Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

Student Price: Contact us to learn more

Principles of Economics will allow you to learn a new set of tools to use in personal, professional, business, and political decision making.

This content has been used by 3,587 students

What is a Top Hat Textbook?

Top Hat has reimagined the textbook – one that is designed to improve student readership through interactivity, is updated by a community of collaborating professors with the newest information, and accessed online from anywhere, at anytime.


  • Top Hat Textbooks are built full of embedded videos, interactive timelines, charts, graphs, and video lessons from the authors themselves
  • High-quality and affordable, at a significant fraction in cost vs traditional publisher textbooks
 

Key features in this textbook

Our Principles of Economics Textbooks extend beyond the page with interactive graphing tools, real-world news clips and articles that relate to current events and examples that are relevant to millennial audiences.
Our Principles of Micro and Principles of Macro textbooks can be adopted together or separately, giving you the flexibility to customize your course.
Question bank is available with every chapter for easy quiz and test creation.

Comparison of Principles of Economics Textbooks

Consider adding Top Hat’s Principles of Economics textbook to your upcoming course. We’ve put together a textbook comparison to make it easy for you in your upcoming evaluation.

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Pricing

Average price of textbook across most common format

Up to 40-60% more affordable

Lifetime access on any device

$130

Hardcover print text only

$175

Hardcover print text only

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Content meets standard for Introduction to Anatomy & Physiology course, and is updated with the latest content

In-Book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

Explore this textbook

Read the fully unlocked textbook below, and if you’re interested in learning more, get in touch to see how you can use this textbook in your course today.

Chapter 3: The U.S. and the World Economy


Figure 3.1​: Various newspaper headlines over the past 10 years.​

Click here to see the source of the data.

- Mark Twain
“I’ve come loaded with statistics, for I’ve noticed that a man can’t prove anything without statistics.”

What is behind the headlines in Figure 3.1? What do they mean? Does it make any difference? How do they affect college students and their families? What are the characteristics of the U.S. economy? There are only a few pieces of data you must learn in a typical macroeconomics course. They include the recent ranges and current averages for economic growth, unemployment rates, and rates of inflation. Even in a microeconomics course, understanding the frequent news stories about overall trends will help you better understand how individual markets interact, how changes in trends may affect the overall data, and how markets are affected by macroeconomic conditions.

Daily newspapers and television news constantly refer to these three sets of data in economic announcements. In surveys of popular opinion regarding Americans’ concerns, the following appear most often: standards of living, unemployment, inflation, crime, health, and education. The ratings of U.S. presidents and their prospects for reelection depend critically on what has been happening during their presidential terms to the standards of living, unemployment, inflation, and prices in some individual markets. In the 1992 election, it was the comment “It’s the economy, stupid!” which helped Bill Clinton defeat President George H.W. Bush. It was the very good economic conditions during the second Clinton administration that helped the administration survive the Monica Lewinsky scandal. And certainly, much earlier, bad economic conditions sealed Herbert Hoover’s fate. President George W. Bush fought accusations that he was responsible for the recession that began early in his first term, while he was calling it the ‘Clinton recession.’ Deteriorating economic conditions in the last year of George W. Bush’s second term surely helped the Democrats win the White House in 2008. Economic conditions at the end of Barack Obama’s administration likely affected the 2016 Presidential race to some degree, as many people had not successfully recovered from the 2007–2009 recession.

“It’s the economy, stupid.”
– James Carville in Bill Clinton Presidential Campaign against George
H. W. Bush (1992)



















Figure 3.2: Bill Clinton defeated George H. W. Bush in the 1992 Presidential election. [1]

3.1 Objectives

After reading this chapter and, of course, answering the questions, you will be able to:

  • Define GDP, inflation, and unemployment.
  • Explain how economists measure GDP, economic growth, inflation, and unemployment.
  • Critically read newspaper and magazine articles about these measures.
  • Describe recent trends in each of the measures.

