Macroeconomics

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Question 1: No format required- minimum 200 words
If you were in charge of regulating the way gross domestic product was calculated, would you include illegal activities in the
calculation? Why, or why not?

Question 2:
Determine whether each of the following would cause a shift of the aggregate demand curve, a shift of the aggregate supply curve,
a shift in neither curve, or a shift in both curves. If a shift is caused, indicate which curve shifts, and in which direction it
shifts. What happens to aggregate output and the price level in each case?

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The price level changes.
Consumer confidence increases.
The supply of resources decreases.
The wage rate decreases.
There is no minimum word requirement for responses. Please label each section of your response with the appropriate number (1, 2, 3, 4).

Question 3:
Compare the classical economic theory that was used prior to the Great Depression to the Keynesian theory used after the Great Depression.
Your response must be at least 200 words in length.

Question 4:
Explain how gross domestic product is calculated using each of the following: the income approach and the expenditure approach.
Your response must be at least 200 words in length

ECO 2302, Principles of Macroeconomics 1

Course Learning Outcomes for Unit III

Upon completion of this unit, students should be able to:

3. Discuss how various national economic indicators relate to economic growth.
3.1 Explain the shapes of the aggregate demand and supply curves and how they interact to

determine real gross domestic product (GDP) and the price level for a nation.
3.2 Describe the differences between classical and Keynesian theories.
3.3 Explain the two ways of calculating GDP.

Course/Unit
Learning Outcomes

Learning Activity

3.1
Unit Lesson
Chapter 5
Unit III Assessment

3.2
Unit Lesson
Chapter 5
Unit III Assessment

3.3
Unit Lesson
Chapter 6
Unit III Assessment

Required Unit Resources

Chapter 5: Introduction to Macroeconomics

Chapter 6: Tracking the U.S. Economy

Unit Lesson

This unit is all about “big picture.” In Unit II, we examined supply and demand of individual products in an
economy, such as the demand for pizza. Now, in Unit III, we are moving to the demand for everything
produced in the economy. We are no longer looking at the price of pizza alone but at the average price of all
goods and services produced. Again, start thinking “big picture” as you enter Unit III.

One of the most used economic indicators of a nation’s economic health is gross domestic product (GDP).
News stories about the economy report GDP. Politicians discuss GDP in political debates. Investment groups
follow GDP. Needless to say, GDP is one of those economic indicators that carries a lot of weight when
evaluating the economic health of an economy. Have you ever wondered what GDP means? McEachern
(2019) tells us that GDP measures the market value of all final goods and services produced in an economy
during a given period; this period is usually a year. That means that calculating the GDP for the United States
would mean we would have to add up the value of all the goods and services from dog food to cab rides. It is
easy to see why GDP is one of the most widely reported economic indicators.

GDP is extremely helpful when trying to compare different economies. For instance, the GDP for the United
States in 2016 totaled $18.62 trillion U.S. dollars and equaled $11.19 trillion U.S. dollars for China that same
year (Google, n.d.). The GDP estimates for the United States and China suggest that the value of output of
goods and services produced in the United States was 66% higher than the value of output of goods and
services produced in China in 2016. This is an example of how GDP can be used to evaluate the economic
condition of two separate nations.

UNIT III STUDY GUIDE

Macroeconomics and
the U.S. Economy

ECO 2302, Principles of Macroeconomics 2

UNIT x STUDY GUIDE

Title

Estimates for the United States show that GDP in 2016 was $18.62 trillion and was $13.86 trillion in 2006
(McEachern, 2019). These estimates show that the economy of the United States grew by 34% during the 10
years from 2006 to 2016. This type of growth sounds great. However, the GDP estimates are in nominal
terms (in current year’s prices). Thus, the GDP estimate for 2016 was in 2016 dollars. The GDP estimate for
2006 was in 2006 dollars. The problem with making this comparison is that inflation has occurred over that
time period. Inflation represents a rise in the average price in the economy. We do not know how much of the
increase in nominal GDP is due to increased output and how much is due to inflation between 2006 and
2016. Therefore, comparing nominal GDP across years is very problematic.

