Economic Indicators and the Business Cycle

The circular-flow model 循环流动模型 shows money moving between households and firms: households supply factors and earn income; firms sell goods and earn revenue. Every dollar of spending is someone's income, which is why output and income are two sides of the same total.

The circular flow of income, with its leakages and injections

Gross domestic product (GDP) 国内生产总值 is the market value of all final goods and services produced within a country in a year. Three ways to measure it give the same number:

• Expenditure approach: $GDP = C + I + G + X_n$ – consumption 消费, investment 投资 (business spending on capital, plus new housing and inventory), government purchases 政府购买, and net exports 净出口 (exports minus imports).
• Income approach: add up all wages, rent, interest, and profit.

Exclude intermediate goods (avoid double counting), used goods, purely financial transactions, and transfer payments.

GDP measures market output, not well-being. It omits non-market production (unpaid housework, volunteering), the underground economy 地下经济, leisure, and the distribution of income, and it ignores environmental damage and resource depletion. So a higher GDP does not automatically mean a better standard of living. GDP per capita (GDP $\div$ population) is a better welfare proxy than total GDP.

GDP per capita shows average output but misses distribution, unpaid work, and more

The labor force 劳动力 is the employed plus the unemployed (those without work who are actively looking). People not looking are not in the labor force.

Three types of unemployment: frictional, structural, and cyclical

Worked example. A country has $150$ million employed and $10$ million unemployed (actively looking), with $40$ million working-age adults not looking. The labor force is $150+10=160$ million, so the unemployment rate is $\dfrac{10}{160}=6.25\%$ and the participation rate is $\dfrac{160}{200}=80\%$.

Three types of unemployment:

• Frictional 摩擦性失业: between jobs or searching for a first job (normal, short).
• Structural 结构性失业: skills or location don't match available jobs (technology, trade).
• Cyclical 周期性失业: caused by a recession (a downturn in the business cycle).

Frictional + structural make up the natural rate of unemployment 自然失业率. At the natural rate cyclical unemployment is zero and the economy is at full employment 充分就业. The rate understates joblessness because it omits discouraged workers 灰心工人 and the underemployed.

Inflation 通货膨胀 is a sustained rise in the average price level. It is measured with a price index 价格指数, most often the consumer price index (CPI) 消费者价格指数, built from a fixed market basket of goods a typical household buys:

Demand-pull and cost-push inflation on the AD-AS diagram

The inflation rate is the percent change in the index between two years. Deflation 通货紧缩 is a falling price level; disinflation is a slowing of inflation.

Worked example. If the CPI is $200$ this year and was $190$ last year, the inflation rate is $\dfrac{200-190}{190}\times100\%=5.3\%$. A basket that cost $\$190$ then costs $\$200$ – the same goods, more dollars.

Inflation redistributes and distorts:

• It hurts lenders and savers and helps borrowers when it is unexpected, because loans are repaid in cheaper dollars. It erodes the value of money and fixed incomes.
• Menu costs and uncertainty discourage investment.
• Anticipated inflation is less harmful because contracts and interest rates adjust for it. This is why we separate nominal and real values.

• Nominal GDP 名义GDP is valued at current prices, so it rises with both output and prices.
• Real GDP 实际GDP is valued at constant (base-year) prices, stripping out inflation, so it reflects true output. Real GDP is the honest measure of growth.

Worked example. Nominal GDP is $\$22$ trillion and the GDP deflator is $110$. Real GDP is $\dfrac{22}{110}\times100=\$20$ trillion. The extra $\$2$ trillion of nominal GDP is pure price rise, not real output – which is why growth is always measured with real GDP.

Exam skill: be fluent converting nominal to real using a price index, and computing an inflation rate or a growth rate as a percent change.

The business cycle 经济周期 is the economy's short-run ups and downs in real GDP around its long-run growth trend: expansion 扩张 (rising output, falling unemployment) up to a peak 顶峰, then contraction/recession 衰退 (falling output, rising cyclical unemployment) down to a trough 谷底, then recovery. A recession is commonly two consecutive quarters of falling real GDP. Unemployment and inflation move roughly opposite over the cycle – the tension the rest of the course tries to manage.

Real GDP swinging around its long-run trend

• Compute GDP by the expenditure method $C+I+G+X_n$ and count only final goods (avoid double counting).
• Unemployment rate = unemployed ÷ labor force; discouraged workers leave the labor force (so the rate can understate joblessness).
• Know the three unemployment types (frictional, structural, cyclical) and that the natural rate excludes cyclical.
• Inflation is the % change in the CPI; convert nominal to real with a price index and always use real GDP for growth.
• Place events on the business cycle (expansion → peak → contraction → trough).