We explore the meaning of economy-wide data early in the semester, because the data discussed in this chapter play such an important role in the daily economics news. Understanding these broad, macroeconomic concepts is key to beginning a macroeconomics course. They are also important to understanding the microeconomic issues that make up the bulk of beginning principles of microeconomics courses. In a macroeconomics course, we study how these variables are determined, what changes them, and the possible policies that might be used. In a microeconomics course, we look at the markets that determine what consumption goods and services are produced, how they are produced, and who consumes the goods and services. We consider the effects of markets on consumption, investments, exports, and imports. We also look at why there is a need for an economic role for government.

The U.S. economy is dominated by economic decisions made in markets. What to produce, how to produce it, and for whom to produce are largely answered in markets—that is, with literally hundreds of millions of buyers and sellers coming together to determine the answers to those questions. They do so with quite different purposes: buyers to purchase what they value and sellers to earn profits.

Of all the goods and services that we produce in a year, the vast majority are produced and sold in markets. Our consumption spending on goods and services, our investment spending by businesses, and even our spending on exports and imports take place in private markets.

Governments do make some decisions about production—actually, about 20 percent of all production of goods and services is due to government spending. But even when the government is deciding what to produce, it faces prices and wages that are largely determined in markets. Governments influence who actually gets the goods and services produced in markets through tax and subsidy efforts.

A variety of labels are often used to describe our mix of market and government decision-making; among them are a market economy, a free enterprise economy, a private enterprise economy, and a laissez-faire economy. Economies with significantly larger roles for governments are described as planned or command economies. With slightly different emphases, the terms socialist and communist are used to describe those economies with larger roles for governments.

Perhaps the most accurate, and the least politically-loaded, descriptive term for the U.S. economy is that of a mixed economy. It is an economy with a very large dominant role for markets and, at the same time, an important economic role for governments.

We begin our look at these concepts with a brief introduction to gross domestic product, economic growth, inflation, and unemployment.

3.2 What Is Gross Domestic Product?

One way to measure the success of any economy is to see how much it produces. The measure which does that best is something we call GDP or Gross Domestic Product.

GDP is all of the final goods and services produced in an economy in a year. “Final goods” means that it does not include intermediate purchases (the goods purchased to produce another good). This method helps to avoid double counting purchases. For example, if guitar strings are purchased to make a guitar, only the sale of the guitar (the final good) is counted and the strings (the intermediate goods) are not.

GDP is “product” in that all of the final goods and services we produce are included. Each good and service is multiplied by its price and added together. It is “domestic” in that it counts only those goods made in the U.S. For instance, automobiles manufactured in the U.S. are included, but those made abroad, regardless of whether they are made by an American company, are not. It is “gross” meaning total—it counts the production of machines and factories even if they just replace those that wear out. (Net domestic product is GDP minus depreciation or the value of the equipment, machines, and buildings that wear out.) Normally, GDP is stated for a specific country and for a given period of time, most often one year. For the United States, the Bureau of Economic Analysis (BEA) publishes updates to GDP growth quarterly. It reports these quarterly estimates at annual rates, meaning it reports what the annual rate would be if the economy continued to grow at that quarterly rate over 4 quarters. At the end of the year, the BEA will then report overall annual rates. The BEA also reports GDP rates by state and metropolitan area.

Economists measure growth in our economy by looking at real GDP, that is, the actual production of goods and services valued at a base year's prices rather than current prices. The purpose of this adjustment is to eliminate the effects of inflation. If our production is growing over time, then the economy may be better off. More GDP means more goods and services produced. If GDP grows faster than population, we, on average, have rising standards of living.

GDP (often called “nominal”) uses actual production valued at current prices. Part of the problem in interpreting news reports about growth in the economy is that “GDP” is often used without saying whether it is GDP in current prices or real GDP that is meant. Look at the following newspaper headlines and excerpts. Both are referring to real GDP, but only the second is very clear.


Q4 gross domestic product up 1.9% vs 2.2% estimate [1]

Gross domestic product increased at a 1.9 percent annual rate, the Commerce Department said on Friday in its first estimate of fourth-quarter GDP. That was a sharp deceleration from the 3.5 percent growth pace logged in the third quarter.

As a result, the economy grew only 1.6 percent in 2016, the weakest pace since 2011. Growth in the first half of the year was curbed by cheap oil and a strong dollar, which undercut company profits and weighed on business investment.