This is where real GDP comes in. Real GDP factors inflation out of the calculation. This is done by
transforming nominal GDP into a common year’s dollars (for example, 2000 dollars). This makes it possible to
compare how much the value of total output has changed over time. For example, real GDP in 2006 equaled
$15.34 trillion, and it equaled $17.69 trillion in 2016. Therefore, the percentage increase in real GDP over that
10-year time period equaled 15%. As you can see, there is a vast difference between the growth of nominal
GDP (34%) and real GDP (15%). This difference can be traced back to inflation. In summary, anytime a
comparison is going to be made using GDP over time, real GDP should be used because it factors inflation
out of the calculation.

Real GDP is also used to construct the aggregate demand curve. Aggregate demand shows us how the
average price level in the economy is related to real GDP, all other things constant (McEachern, 2019). This
aggregate demand is the sum of all demands from households, firms, governments, and the rest of the world.
When we graph the aggregate demand curve, the composite price level of all goods is on the vertical axis and
real GDP is on the horizontal axis. As with the demand curves in Unit II, aggregate demand slopes downward
to the right. Pay special attention to the Chapter 5 reading to learn why the aggregate demand curve slopes
downward to the right.

As with the supply curve in Unit II, the aggregate supply curve slopes upward to the right. The aggregate
supply curve shows how much producers of a nation are willing and able to supply at each price level, holding
other things constant (McEachern, 2019). Equilibrium real GDP is found where the aggregate supply and
demand curves cross. It is at equilibrium real GDP where total output of an economy and the price level in the
economy will be determined.

Below is a figure showing the United States aggregate demand and supply in 2016. Take note of how real
GDP is shown in 2009 dollars, and the price level is reported as an index where 2009 equals 100%. This
figure shows that the price level in 2016 for the United States was at 111.4. We interpret this as the price level
in 2016 was 11.4% (111.4 – 100) higher than in 2009.

ECO 2302, Principles of Macroeconomics 3

UNIT x STUDY GUIDE

Title

When GDP is used to compare changes in the value of output over time, we can also draw conclusions
regarding the status of the economy. Take special note of the terms expansion, contraction, depression, and
recession in Chapter 5 as they relate to GDP. Expansions occur when an economy has rising output,
employment, income, and other aggregate measures (McEachern, 2019). The reading suggests that a
contraction is just the opposite (falling output, employment, income, and other aggregate measures).
Dramatic contractions that last a long period of time are called depressions. Finally, a recession results from
declining economic activity (falling output, employment, income, and other aggregate measures) that only
lasts a few months. Take note that in every definition here, either falling or rising output is used. This means
that expansions, contractions, depressions, and recessions can be measured by examining the level of GDP
over time.

One key period of history for the United States was the Great Depression. During this time, real GDP dropped
from $1.057 trillion (in 2009 dollars) in 1929 to $778 billion (in 2009 dollars) in 1933 (McEachern, 2019). This
change was due to the aggregate demand curve shifting to the left. As pointed out in Chapter 5, the cause of
this shift is debated. However, most agree that the stock market crash in 1929 started the ball rolling. After
that, investment was reduced because of negative business expectations, consumer spending dropped,
banks began to fail, the nation’s money supply decreased, and world trade was hampered by high tariffs
(McEachern, 2019). A key policy point to remember about the Great Depression is that markets were
generally left alone before this event. The view was that sharp contractions and peaks naturally occurred in
the economy and would self-correct. This laissez-faire (hands off) approach was the basis of classical
economic theory.

