Measuring the Economy
Measuring the Economy
MEASURING THE ECONOMY
HOW DO ECONOMISTS MEASURE A NATION’S ECONOMIC HEALTH?
OBJECTIVES:
Summarize the ways In which economic health is measured.
Create an illustration to show how gross domestice product, unemployment rate, and inflation rate are calculated.
Analyze and interpret key economic indicators to evaluate economic health in four historical case studies.
Research and assess the current health of the U.S. economy, using key economic indicators.
HOW DO ECONOMISTS MEASURE THE SIZE OF AN ECONOMY?
Economic indicators are statistics that help economists assess the health of an economy. Gross domestic product - the market value of all goods and services produced within a country during a given period of time - measures a country’s total output. A steadily growing GDP is generally a sign of a healthy economy.
Economists calculate GDP by adding the spending from the four sectors of the economy:
Household consumption
Business investment
Government purchases
Net of exports minus imports
*Nominal GDP is calculated in current dollars.
*Real GDP is calculated in constant dollars to compensate for the effects of inflation.
There are limitations to using GDP to measure an economy’s health. For example, it does not include unpaid or volunteer work and ignores negative externalities.
The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's economy. It represents the total dollar value of all goods and services produced over a specific time period - you can think of it as the size of the economy. Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.
Measuring growth is complicated (which is why we leave it to the economists), but at its most basic, the calculation can be done in one of two ways: either by adding up what everyone earned in a year (income approach), or by adding up what everyone spent (expenditure method). Logically, both measures should arrive at roughly the same total.
The income approach, which is sometimes referred to as GNP (Gross National Product) or GDP(I), is calculated by adding up total compensation to employees, gross profits for incorporated and non incorporated firms, and taxes less any subsidies. The expenditure method is the more common approach (GDP) and is calculated by adding total consumption, investment, government spending and net exports.
As one can imagine, economic production and growth, what GDP represents, has a large impact on nearly everyone within that economy. For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market. It's not hard to understand why: a bad economy usually means lower profits for companies, which in turn means lower stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession.
WHAT DOES THE UNEMPLOYMENT RATE TELL US ABOUT AN ECONOMY’S HEALTH?
The unemployment rate is an economic indicator that measures the percentage of the population that is jobless and seeking work. A low unemployment rate is generally a sign of a healthy economy.
Economists calculate the unemployment rate using a survey conducted by the Bureau of Labor Statistics. Eligible workers are classified as employed, unemployed, or not in the labor force.
Full employment does not mean 100 percent of workers are employed, but that all available labor resources are being used effectively. An economy with full employment is said to have a natural rate of unemployment.
There are limitations when using the unemployment rate to measure an economy’s health. It does not account for discouraged workers who have given up looking for jobs, involuntary part-time workers who would prefer to work full-time, “under-employed” workers who are not working at their skill levels, or under-ground workers.
WHAT DOES THE INFLATION RATE REVEAL ABOUT AN ECONOMY’S HEALTH?
Inflation is the increase in the average price level of goods and services in an economy. The inflation rate is an economic indicator that measures the percentage increase in inflation from one time period to another.
Economists track inflation using the Consumer Price Index. The CPI is a price index for a market basket of goods and services. Changes in the average prices of these items approximate the change in overall prices paid by consumers. Like GDP, prices can be measured in nominal and real dollars.
Inflation is caused by an increase in the money supply, overall demand, or the cost of the factors of production. Though Americans are accustomed to an annual inflation rate of about 3.4 percent, any inflation has economic costs.
HOW DOES THE BUSINESS CYCLE RELATE TO ECONOMIC HEALTH?
All economies experience periods of growth and decline in economic activity known as the business cycle. Economists use the key economic indicators to determine an economy’s position in the business cycle at any given time.
The business cycle has four phases:
Expansion
Peak
Decline or contraction
Trough or bottom
A recession is a decline across an economy lasting at least six months. A depression is a prolonged economic downturn with plunging real GDP and high unemployment.