CNBC, 27 January, 2017

U.S. Has Record 11th Straight Year Without 3% Growth in GDP [2] 

“Real GDP increased 1.6 percent in 2016 (that is, from the 2015 annual level to the 2016 annual level), compared with an increase of 2.6 percent in 2015,” the BEA said in a release put out this morning.

The BEA has calculated GDP for each year going back to 1929. Since 1930, it has calculated the inflation-adjusted annual change in GDP.

CNS News, Terence P. Jeffrey, 27 January 2017

But even real GDP can be deceiving. If the population is growing faster than real GDP, then on average we are worse off. That is, output (real GDP) per person is getting smaller. Of all three measures—GDP, real GDP, and real GDP per person (or per capita)— real GDP per capita is the best measure of our well-being. In the study of macroeconomics, you will learn that there are weaknesses even in the measure of real GDP per capita. Figure 3.3 demonstrates the process for converting annual changes in nominal GDP to annual changes in real GDP per capita.

ECN03_fig3.3_updated.jpg
Figure 3.3: Converting the nominal annual percent change in GDP to the percent change in real GDP per capita.

Click here to see the source of the data.

Question 3.01

How is real GDP measured?

A

Current value of all final goods and services produced in a country in a year

B

Sum of domestic production in the U.S. in one year minus changes in prices

C

Total of all final goods and services consumed in the U.S. valued at a base year’s prices

D

Total of all final goods and services produced in the U.S. valued at a base year’s prices


Question 3.02

GDP calculated using current year prices is often called ______________ GDP.


Question 3.03

GDP calculated using base year prices is called ______________ GDP.


Question 3.04

GDP divided by the number of people in the country is called GDP ______________.


Question 3.05

Imagine a country where Real GDP grew from $300 million to $350 million in 10 years. Meanwhile the population grew from 5 to 7 million. On average, did individuals in the country improve?

A

Yes

B

They stayed the same

C

No

ECN03_tfigure3.4_updated.jpg
Figure 3.4: Annual rates of change in real GDP per capita from WW2 to 2018.

Click here to see the source of the data.

The average annual rate of growth in real GDP for the last part of the 1990s had been just over 4 percent, and in fact, economic conditions were amazingly good. But the longer-run trend in change in real GDP per capita is less good. Figure 3.4 shows the trend in real GDP per capita for the period just after WWII to 1973, 1974 to 2000, and the annual average increase from 2000 to now.

Obviously, our growth has slowed significantly from the immediate post-WWII period (2.5% to 1.2%). Does the 0.4 percent lower growth from 1974 to 2000 make much of a difference? Yes, it does over such a long time period. If we had grown at the WWII – 1973 rate for the last 40 years, we would have a real GDP that would be almost 40 percent higher than it is now. That means that our average incomes would be 40 percent higher. In other words, it is likely that the families of students in this course would have 40 percent higher incomes. And for most of you, that means your families could have enjoyed their current levels of income, easily paid your college tuition out of the 40 percent increase in income, and had a little left over. Total national production at a 40 percent higher level could buy a lot of consumer goods and solve a lot of problems.

Figure 3.5 shows the annual GDP growth rates from 1996 to 2018. As already mentioned, growth rates were high during the end of the 1990s. Annual GDP growth rates then dipped below 0 during the Great Recession of the late 2000s (end of 2007 to mid-2009). From the Great Recession to now, Annual GDP growth rates in the United States have remained below 3%.

ECN03_fig3.5_updated.jpg
Figure 3.5: Percent change in real GDP since 1996.

Click here to see the source of the data.

Many developing countries see much higher growth rates than the United States (although many also have lower or negative growth rates). For example, the World Bank reports that in 2015 Ethiopia had an annual growth rate of close to 10% for the last ten years. How can it achieve such high rates while the United States is hovering around 2%? One big reason is that GDP in Ethiopia in 2015 was $61.54 billion (source); meanwhile, the GDP in the world in 2015 was $74.15 trillion (source). Developing countries are often able to achieve such high growth rates because they are starting from a lower level with greater potential for advancements. Countries are able to benefit from adapting technology already developed in other countries and improving their education systems, which are often below the standards of developed countries.

