GDP, Unemployment and Inflation

Thinking Like an Economist


Economics
 Economics

is a social science which
attempts to explain the behavior and
interactions of economic actors in
terms of the items of value they
exchange.
 Actors = individuals, households,
firms, industries, governments or
countries


Economics
 Economic

 Models:

Reasoning

a model or theory is a
framework that helps us to
understand relationships between
cause and effect. They are a
simplification of reality.


Basic Questions: Micro

 Microeconomic
 What

Questions

should we produce?
 How should we produce?
 For whom should we produce?


Basic Questions: Macro
 Macroeconomic
 How

Questions

can sufficient growth be attained
so that the well being of society
increases?
 How should productive capacity be
utilized so that there will be full
employment with stable prices?


The Economy as a Circular
Flow
Resources
Income

Firms

Households

Expenditures
Goods and Services


Savings and Investment
Income

Firms

Investment

Households

Expenditures
Borrowings

Financial Markets

Savings


Financial Markets
Savers
Individuals
Businesses
Government
Financial Intermediaries

Banks
Pension funds
Mutual funds
Borrowers
Individuals
Businesses
Government


Financial Intermediaries
Financial intermediaries include banks,
insurance companies, investment
companies, etc
 Financial intermediaries act as the gobetween in arrangements between savers
and borrowers.
 They reduce the uncertainty facing
individual households or businesses
through diversification.



Financial Market:
Participants
 The

suppliers of credit or loanable
funds:
 Household

Sector

 Business Sector
 Foreign Sector
 Government Sector


Financial Market: Participants
 The

demanders of credit or
loanable funds:
 Government

Sector
 Business Sector
 Foreign Sector
 Household Sector


Interest Rates: Facts
 Interest

rates serve many roles:

 Interest

rates are the price of

credit.
 Interest rates are a premium paid
to forego consumption.

 Interest rates are the return to
capital as a factor of production.


Real and Nominal Rates
 Nominal

interest rates are rates
unadjusted for the effect of
inflation or deflation.
 Real rates are adjusted for price
level changes.


Inflation and Interest Rates
 Nominal

variables are not adjusted to
reflect changes in the price level.
 They

are the percentage by which
the money a borrower pays back
exceeds the money he borrowed,
making no adjustment for any
change in purchasing power.


Inflation and Interest Rates
 Real

interest rates are the percentage
increase in purchasing power that the
borrower pays to the lender for the
privilege of borrowing.
Real interest rates are nominal interest
rates minus the rate of inflation.
 Real interest rates may be positive, zero,
or negative.



Nominal Rates: The Fisher
Effect
THE FISHER EFFECT:
NOMINAL RATE

=

REAL RATE +
EXPECTED INFLATION


Circular Flow with
Government
Income

Firms

Households

Investment
Taxes
Government
Purchases of
Goods and Services
Subsidies
Borrowing

Expenditures

Taxes

Government
Government
Government

Government Salaries
and Transfers

Borrowing
Saving

Financial Markets

Savings


The Role of Government:
Market Failure

 Inequity
 Standards

of fairness are determined
by society and may not be met by
the market’s distribution of benefits.

 Failure

of Competition

 Markets
•
•

may not be competitive.

Regulation
Anti-trust


The Role of Government:
Market Failure
 Public


Goods

Some goods cannot be produced
profitably by the private market and as a

result must be provided by government.
•

Free Rider Problem

 Externalities


Some activities provide benefits or impose
costs on others that are not captured by the
the price system.


The Role of Government:
Market Failure
 Underutilized

Resources

 Macroeconomic
•
•

Fiscal Policy
Monetary Policy

stabilization


Circular Flow with Government and

the Rest of Foreign
the World
Countries
Foreign Borrowing

Foreign Savings

Exports

Investment

Imports
Income

Households

Firms
Taxes

Government
Purchases of
Goods and Services
Subsidies
Borrowing

Expenditures

Taxes

Government

Government
Government

Borrowing
Saving

Financial Markets

Government Salaries
and Transfers

Savings


The Rest of the World
 An

economy has two basic kinds of
economic interactions with the rest
of the world.
 Buying

and selling goods and
services
 Buying and selling assets.


The Rest of the World
 Exports

are those goods we produce
for sale in the rest of the world.
Imports are those goods we buy from
the rest of the world.
 We also lend to the rest of the world
and borrow from them.


Measuring GDP


What Is GDP?


GDP, Gross Domestic Product, is the
total dollar value of all final goods and
services produced in a country during a
year.
Current market prices are used to
aggregate different outputs to a dollar
total.
 Government purchases, many of which do
not occur in markets, are valued at their
cost of production.
