CH 5 - 0 The CircularFlow Diagram The circularflow diagram...

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Unformatted text preview: 0 The CircularFlow Diagram The circularflow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. The Circular Flow MARKETS FOR GOODS AND SERVICES Firms sell Goods Households buy and services sold Revenue Spending Goods and services bought FIRMS Produce and sell goods and services Hire and use factors of production HOUSEHOLDS Buy and consume goods and services Own and sell factors of production Factors of production Wages, rent, and profit MARKETS FOR FACTORS OF PRODUCTION Households sell Firms buy Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars The big picture Measuring the Size of the Economy Real gross domestic product (GDP): a measure of the value of all newly produced goods and services in a country during some period of time, adjusted for changes in prices over time. Real GDP is the most comprehensive measure of how well the economy is doing. Economic Growth and Fluctuations Measuring the Size of the Economy The vertical shaded bars in Figure 1 mark the six recessions experienced by the U.S. economy since 1970. The thicker shaded bars represent longer recession periods. The straight black line shows the growth trend in the U.S. real GDP over time. Measuring the Size of the Economy Economic growth: an upward trend in real GDP, reflecting an expansion in the economy over time. Economic fluctuations: swings in the real GDP that cause the economy to deviate from its longterm trend. Economic Growth: The Relentless Uphill Climb Facts about the U.S. GDP The U.S. economy almost tripled in value over the last 35 years. During this period, the U.S. economy grew by 3 percent per year. The U.S. real GDP in 2005 was larger than the economies of Japan (the world's second largest economy) and Germany (the world's third largest economy) combined. Visualizing Economic Growth Economic Fluctuations: Temporary Setbacks and Recoveries Business cycles: the ups and downs in GDP experienced by an economy. Phases of business cycles: Peak Recession Trough Recovery Source: p. 406 Economic Fluctuations: Temporary Setbacks and Recoveries Recession: a decline in real GDP that lasts for at least 6 months. Peak: the highest point in real GDP before a recession. Trough: the lowest point in real GDP at the end of a recession. Economic Fluctuations: Temporary Setbacks and Recoveries Expansion: the period between the trough of the recession and the next peak, representing a general rise in output and employment. Recovery: the early part of an economic expansion, which occurs immediately after a recession. Figure 3: The Phases of Business Cycles Economic Fluctuations: Temporary Setbacks and Recoveries The shortest period of recession in U.S. history was between July 1990 and March 1991. The longest period of expansion in U.S. history was between March 1991 and March 2001 (120 months). The longest recession since the 1920s was during the Great Depression, when the U.S. economy was in recession for 43 months. Economic Fluctuations: Temporary Setbacks and Recoveries Depression: a prolonged and deep recession; no formal definition. The Great Depression: the depression experienced by the United States from August 1929 to March 1933. During this period, real GDP fell by 32.6 percent. Growth and Fluctuations Throughout the Twentieth Century Unemployment During Recessions Unemployment rate: the percentage of the labor force that is unemployed. Labor force: those workers who are either working (employed) or looking for work (unemployed). Unemployed: those workers who are willing to work at a given wage, but who cannot find jobs. The Unemployment Rate Inflation Inflation rate: the percentage increase in the overall price level over a given period of time, usually one year. Disinflation: a decline in the inflation rate. Deflation: a negative inflation rate; occurs when the price level drops. The Ups and Downs in Inflation Interest Rates Interest rate: the amount received per dollar loaned per year, usually expressed as a percentage (e.g., 6 percent) of the total loan. Interest Rates Types of Interest Rates 1. The mortgage interest rate: the rate on a loan to buy a house 2. Savings deposit interest rate: the rate people get on their savings deposits at banks 3. The Treasury Bill rate: the interest rate the federal government pays when it borrows money from people for one year or less 4. Federal funds rate: the interest rate banks charge one another on veryshortterm loans Interest Rates Real interest rate: the interest rate minus the expected rate of inflation. It adjusts the nominal interest rate for inflation. Nominal interest rate: the interest rate uncorrected for inflation. The Theory of LongTerm Economic Growth Potential GDP( Aggregate Supply): the longterm growth trend for real GDP within an economy; determined by the available supply of capital, labor, and technology. The real GDP fluctuates above and below the potential GDP. Labor: the number of hours people are available for work in producing goods and services. Capital: the factories, improvements to cultivated land, machinery and other tools, equipment, and structures used to produce goods and services. Technology: anything that raises the amount of output that can be produced with a given amount of labor and capital. Economic Growth and Fluctuations The Production Function Real GDP = F(labor, capital, technology) F=Function; which means that there is some general relationship between these variables Government Policy and Economic Growth Fiscal policy: government policy concerning taxing, spending, and borrowing. Monetary policy: government policy concerning the money supply and the control of inflation. Macroeconomic Policy and Economic Fluctuations Demandside policies: economic policies that aim to influence economic fluctuations. Fiscal policy: The primary tools used to influence demand are taxes and government spending. Monetary policy: The primary tools used to influence demand are interest rates. real gross domestic product (real GDP) economic growth economic fluctuations recession peak trough expansion recovery unemployment rate inflation rate Key Terms interest rate real interest rate nominal interest rate potential GDP aggregate supply labor capital technology production function ...
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