Question 3.06

How has recent growth (from 2001 to today) in real GDP per capita for the U.S. compared to the post-WWII period?

A

Higher

B

The same

C

Lower


Question 3.07

What happened to the real GDP growth rate during the Great Recession of the late 2000s?

A

Positive growth

B

Negative growth rates

C

Constant growth rates


Question 3.08

In 2016 the rate of growth in real GDP (increased/decreased/not changed) ______________ when compared to the previous year. The growth trend from the late 1990s was (greater than/less than/the same as) ______________ the growth in the last four years (2012-2016).

A

Decreased/greater than

B

Decreased/less than

C

Increased/the same as

D

Not changed/the same as

# We could update this question by asking about 2018. 

Question 3.09

Question 3.09

Why might developing countries have greater GDP growth rates than the United States?

Hover here to see the hint for Question 3.09.
Click here to see the answer to Question 3.09.

3.3 What Kind of Production Is Included in GDP?

We will use a convenient framework to divide GDP into four components. The formula that summarizes the components of GDP will become a familiar sight as you continue to study economics.

ECN03_figure3.6_updated.jpg
Figure 3.6: Components of GDP.

Click here to see the source of the data.

Most of our production, by far, goes to consumption– the things that you and I buy on a daily basis, like food, movies, clothing, cars, gasoline, housing, health care, utilities and more.

A substantial portion is used for investment purposes. Investment means the creation of new factories, office buildings, machines, and business computers. Investment is the creation of tools to use to manufacture other goods or to provide services. Around 20% of investment also comes from residential investments.

Some of our production goes to government goods and services, such as police protection, fire departments, education, highways, and national defense. While private investments are included in Investment spending, public investments are included in Government Spending. We don’t count social security, retirement, or unemployment compensation, because no goods or services are produced directly for these payments. They are simply transfer payments from one group of individuals to another group of individuals. Within the U.S., around 40% of government spending is from Federal expenditures (over half which is for National Defense), while around 60% comes from state and local government expenditures. Government consumption expenditures include education, while gross investment includes spending on construction, equipment, and research and development. (For a further breakdown of government spending, see BEA Table 3.9.5 Government Consumption Expenditures and Gross Investment)

Finally, some goods that we produce are shipped abroad (exports) and some goods that we purchase were produced abroad (imports). The balance is what we call net exports . If the balance is positive, we are exporting more than we are importing. Right now, net exports in the U.S. are negative. This is the same thing as saying we have a deficit in our balance of trade or that our imports are greater than our exports. (The reason that we subtract imports is that consumption spending, government spending, and investment spending all include some spending on imports. Gross domestic product measures only those goods and services produced within the U.S. Thus, in order to include only domestic goods, we subtract spending on imports.)

Question 3.10

In the last few years in the U.S., have imports been greater than or less than exports?

A

Imports have been greater than exports, resulting in negative net exports.

B

Imports have been less than exports, resulting in positive net exports.

C

Imports have been about equal to exports, so next exports were 0.


Question 3.11

Government Spending and Investment spending each make up about what percent of U.S. GDP?

A

2-10%

B

15-20%

C

30-40%


Question 3.12

Is it possible for the percentage of GDP made up of consumption spending, investment spending, and government spending to add up to more than 100%?

A

No, they must add up to 100%.

B

Yes, if net exports are positive.

C

Yes, if net exports are negative.


Question 3.13

A man in Washington, DC buys a Volvo directly from Sweden for $30,000. Which of the following is true? (Multiple answers can be correct.)

A

The value of consumption increases by $30¸000.

B

The value of exports increases by $30¸000.

C

The value of imports increases by $30¸000.

D

The value of net exports decreases by $30¸000.


Question 3.14

The purchase of the Volvo for $30,000 in the previous question changes GDP by how much?


Question 3.15

The largest component of GDP in the U.S. is ___________.

A

Consumption

B

Investment

C

Government spending

D

Net exports


Question 3.16

Investment in public education and highways counts as what component of GDP?

