The graph shows nominal GDP in Argentina between and Nominal GDP grew overall during this period, although it decreased for several years in the second half of the decade. Now suppose that in your hotel room one morning you hear on the radio that government statisticians in Argentina forecast that nominal GDP next year will be million pesos greater than this year.
How should you interpret this news? Without some context, it is difficult to make any judgment at all. The first thing to do is to work out if million pesos is a big number or a small number. It certainly sounds like a big number or looks like a big number if we write it out in full ,, If we stacked million peso bills on top of each other, the pile would be over miles high. But the real question is whether this is a big number relative to existing nominal GDP.
We have been told that the change in nominal GDP is million, but we would like to know what this is as a growth rate The change in a variable over time divided by its value in the beginning period. Toolkit: Section A growth rate is a percentage change in a variable from one year to the next.
That is, a growth rate is the change in a variable over time divided by its value in the beginning period. For example, the growth rate of GDP is calculated as follows:. In our example for Argentina, the percentage change is equal to the change in nominal GDP divided by its initial value. Remember than nominal GDP in was about billion pesos, so.
When we express this change in nominal GDP as a percentage, therefore, we see that it is in fact very small—one-tenth of 1 percent. If you heard on the radio that nominal GDP was expected to grow by million pesos in a billion peso economy, the correct conclusion would be that nominal GDP would hardly change at all. This is a substantial change in nominal GDP. In your bid to understand the economy of Argentina, you have seen that nominal GDP increased by one-third between and One possibility is that Argentina is producing one-third more pizzas than it was a decade ago—30 billion pizzas instead of This would be good news.
Producing more pizzas is something we would normally think of as a good thing because it means that we are experiencing economic growth: there are more goods and services for people to consume. In talking to people about the Argentine economy, however, you learn something disconcerting. They tell you that the prices of goods and services are greater this year than they were last year and much greater than they were a decade ago.
You begin to wonder: perhaps Argentina is producing no more pizzas than before but instead pizzas have become one-third more expensive than they formerly were. We would typically feel very differently about this outcome. Yet another possibility is that there has been an increase in both the number of pizzas produced and the price of pizza, and the combined effect doubled nominal GDP.
We need a way of distinguishing among these different possibilities. In our pizza economy, it is easy to tell the difference between an increase in production and an increase in prices. We can measure increased production by counting the number of pizzas, and we can measure increased prices by looking at the price of a pizza. We call the number of pizzas real gross domestic product GDP A measure of production that has been corrected for any changes in overall prices.
In our example, the price level is 10 pesos, and real GDP is 30 billion pizzas. Multiplying these numbers together, we find that nominal GDP is indeed billion pesos. Sometimes, for shorthand, we use the term price to mean the price level in a given year and the term output to mean real GDP in a given year. Real GDP is the variable that most interests us because it measures the quantity of goods and services produced in an economy.
We would therefore like to find a way to decompose nominal GDP into the price level and the level of real GDP in actual economies. But real economies produce lots of different goods and services, the prices of which are continually changing. In fact, even in our pizza economy, there is still an arbitrariness about the units. Imagine that we cut each pizza into 10 slices.
Then we could just as easily say that real GDP is billion pizza slices instead of 30 billion pizzas, but that the price level—the price per slice—is 1 peso. We would still conclude that nominal GDP—the number of slices multiplied by the price per slice—was billion pesos.
So is it possible to say, in a real economy producing multiple goods and services, that nominal GDP is equal to the product of the price level and the level of real GDP? Does it still make sense to write. The answer, as it turns out, is yes. To see how this works, we begin by looking at how prices and output change from one year to another. This is one measure of the growth in nominal GDP from to Specifically, this measures the gross growth rate of nominal GDP.
See the toolkit for details of the mathematics of growth rates. Remember that nominal GDP equals total output produced in a year, valued at the prices prevailing in that year. Comparing nominal GDP in and therefore gives us. Now we use a trick. When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets.
This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus. Neoclassical economists generally emphasize crowding out, while Keynesians argue that fiscal policy can still be effective especially in a liquidity trap where, they argue, crowding out is minimal, while Austrians argue against almost any government distortion in the market.
Some classical and neoclassical economists argue that crowding out completely negates any fiscal stimulus; this is known as the Treasury View, which Keynesian economics rejects. The same general argument has been repeated by some neoclassical economists up to the present. Many times, they point to the American Recovery and Reinvestment Act of as an example. In the classical view, the expansionary fiscal policy also decreases net exports, which has a mitigating effect on national output and income.
When government borrowing increases interest rates, it attracts foreign capital from foreign investors. This is because, all other things being equal, the bonds issued from a country executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return.
Once the currency appreciates, goods originating from that country cost more to foreigners than they did before, and foreign goods cost less than they did before. Consequently, exports decrease, and imports increase. Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy, and inflationary effects driven by increased demand.
In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing labor demand, while labor supply remains fixed, leading to wage inflation and, therefore, price inflation.
In every country, the government takes steps to help the economy achieve the goals of growth, full employment, and price stability. Through monetary policy, the government exerts its power to regulate the money supply and level of interest rates.
