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Explore the connection between the economic indicators and real-world issues. These lessons typically can be done in one class period.

KEY CONCEPTS

Exchange Rate, Exports, Imports

Current Key Economic Indicators

as of November 10, 2014

Inflation

The Consumer Price Index for All Urban Consumers increased 0.1 percent in October on a seasonally adjusted basis. The core inflation rate increased the same amount. For the previous 12 months, the index increased 1.7%, the same rate as reported in the September report.

Employment and Unemployment

According to the October report of the Bureau of Labor Statistics, the unemployment rate fell from 5.9% to 5.8%, and the number of individuals unemployed also decreased. Total nonfarm employment rose by 214,000 in October. Employment gains were concentrated in retail trade, food services and health care.

Real GDP

The advance estimate for real GDP growth in the third quarter of 2014 was 3.5%, a decrease from the revised second quarter growth of 4.6%. Inventory investment reduced third quarter growth, while it added to second quarter growth. In addition, consumer spending increased at a lower rate in the third quarter, compared to the second. Finally, business investment increased in the third quarter, but at a lower rate than in the second quarter.

Federal Reserve

The FOMC believes that the labor market has shown considerable improvement and the risks of inflation rising above its 2% target are low. Therefore, the Federal Reserve announced plans to end its purchase of financial assets. In addition, the federal funds rate will remain at its current low level. However, the FOMC has signaled its willingness to increase the federal funds rate if inflation shows signs of rising above the 2% target.


Announcement

Real gross domestic product (GDP) during the fourth quarter (October through December) of 2003 increased at an annual rate of 4.0 percent. Real GDP increased at an annual rate of 4.3 percent during the entire year of 2003 as compared to an increase of 2.8 percent during 2002.

Notes to Teachers

Material that appears in italics is included in the teacher version only. All other material appears in the student version. Throughout the semester, the GDP cases will become progressively more comprehensive and advanced.

You may wish to use the following larger versions of the graphs and tables from this lesson for overhead projection or handouts in class:

Meaning of the Announcement

The U.S. economy experienced a recession in 2001 and experienced only modest growth in real GDP since. However, growth throughout 2003 has shown improvement, particularly in the last half of the year. Employment has fallen and unemployment has increased for much of the time since the recession ended in November of 2001. The current announcement along with improving employment reports is good news.

Real GDP for the entire year of 2003 was 3.1 percent higher than 2002. Real GDP in 2002 was 2.2 percent higher than 2001 and 2001 was only .5 higher than 2000. Real GDP is expected to increase at about 4 percent during 2004.

Goals of Case Study

The goals of the GDP case studies are to provide teachers and students:

  • access to easily understood, timely interpretations of monthly announcements of rates of change in real GDP and the accompanying related data in the U.S. economy;
  • descriptions of major issues surrounding the data announcements;
  • brief analyses of historical perspectives;
  • questions and activities to use to reinforce and develop understanding of relevant concepts; and
  • a list of publications and resources that may benefit classroom teachers and students interested in exploring inflation.

Definition of Gross Domestic Product

Gross domestic product (GDP) is one measure of economic activity, the total amount of goods and services produced in the United States in a year. It is calculated by adding together the market values of all of the final goods and services produced in a year.

  • It is a gross measurement because it includes the total amount of goods and services produced, some of which are simply replacing goods that have depreciated or have worn out.
  • It is domestic production because it includes only goods and services produced within the U.S.
  • It measures current production because it includes only what was produced during the year.
  • It is a measurement of the final goods produced because it does not include the value of a good when sold by a producer, again when sold by the distributor, and once more when sold by the retailer to the final customer. We count only the final sale.

Changes in GDP from one year to the next reflect changes in the output of goods and services and changes in their prices. To provide a better understanding of what actually is occurring in the economy, real GDP is also calculated. In fact, these changes are more meaningful, as the changes in real GDP show what has actually happened to the quantities of goods and services, independent of changes in prices.

Why are Changes in Real Gross Domestic Product Important?

The measurement of the production of goods and services produced each year permits us to evaluate our monetary and fiscal polices our investment and saving patterns, the quality of our technological advances, and our material well-being. Changes in real GDP per capita provide our best measures of changes in our material standards of living.

While inflation and unemployment rates and changes in our income distribution provide us additional measures of the successes and weaknesses in our economy, none is a more important indicator of our economy's health than the rate of change in real GDP.