A

Consumption

B

Investment

C

Government spending

D

Net exports


Question 3.17

Question 3.17

Why are transfer payments (Social Security payments and unemployment assistance) not included in GDP?


Hover here to see the hint for Question 3.17.
Click here to see the answer to Question 3.17.

3.4 What Is Unemployment? How Do We Measure It?

ECN_toptip3.4.jpg

Most of the time, real GDP increases from one year to the next, sometimes faster and sometimes more slowly. When for two consecutive quarters real GDP declines, the popular interpretation is that we are in a recession – output is falling and, in most cases, unemployment is rising. Unemployment rises because less labor is needed to produce the lower levels of output. Even without a recession, if real GDP is growing more slowly than the labor force and assuming that productivity is constant or growing, unemployment increases. The definition of a recession is somewhat more complicated than the common press interpretation of two consecutive quarters of decline in real GDP. The recession beginning in December of 2007 and ending in June of 2009 was determined to have begun based on declining employment, considerable slowing of growth in retail sales and personal income, and a continued decline in manufacturing production.

The unemployment rate is defined as the number of individuals unemployed divided by the labor force. The current labor force is equal to approximately 160 million people. The other approximately 160 million persons in the U.S. are retired, in school, taking care of children at home, too young to work, or for some other reason not looking for work. The labor force also does not include people working at home for no pay or those in the military.

In October of 2009, the unemployment rate reached a high of 10.0 percent, higher than at any time since 1983, the end of a major recession. It represented approximately 15.4 million unemployed individuals.

ECN03_fig3.7_updated.jpg
Figure 3.7: Annual unemployment rates since 1996.

Click here to see the source of the data.

Question 3.18

Imagine that there are 160,000 people in the population of working age. 150,000 have jobs, 5,000 do not have jobs and are looking for work, and 5,000 do not have jobs but are not looking. Calculate the unemployment rate (in percentage).


Question 3.19

The average unemployment level was 7,900,000 in December 2015 and 7,500,000 in 2016. Calculate the percent change in the unemployment level.

A

3%

B

-3%

C

-5%

D

5%


Question 3.20

Over the last twenty years, what year had the highest unemployment rate?

A

2000

B

2007

C

2010

D

2011


Question 3.21

If the labor force increases, but the number of people unemployed stays the same, what happens to the unemployment rate?

A

Increases

B

Decreases

C

Stays the same


Question 3.22

During times of low employment, some people get discouraged, stop looking for work, and go back to school. How does going back to school affect the labor force?

A

It does not change it.

B

It increases the number in the labor force.

C

It decreases the number in the labor force.


Question 3.23

In a period with a rising unemployment rate, which of the following is most likely true?

A

The population is growing quicker than real GDP.

B

Real GDP is growing slower than the labor force.

C

The labor force is decreasing while the number of unemployed is decreasing.

D

The number of employed people is increasing as real GDP increases.

3.5 What Is Inflation? How Do We Measure It?

The third most often mentioned statistic is inflation.

Inflation means generally rising prices. That is, prices on average are rising. There are three main price indexes used for inflation: the first measures the changes in prices of goods and services that the typical customer buys (called the Consumer Price Index), the second uses the prices of goods sold by domestic producers (the Producer Price Index), and the third includes the entire GDP when calculating price changes (the GDP deflator). The consumer price index (CPI), reported by the Bureau of Labor Statistics (BLS), is the one most commonly referred to in by the press and used by statisticians; it is the one we will use in this chapter. The BLS also has many different measures of CPI, including one that is often referred to the “core” CPI as it includes all items except food and energy (goods where prices fluctuate on a greater basis).

At any one time, some prices are rising and others are falling. But if the average price level is increasing, then we say we have inflation. Inflation was relatively low from 2002 to 2004 (See Figure 3.8). Inflation then started increasing. In the last part of 2007 and early 2008, it reached annual rates of almost 4 percent.

“Rising gasoline, rents push U.S. inflation higher in September” [3]

U.S. consumer prices recorded their biggest gain in five months in September as the cost of gasoline and rents surged, pointing to a steady pickup of inflation that could keep the Federal Reserve on track to raise interest rates in December.