When the Great Depression occurred, it was so severe that the economy could not pull itself out. A noted
economist, John Maynard Keynes, argued that aggregate demand was just naturally unstable (McEachern,
2019). McEachern goes on to suggest that Keynes proposed that governments could intervene and help
guide the economy out of a depression by increasing aggregate demand. According to Keynes, the
government could stimulate increases in aggregate demand by increasing its own spending or cutting taxes
(but both of these would likely result in government spending being more than revenues, thereby causing a
budget deficit). The thought process by Keynes was completely foreign to the way policy had been conducted
previously. However, this demand-side economics approach to influencing aggregate demand to promote full
employment and price stability caught on and is still used today. Take time to read through the various
economic situations the United States has faced over the years; these are presented on pages 84–90 in your
textbook. Note there have also been attempts to influence the aggregate supply curve through supply-side
economics.

When we get to Chapter 6, we see that there are two different ways to calculate GDP. The first approach is
the expenditure approach, which adds up spending on all the final goods and services produced in a nation
during the year (McEachern, 2019). The second way of calculating GDP is using the income approach, which
adds up all the earnings from resources used to produce output. An important point to remember here is that
GDP only includes the final goods and services sold to the final or end user. McEachern points out that the
final user is dependent on who purchases the product. For example, when you purchase flour to bake a cake,
you are the final user. However, the grocery story who purchases flour to bake a cake for sale is not the final
user. The cake made by the grocery store will be sold to the final user. The flour purchased by the grocery
store would be an intermediate good. Sales of intermediate goods are not used in the calculation of GDP as
doing so would double-count these goods.

Taking a closer look at the expenditure approach for calculating GDP, we find the following formula.

GDP = Consumption + Investment + Government Purchases + (Exports – Imports)

Consumption represents purchases of final goods and services by households. Consumption is the largest
spending category and averages 68% of GDP in the United States (McEachern, 2019). Investment is
spending on items such as new capital goods, construction, and intellectual property as well as additions to
inventory. Government purchases represent spending by the government on goods and services.
Government purchases represent about 19% of GDP in the United States (McEachern, 2019). Exports are
goods and services that are purchased by foreign countries, and imports are goods and services purchased
from other countries. Adding all of these expense categories up results in GDP (or aggregate expenditure).

ECO 2302, Principles of Macroeconomics 4

UNIT x STUDY GUIDE

Title

As mentioned above, the income approach to calculating GDP consists of adding up all the earnings from
resources used to produce output in an economy. As an example, let’s say that we wanted to calculate the
final market value of milk. Let’s simplify this example to only four steps. To make a gallon of milk, we start with
milk on a dairy farm. This milk is transported to a processing plant where it is pasteurized and bottled. The
bottled milk is then transported to the grocery store where it is sold to customers.

What we see in the table above is that the dairy farmer sells the raw milk for $1.60 per gallon. The
transportation sector from the dairy to the pasteurization and bottling facility earns $0.25 per gallon. The
pasteurization and bottling facility earns $0.55 per gallon. The transportation sector from the pasteurization
facility to the grocery store earns $0.25 per gallon. Finally, the grocery store earns $0.85 per gallon. Adding
up all the earnings per stage, we get a final market value of $3.50 per gallon of milk.

Chapter 6 also introduces that there are some limitations to national income accounting. For one, some
production is not counted in GDP. Any do-it-yourself productions such as child care, home maintenance,
house-cleaning, and so on, are ignored when it comes to GDP. Illegal activities are also not counted when it
comes to calculating GDP. Also, GDP does not reflect the costs associated with negative externalities
produced in the economy. These externalities can include increased pollution that is associated with
increased production or real estate developments that displace wildlife, just to name two. Even with the
limitations of national income accounting, GDP is still the best measure we have of the economy.

References

Google. (n.d.). Gross domestic product: United States and China [Graph]. Retrieved November 26, 2019,
from
https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_mktp_cd&idim=coun
try:USA:CHN&hl=en&dl=en

McEachern, W. A. (2019). Macro ECON6: Principles of macroeconomics (6th ed.). 4LTR Press.

  • Course Learning Outcomes for Unit III
  • Required Unit Resources
  • Unit Lesson
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