Changes in real GDP are discussed in the press and on the nightly news after every monthly announcement of the latest quarter's data or revision. The current increase in real GDP is discussed in news reports as a sign that the economy is growing and may well continue to do so. (There also is considerable concern with lagging growth in employment. See the latest unemployment case.)

Real GDP trends are prominently included in discussions of potential slowdowns and economic booms. They are featured in many discussions of trends in stock prices. Economic commentators use decreases in real GDP as indicators of recessions. The most popular (although inaccurate) definition of a recession is at least two consecutive quarters of declining real GDP.

Data Trends

The growth in real GDP at the end of the 1990s has been relatively high when compared with the early part of the 1990s. However, during the last two quarters of 2000, the rate of growth of real gross domestic product slowed significantly. During the first three quarters of 2001, the rate of growth of real gross domestic product was actually negative as the U.S. economy entered a recession in March of 2001 lasting through November of 2001. (The change in real GDP was also negative (-.5 percent) in the third quarter of 2000.)

The Federal Reserve responded to slowing growth and the recession by reducing the target federal funds rate by 475 basis points (4.75%) from January 2001 to December 2001 and then two more times since. The most recent was in June of 2003. (See Federal Reserve and Monetary Policy Cases.) The effects of stimulative monetary policy and the resulting low interest rates, along with the stimulative federal government spending and taxing efforts, helped increase consumer spending during and since the recession.

The price index for GDP increased at an annual rate of 1.0 percent during the fourth quarter of 2003, compared to an increase of 1.6 percent during the third quarter of 2003. It increased at an annual rate of 1.6 percent for 2003, compared to 1.5 percent for 2002.

Trends in the 1990s

The rate of increase in real GDP was not only higher in the last part of the 1990s than in the first part of the 1990s, but also when compared to much of the 1970s and 1980s. Economic growth, as measured by average annual changes in real GDP, was 4.4 percent in the 1960s. Average rates of growth decreased during the 1970s (3.3%), the 1980s (3.0%), and the first half of the 1990s (2.3%). In the last five years of the 1990s, the rate of growth in real GDP increased to 3.9 percent, with the last three years of the 1990s being at or over 4.2 percent per year. (The average annual increase since, including the recession year of 1002, has been 2.4 percent.)

Figure 2: Quarterly Changes in Real GDP at Annual Rates (1990-2003)

The upward trend in economic growth over the past decade has been accompanied by increases in the rates of growth of consumption spending, investment spending, and exports. Productivity increases, expansions in the labor force, decreases in unemployment, and increases in the amount of capital have allowed real GDP to grow at the faster rates.

Details of the Fourth-Quarter Changes in Real GDP

Real GDP increased at an annual rate of 4.0 percent in the fourth quarter of 2003 compared to a rise of 8.2 percent in the third quarter of 2003. The major contributors to the increase in real GDP were the increase in consumption and investment spending. The rate of growth slowed from the very high, third-quarter increase of 8.2 percent due to slower growth in consumption and investment and a rise in imports.

Gross private domestic investment increased at an annual rate of 12.4 percent during the fourth quarter of 2003, compared to an increase of 14.8 percent in the third quarter of 2003. For all of 2003, investment spending increased by 4.1 percent.

Fourth quarter exports increased by 19.1 percent (compared to a decrease of 9.9 percent in the third quarter) and imports increased by 11.3 percent (compared to an increase of .8 percent in the third quarter).

Government spending rose at an annual rate of .8 percent compared to a 1.8 percent increase in the third quarter.

GDP, Productivity, and Unemployment

A major factor in the continued growth in the American economy, as seen in the last half of 2003 rate of growth in real GDP growth of 6.1 percent, is the continued improvement in productivity. Productivity, defined as the amount of output per hour of work, increased at an annual rate of 2.7% in the fourth quarter and 9.4% growth in the third quarter. Businesses are able to gain more output from the same number of workers, boosting economic results. This explains how the economy continues to grow strongly even as the unemployment rate stays high and employment grows only slowly.

The Federal Reserve has stated in its recent releases that continued productivity growth is a key component in the continued growth in the American economy. Businesses are able to keep costs low by reducing the need to hire new employees to create growth. The biggest cause of this productivity growth has been investment in information technology and software. This growth has allowed the Fed to cut rates more than it would otherwise, as inflationary pressures are reduced. Alan Greenspan has repeatedly cited productivity growth and was one of the first to view the 1990’s boom in technology spending as a period of sustainable growth above historical levels. Eventually, continued productivity and economic growth will spur new investment and hiring.