The Labor Department said on Tuesday its Consumer Price Index increased 0.3 percent last month after rising 0.2 percent in August. In the 12 months through September, the CPI accelerated 1.5 percent, the biggest year-on-year increase since October 2014. The CPI rose 1.1 percent in the year to August.

Lucia Mutikani, Reuters, October 18, 2016

ECN03_figure3.8_updated.jpg
Figure 3.8: Inflation rates since 1996.

Click here to see the source of the data.

During the recession in the last half of 2008 and the first half of 2009, prices actually fell by 0.4 percent. A period of continually falling average prices is described as deflation. The decrease in 2009 was a result of the economy doing poorly. Japan has experienced overall falling prices over longer periods.

In the U.S., inflation around 0.5% to 2% is expected. Policy makers often target 2% as a good and natural level of inflation. When inflation reaches 3% or more, then it becomes a concern. In the past twenty years, average yearly inflation rates have not reached higher than 4%, although, as Figure 3.8 shows, we have experienced years with inflation almost reaching that level.

Question 3.24

Has the U.S. experienced any years with deflation in the past twenty years?

A

No

B

Yes, in 2015

C

Yes, in 2009


Question 3.25

Inflation means that which of the following is true?

A

A single price increases.

B

Average price levels are decreasing.

C

Average price levels are increasing.


Question 3.26

The typical measure used to calculate inflation is CPI. CPI uses what to calculate price levels?

A

A typical basket of goods purchased by consumers

B

All of GDP

C

The consumption component of GDP

3.6 When and Why Should We Be Concerned About Unemployment and Inflation?

Economic efficiency means using our resources in such a manner that we are as well off as we can possibly be given our resources and technology. Unemployment means that we are not using all of our available resources. We could be better off. Thus, one of the costs of unemployment is that our economy is not producing as much as it could. Obviously, there are tremendous personal costs borne directly by those who lose their jobs. They have less income than before and, in most cases, are forced to change their living standards. There are some natural levels of unemployment as people transition to new jobs or some industries go obsolete, and people need to retrain for new jobs. Economists, therefore, typically say that “full” employment occurs where unemployment rates are around 4.0% to 5.5%. During recessions (such as the Great Recession during the late 2000s), unemployment rates were much higher than 5.5% (refer to Figure 3.7).

Question 3.27

Question 3.27

Why would we expect there to naturally be some levels of unemployment?

Hover here to see the hint for Question 3.27.
Click here to see the answer to Question 3.27.

The costs of inflation are somewhat more difficult to identify. We seem to dislike inflation a great deal because we believe that the real value of our incomes is lowered by inflation – that is, we cannot buy as much. Actually, in most inflationary periods, average wages also rise along with prices. Simply put, unhappiness may be reason enough for reducing inflation.

There is an even more important reason to be concerned. Inflation does mean that a portion of a typical family’s wealth, such as money kept in checking accounts or cash kept at home, loses value. Additionally, our past savings may be invested in ways that do not respond well to increased prices. In those cases, individuals and institutions may devote more resources to simply protecting themselves from possible losses due to inflation. So, if inflation means that resources are devoted to reducing the effects of inflation and that therefore, fewer resources are left over to produce other meaningful goods and services, we will not be as well-off as we possibly can be. We are not economically efficient.

Figure 3.9 depicts how unemployment and inflation could be represented on a production possibilities frontier graph. Under high levels of unemployment (on the left), the economy is not producing along its PPF (or the economy is producing below its potential for GDP) because not all of the area’s resources (people) are being used. Thus, we can think of it as producing below potential. When the economy is experiencing levels of full employment (4-5.5%), then we would expect that the economy is producing along the PPF and we are producing at our potential for GDP.

When we are experiencing periods of high inflation or periods of high deflation, resources are being employed but perhaps in ways that do not make the economy more productive. The economy will not be able to produce as much with the resources that are left to produce goods and services. This result can be depicted as a decrease in the PPF (right panel in Figure 3.9). It could also be argued that we are just producing below our PPF (as shown for high unemployment). In either case, both high levels of unemployment and inflation lead to the economy producing below its potential.




