Through fiscal policy, it uses its power to tax and to spend. When the Fed believes that inflation is a problem, it will use contractionary policy to decrease the money supply and raise interest rates. In theory, when rates are higher, borrowers have to pay more for the money they borrow, and banks are more selective in making loans. To counter a recession, the Fed uses expansionary policy to increase the money supply and reduce interest rates.
Since the s, monetary policy has generally been formed separately from fiscal policy. Even prior to the s, the Bretton Woods system still ensured that most nations would form the two policies separately. Within almost all modern nations, special institutions such as the Fed in the United States, the Bank of England, and the European Central Bank exist which have the task of executing the monetary policy, often independently of the executive.
The beginning of monetary policy as such comes from the late nineteenth century, where it was used to maintain the gold standard.
Monetary policy rests on the relationship between the rates of interest in an economy the price at which money can be borrowed and the total money supply.
Monetary policy uses a variety of tools to control one or both of these in order to influence economic growth, inflation, exchange rates, and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and, thus, influence the interest rate to achieve policy goals.
The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, company bonds, or foreign currencies.
All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually, the short-term goal of open market operations is to achieve a specific short-term interest rate target.
In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the United States, the Fed targets the federal funds rate, the rate at which member banks lend to one another overnight; however, the monetary policy of China is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies.
An expansionary policy increases the size of the money supply more rapidly or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight, if intended to reduce inflation. Privacy Policy. Skip to main content.
Economics and Business. Search for:. Measuring Economic Performance. The Business Cycle The business cycle is the medium-term fluctuation of the economy between periods of expansion and contraction. Learning Objectives Summarize the phases and turning points inherent in the business cycle. Key Takeaways Key Points The business cycle reflects economy -wide shifts and therefore is measured with close consideration of trends in Gross Domestic Product.
Business cycles consist of two phases and two turning points. Although termed a cycle, the business cycle does not follow a predictable pattern. More recently, economists describe this phenomenon as economic fluctuations, where the long-run expansionary trend of an economy experiences shocks to the system that create short-term departures.
Key Terms business cycle : economics A long-term fluctuation in economic activity between growth and recession recession : a period of reduced economic activity fluctuation : A motion like that of waves; a moving in this and that direction.
Economic Indicators Economic indicators are key statistics about diverse sectors of the economy that are used to evaluate the health and future of the economy.
Learning Objectives Identify the major economic indicators and what economic factors they measure. Key Takeaways Key Points Many different economic indicators are tracked in order to evaluate the economy in different ways or from different perspectives. Government agencies, such as the Bureau of Labor Statistics, and private entities, such as the National Bureau of Economic Research, report and compile many useful economic indicators.
Economic indicators are used to evaluate the past performance of the economy as well as predict future economic conditions. Key Terms leading indicator : Leading indicators are indicators that usually change before the economy as a whole changes. Lagging indicators : Lagging indicators are indicators that usually change after the economy as a whole does.
Economic indicators allow analysis of economic performance and predictions of future performance. Gross Domestic Product GDP is defined as the value of all the final goods and services produced in a country during a given time period.
Learning Objectives Differentiate the product, income, and expenditure approaches to calculating GDP. The product approach sums the outputs of every class of enterprise to arrive at total GDP. For the GDP of a particular country, production by foreigners within that country is counted and production by nationals outside of that country is not counted.
For GNP, production by foreigners within a particular country is not counted and production by nationals outside of that country is counted. Thus, while GDP is the value of goods and services produced within a country, GNP is the value of goods and services produced by citizens of a country.
For example, in Country B, represented in , bananas are produced by nationals and backrubs are produced by foreigners. Since the majority of production within a country is by nationals within that country, GDP and GNP are usually very close together. In general, macroeconomists rely on GDP as the measure of a country's total output.
GDP is an excellent index with which to compare the economy at two points in time. That comparison can then be used formulate the growth rate of total output within a nation.
There is an obvious problem with this method of computing growth in total output: both increases in the price of goods produced and increases in the quantity of goods produced lead to increases in GDP.
From the GDP growth rate it is therefore difficult to determine if it is the amount of output that is changing or if it is the price of output undergoing change. This limitation means that an increase in GDP does not necessarily imply that an economy is growing. While the market value of the goods and services produced by Country B increased, the amount of goods and services produced did not.
This problem can make comparison of GDP from one year to the next difficult as changes in GDP are not necessarily due to economic growth.
Nominal GDP is the sum value of all produced goods and services at current prices. This is the GDP that is explained in the sections above. Real GDP is the sum value of all produced goods and services at constant prices. The prices used in the computation of real GDP are gleaned from a specified base year. By keeping the prices constant in the computation of real GDP, it is possible to compare the economic growth from one year to the next in terms of production of goods and services rather than the market value of these goods and services.
You can see that investment is not a big part of the economy but it can have a big influence on the direction of economic growth because it is very volatile. GDP is an excellent measure of how much we produce, but it is important to remember that production and spending are all it measures.
It is not a measure of the standard of living, although it is often used as such.
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