Summary 149
Disposable income,total household income minus
taxes plus government transfers, is allocated to con-
sumer spending(C) in the product marketsandpri-
vate savings.Via the financial markets,private savings
and foreign lending are channeled to investment spend-
ing(I), government borrowing, and foreign borrowing.
Government purchases of goods and services(G) are
paid for by tax revenues and government borrowing.
Exports(X) generate an inflow of funds into the country
from the rest of the world, but imports(IM) lead to an
outflow of funds to the rest of the world. Foreigners can
also buy stocks and bonds in the U.S. financial markets.- Gross domestic product,orGDP,measures the value
of all final goods and servicesproduced in the econ-
omy. It does not include the value of intermediate
goods and services,but it does include inventories
andnet exports(X−IM). It can be calculated in three
ways: add up the value addedby all producers; add up
all spending on domestically produced final goods and
services, leading to the equation GDP=C+I+G+X−
IM,also known as aggregate spending;or add up all
the income paid by domestic firmsto factors of pro-
duction. These three methods are equivalent because in
the economy as a whole, total income paid by domestic
firms to factors of production must equal total spend-
ing on domestically produced final goods and services. - Real GDPis the value of the final goods and services
produced calculated using the prices of a selected base
year. Except in the base year, real GDP is not the same as
nominal GDP,the value of aggregate outputcalculated
using current prices. Analysis of the growth rate of aggre-
gate output must use real GDP because doing so elimi-
nates any change in the value of aggregate output due
solely to price changes. Real GDP per capitais a measure
of average aggregate output per person but is not in itself
an appropriate policy goal. U.S. statistics on real GDP are
always expressed in “chained dollars,” which means they
are calculated with the chain-linkingmethod of averag-
ing the GDP growth rate found using an early base year
and the GDP growth rate found using a late base year. - Employedpeople currently hold a part-time or full-
time job; unemployedpeople do not hold a job but are
actively looking for work. Their sum is equal to the
labor force,and the labor force participation rateis
the percentage of the population age 16 or older that is
in the labor force.
5.Theunemployment rate,the percentage of the labor
force that is unemployed and actively looking for work,
can overstate or understate the true level of unemploy-
ment. It can overstate because it counts as unemployed
those who are continuing to search for a job despite hav-
ing been offered one (that is, workers who are friction-
ally unemployed). It can understate because it ignores
frustrated workers, such as discouraged workers, mar-
ginally attached workers,and the underemployed.In
addition, the unemployment rate varies greatly among
different groups in the population; it is typically higher
for younger workers and for workers near retirement age
than for workers in their prime working years.
6.The unemployment rate is affected by the business cycle.
The unemployment rate generally falls when the growth
rate of real GDP is above average and generally rises
when the growth rate of real GDP is below average.
7.Job creation and destruction, as well as voluntary job
separations, lead to job searchandfrictional unem-
ployment.In addition, a variety of factors such as mini-
mum wages, unions, efficiency wages,and government
policies designed to help laid -off workers result in a sit-
uation in which there is a surplus of labor at the market
wage rate, creating structural unemployment.As a re-
sult, the natural rate of unemployment,the sum of
frictional and structural unemployment, is well above
zero, even when jobs are plentiful.
8.The actual unemployment rate is equal to the natural
rate of unemployment, the share of unemployment that
is independent of the business cycle, plus cyclical un-
employment,the share of unemployment that depends
on fluctuations in the business cycle.
9.The natural rate of unemployment changes over time,
largely in response to changes in labor force characteris-
tics, labor market institutions, and government policies.
10.Inflation does not, as many assume, make everyone
poorer by raising the level of prices. That’s because if
wages and incomes are adjusted to take into account a
rising price level, real wagesandreal incomeremain
unchanged. However, a high inflation rate imposes
overall costs on the economy: shoe- leather costs,
menu costs,andunit -of-account costs.
11.Inflation can produce winners and losers within the econ-
omy, because long -term contracts are generally written in
dollar terms. Loans typically specify a nominal interest
rate,which differs from the real interest ratedue to in-
flation. A higher-than-expected inflation rate is good for
borrowers and bad for lenders. A lower-than-expected in-
flation rate is good for lenders and bad for borrowers.
12.It is very costly to create disinflation,so policy makers
try to prevent inflation from becoming excessive in the
first place.
13.To measure the aggregate price level,economists cal-
culate the cost of purchasing a market basket.Aprice
indexis the ratio of the current cost of that market bas-
ket to the cost in a selected base year, multiplied by 100.
14.Theinflation rateis the yearly percent change in a
price index, typically based on the consumer price
index,orCPI,the most common measure of the aggre-
gate price level. A similar index for goods and services
purchased by firms is the producer price index,or
PPI.Finally, economists also use the GDP deflator,
which measures the price level by calculating the ratio
of nominal to real GDP times 100.Section 3 Summary