Figure 3.9: Effects of high unemployment and high Inflation on production possibilities
Question 3.28

Recall our discussion of production possibilities frontiers. Click on the graph where 'A' represents a higher than normal unemployment.


Question 3.29

High inflation rates will cause which of the following changes in an economy’s production possibilities frontier?

A

A shift to the right

B

A shift to the left

C

No change in the frontier. The economy will simply move to a new position on the frontier.

D

No change in the frontier. The economy will move to a point below the frontier.


Question 3.30

If the U.S. unemployment rate was 10%, would the current economy likely be producing at its capacity?

A

No

B

Yes

C

Do not know.


Question 3.31

Question 3.31

Summarize why changes in real GDP, unemployment, and inflation are desirable or undesirable.

Hover here to see the hint for Question 3.31.
Click here to see the answer to Question 3.31.

3.7 Summary

  • Gross domestic product (GDP) is the value of all the final goods and services produced in an economy in a year. It is the statistic most commonly used to measure the size of an economy.
  • When comparing changes over time, real GDP is a more accurate measure of changes in production as it removes the effects of changes in prices.
  • Changes in real GDP per capita provide indications of economic growth that result in an improvement of living standards over time.
  • Unemployment rates and levels of employment tell us how thoroughly an economy is using its human resources.
  • Inflation is a continual rise in the overall price level and is most often measured by changes in the consumer price index.

3.8 Key Concepts

  • Gross Domestic Product
  • GDP = C + I + G + (EX – IM)
  • Real GDP, Nominal GDP, and GDP per capita
  • Economic Growth
  • Unemployment
  • Inflation
  • Deflation

3.9 Glossary

Consumer price index: A price index that measures changes in average prices of goods and services purchased by a typical consumer.
Consumption: Spending by households, including durable goods (washing machine, stereos, and cars), non-durable goods (food, clothing, and gasoline), and services (haircuts, medical care, education).
Deflation: A continual decrease in the average price level.
Economic growth: Economists use the term to refer to continual increases in real GDP or real GDP per capita. The term is often used in the press to mean increases in total spending.
Exports: Goods and services produced domestically and sold abroad.
GDP: The market value of all of the final goods and services produced annually within a nation.
Government spending: The sum of federal government, state, and local government purchases of goods and services counted in GDP. It includes public investments.
Imports: Goods produced abroad and purchased domestically.
Inflation: An increase in the overall level of prices of goods and services in the economy. Often expressed as an annual rate of increase.
Investment: When used in reference to GDP or the entire economy, it is any spending intended to increase future output. For example, goods purchased by individuals and firms that consist of fixed investment (new factories, new machines, and new houses) and inventory investment (change in inventories at business firms).
Labor force: The number of individuals who have jobs plus the number who are actively looking for work.
Net exports: Exports of goods and services minus imports of goods and services.
Real GDP: The real value of all final goods and services produced in an economy in a year. Real GDP is measured in dollars adjusted for changes in the overall price level.
Real GDP per capita: Real GDP per person; real GDP divided by population.
Unemployed: An individual is counted as unemployed if he or she does not have a job and is actively looking for work.
Unemployment rate: The percentage of the labor force that is unemployed.





Locked Content
This Content is Locked
Only a limited preview of this text is available. You'll need to sign up to Top Hat, and be a verified professor to have full access to view and teach with the content.

Answer Keys

Answer to Question 3.09

Your gist statement should discuss the relative sizes of GDPs. When comparing two countries with different starting levels of GDP—one with a significantly smaller GDP than the other—the same change in GDP will result in a much greater percent change for the country with the smaller base. Countries with lower levels of GDP can also use innovations developed in other countries to help them grow. Your answer might include discussion of the education levels in developing countries.

Click here to return to Question 3.09.












Answer to Question 3.17

Payments do not represent any new production of goods and services. Transfer payments are using tax receipts to provide an income subsidy to other individuals.

Click here to return to Question 3.17.














Answer to Question 3.27

Your gist statement should discuss how it takes people time to find a job that is a good match. Think about when you graduate; it might take time to find a job, even if you are looking for a job immediately. There might be many jobs that you could get, but you will want to find a job that fits your new skills.

