Circular Flow Model, GDP, Inflation, and Unemployment

Circular Flow

• Circular flow represents transactions within an economy, looking in a broad sense
• The goods and services flow clockwise in a circular flow model

 Economic Factors

• Households- person or group of people that share their income
• Government: can refer to local or national
• Firm- an organization that produces goods & services for sale

Markets

• Resource/Factor Market- households sell resources and firms buy them
• Product Market- firms produce goods and services, and households buy them

Gross Domestic Product

• market value of all final goods and services produced within a nation within a given year

Not Included in GDP

• Intermediate goods- goods that require further processing before they are ready for final use
• Used/Secondhand goods- trying to avoid double counting
• Purely financial transactions- stocks and bonds
• Unreported business activity- unreported tips; underground market
• Non-market activities-anything you do for yourself; volunteering
• Transfer payments- public such as social security or private transfer payments such as scholarships

Included in GDP

• C- personal consumption expenditures- wages, etc.
• Ig-Gross private domestic investments- new factory equipment, factory equipment maintenance, construction of housing, unsold inventory of products built in a year
• G- government spending
• Xn- net exports- (exports-imports)

Formulas

• Expenditure approach- C + Ig + G + Xn
• Income Approach- W(wages) + R(rent) + I(interest) + P(profits)
• Nominal GDP- Price of current year x quantity of current year
• Real GDP- Price of base year x quantity of current year 

• Net Domestic Product(NDP) - GDP- depreciation
• Net national product(NNP)- GNP- depreciation
• GNP- GDP + Foreign factor payment

• Budget surplus/deficit- government purchases- government taxes and fees collection + government transfer payments
• Trade Surplus/deficit- Exports- imports
• National income- GDP- indirect business taxes-depreciation-net foreign factor payment 
• Disposable income- national income-personal household taxes + government transfer payments

Inflation

• general increase in prices and fall in the purchasing value of money

GDP Deflator

• price index- used to adjust from nominal to real
• (nominal GDP/ real GDP) x 100
• in base year, the GDP deflator will always equal 100
• for years after the base year, GDP deflator is greater than 100
• for years before the base year, GDP deflator is less than 100

Consumer Price Index (CPI)

• most commonly used measurement for inflation
• measures the cost of a market basket of goods for a typical urban American family
• (cost of market basket of goods in given year/ cost of market basket of goods in base year) x 100

Inflation

• [(price index in year 2 - price index in year 1) / price index in year 1] x 100

Interest Rate

• Nominal Interest Rate- percentage increase in money the borrower must pay the lender for a loan; not adjusted for inflation; Expected interest rate + inflation premium
• Real Interest Rate- percent increase in purchasing power the borrower must pay the lender for a loan; adjusted for inflation; nominal interest rate- inflation

• Hurt by inflation- savers, those on a fixed income, creditors and debtors
• Helped by inflation- debtors
• Cost of living adjustment(COLA)- automatic wage increase when inflation occurs

Unemployment

• failure to use available resources, particularly labor to produce desired goods and services
• Underemployment- not using resources effectively

Labor Force

• above 16 years old of age
• able/ willing to work
• employed and unemployed
• Not in labor force- military, students, retired, disabled, home makers, mental institutions, people in prison, those not looking for a job

Unemployment Rate

• [ # of employed / ( # of employed + # of unemployed)] x 100
• full employment/ natural rate of employment- 4-5 percent

Types of Unemployment

• Frictional- searching for a job, temporarily unemployed or in between jobs; have transferable skills; better opportunity; HS and college graduates
• Structural- changes in structure of the labor force, which makes some skills and jobs obsolete; does not have transferable skills
• Seasonal- depends on the time of year and nature of the job, school bus drivers, life guards, etc.
• Cyclical- results from economic downturn such as a recession, as demand for goods fall, demand for labor falls as well, and workers are laid off

• Frictional + Structural = NRU
• Full employment- no cyclical unemployment

• GDP Gap- amount by which actual GDP falls short of potential GDP
• Okun's Law- for every 1% in which actual unemployment rate exceeds NRU, a GDP gap of about 2% exists
• Rule of 70- amount of years to double income= 70/ growth rate