxes and unemployment insurance
• Central banks use monetary policy to influence the economy by adjusting the money supply and interest rates
• Expansionary monetary policy involves increasing the money supply or lowering interest rates to stimulate economic growth during a recession
  • Encourages borrowing and spending, leading to higher GDP and lower unemployment
• Contractionary monetary policy involves decreasing the money supply or raising interest rates to control inflation during an expansion
  • Discourages borrowing and spending, leading to lower GDP and higher unemployment
• The Federal Reserve (the U.S. central bank) sets the federal funds rate, which influences other interest rates in the economy

Real-World Applications and Case Studies

• The Great Depression (1929-1939) was the worst economic downturn in modern history, characterized by high unemployment, deflation, and a severe contraction in global trade
  • Caused by a combination of factors, including the stock market crash of 1929, bank failures, and a lack of government intervention
• The Great Recession (2007-2009) was a global economic downturn triggered by the subprime mortgage crisis in the United States
  • Led to high unemployment, a sharp decline in housing prices, and a significant contraction in global trade
• The COVID-19 pandemic (2020-present) has caused a severe global economic downturn, with many countries experiencing sharp declines in GDP and high unemployment
  • Governments and central banks have implemented unprecedented fiscal and monetary stimulus measures to support their economies
• The European debt crisis (2009-2012) was a period of economic instability in the European Union, particularly affecting Greece, Ireland, Portugal, Spain, and Cyprus
  • Caused by high government debt levels, budget deficits, and a lack of competitiveness in some economies
• The Japanese "Lost Decade" (1991-2001) was a period of economic stagnation in Japan following the bursting of an asset price bubble in the early 1990s
  • Characterized by low growth, deflation, and a banking crisis
• The Venezuelan economic crisis (2010-present) has led to hyperinflation, shortages of basic goods and services, and a severe contraction in economic activity
  • Caused by a combination of factors, including a decline in oil prices, government mismanagement, and political instability