Click here to return to Question 3.27.













Answer to Question 3.31

Your gist statement should discuss the benefits of more goods and services – higher standards of living on average. A better measure than real GDP would be real GDP per capita. Rising unemployment means fewer goods and services are produced. There are also considerable personal costs borne by the individuals who are unemployed. A rise in inflation means that we use resources to avoid the effects of inflation and those resources could be used to satisfy other wants.

Click here to return to Question 3.31.


Data Sources

Figure 3.1

Sources: Gillespie, P. (2016, December 2). November jobs report: Unemployment drops to 4.6%, lowest since 2007. Retrieved April 28, 2017, from http://money.cnn.com/2016/12/02/news/economy/november-jobs-report/

Reuters. (2016, May 17). Consumer Prices Post Biggest Gain in More Than 3 Years. Retrieved April 28, 2017, from https://www.nytimes.com/2016/05/18/business/economy/consumer-prices-post-biggest-gain-in-more-than-3-years.html

Harlan, C. (2015, April 29). U.S. economic growth slows to 0.2 percent, grinding nearly to a halt. Retrieved April 28, 2017, from https://www.washingtonpost.com/news/wonk/wp/2015/04/29/the-u-s-will-release-economic-growth-this-morning/?utm_term=.308e80f87c75

Goodman, P. (2009, November 6). U.S. Unemployment Rate Hits 10.2%, Highest in 26 Years. Retrieved May 4, 2017, from http://www.nytimes.com/2009/11/07/business/economy/07jobs.html

Figure 3.3

Source: Annual % Change in GDP and real GDP calculated from U.S. Bureau of Economic Analysis. . . National Economic Accounts. Gross Domestic Product. . . Percent Change from Previous Period https://www.bea.gov/national/index.htm#gdp. . . Retrieved January 29, 2017. . . Real GDP per capita calculated from U.S. Bureau of Economic Analysis, Real gross domestic product per capita [A939RX0Q048SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/A939RX0Q048SBEA, January 28, 2017.​

Figure 3.4

Source: U.S. Bureau of Economic Analysis, Real gross domestic product per capita [A939RX0Q048SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/A939RX0Q048SBEA, January 28, 2017. ​

Figure 3.5

Source: BEA Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product​

Figure 3.6

Source: BEA Table 1.1.10. Percentage Shares of Gross Domestic Product. http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&step=3&isuri=1&903=14, Retrieved: January 28, 2017. . . Percentages do not add up to 100% due to rounding.​

Figure 3.7

Note: Data collected from the Bureau of Labor Statistics (https://www.bls.gov/) data tools Unemployment Rate (Seasonally Adjusted) LNS13000000. Pulled on January 16, 2017.

Figure 3.8

Source: Data is calculated by pulling the Consumer Price Index - All Urban Consumers from the Bureau of Labor Statistics (https://data.bls.gov/pdq/SurveyOutputServlet).

Image Credits

[1] Image courtesy of the White House in the Public Domain

      Image courtesy of the White House in the Public Domain

Gross Domestic Product
The value of all of the final goods and services produced in a country in a year.
See discussion at end of Section 3.2
Consumption
The total spending by individuals on consumption goods and services.
Investment
Investment is spending on new buildings, machines, tools, and new residential construction. Additions to inventories are also included. Investment spending represents an increase in capacity to produce future output.
Government
Government spending is the total spending on goods and services by all levels of government (federal, state, and local. This does not include expenditures normally described as transfer payments (social security, unemployment compensation, and welfare payments).
Net Exports
Exports and Imports are the total amounts spent in U.S. dollars on goods and services that are exported and imported. Net exports (exports minus imports) are very close to what is normally described as the trade deficit.
Think back to the definition of of GDP
Unemployment Rate
Number of unemployed divided by the number in the labor force.
Unemployed
Individuals who do not have jobs and are actively looking for jobs.
Labor Force
Those who have jobs plus those looking for jobs; unemployed + employed.
Inflation
A continual increase in the average price level.
Deflation
A continual decrease in the average price level.
See beginning of Section 3.6.
See Section 3.6.