If real GDP increases by 4.0 percent and productivity, as measured by output per hour, increases by 3.0 percent, what should be happening to the approximate number of hours worked in the economy?

  1. increase by 1 percent
  2. decrease by 1 percent
  3. increase by 9 percent
  4. decrease by 9 percent
  5. increase by 8.2 percent

[Correct answer. A. If output rises at rate of increase that is faster than the increase in output per hour, than the number of hours must have been increasing. An approximate measure of the amount is to subtract the rate of increase in productivity from the rate of growth in output. (The actual number will not match exactly as productivity, real GDP, and hours worked are taken from slightly different samples.)]

Recessions

A recession began in March of 2001 and ended in November of 2001. Much of the discussion in the economic news since has focused on a rather slow return to economic growth rates that we experienced in the late 1990s. Real GDP has failed to grow as rapidly as prior to the recession and, over much of time period since, employment has fallen and unemployment has increased.

The National Bureau of Economic Research, the agency that determines the official beginning and end of recessions, defines a recession as a "significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade." The data show a decline in employment, but not as large as in the previous recession. Real income growth declined. Manufacturing and trade sales and industrial production both declined.

A Hint About News Reports

Many news reports simply use "gross domestic product" as a term to describe this announcement. The actual announcement focuses on the real gross domestic product, and that is the meaningful part of the report. In addition, newspapers will often refer to the rate of growth during the most recent quarter and will not always refer to the fact that it is reported at annual rates of change. This is contrasted to the reports of the consumer price index, which are reported at actual percentage changes in the index for a single month, and not at annual rates.

Explanations of GDP and its Components

It is common to see the following equation in economics textbooks:

GDP = C + I + G + NX

Consumption spending (C) consists of consumer spending on goods and services. It is often divided into spending on durable goods, non-durable goods, and services. These purchases accounted for 71 percent of GDP in 2003.

  • Durable goods are items such as cars, furniture, and appliances, which are used for several years (9%).
  • Non-durable goods are items such as food, clothing, and disposable products, which are used for only a short time period (20%).
  • Services include rent paid on apartments (or estimated values for owner-occupied housing), airplane tickets, legal and medical advice or treatment, electricity and other utilities. Services are the fastest growing part of consumption spending (42%).

Investment spending (I) consists of non-residential fixed investment, residential investment, and inventory changes. Investment spending accounts for 15 percent of GDP, but varies significantly from year to year.

  • Non-residential fixed investment is the creation of tools and equipment to use in the production of other goods and services. Examples are the building of factories, the production of new machines, and the manufacturing of computers for business use (10%).
    Residential investment is the building of a new homes or apartments (5%).
    Inventory changes consist of changes in the level of stocks of goods necessary for production and finished goods ready to be sold (0%).

Government spending (G) consists of federal, state, and local government spending on goods and services such as research, roads, defense, schools, and police and fire departments. This spending (19%) does not include transfer payments such as Social Security, unemployment compensation, and welfare payments, which do not represent production of goods and services. Federal defense spending now accounts for approximately 5 percent of GDP. All federal spending on goods and services makes up 7 percent of GDP. State and local spending on goods and services accounts for 12 percent of GDP.

Net Exports (NX) is equal to exports minus imports. Exports are items produced in the U.S. and purchased by foreigners (10%). Imports are items produced by foreigners and purchased by U.S. consumers (14%). Thus, net exports (exports minus imports) are negative, about -4% of the GDP.

Questions

Catagories of Spending
(in Billions of Dollars)

 
Consumption spending $8,000
Social security payments 500
Income tax receipts 1,000
Exports 1,000

Business purchases of new factories and equipment and changes in inventories

1,100

Federal government spending on goods and services

800
Construction of new homes 500

State and local spending on goods and services

1,300
Changes in inventories - 100
Imports 1,500
Wages 6,000

 

1. Given the hypothetical data in the table, calculate the following.

  1. what is the level of investment?

    [Investment equals $1,500 [1,100 + 500 +(- 100)].

    New factories and equipment and construction of new homes are included in investment. However, since business inventories fell, we subtract $300 billion from investment in structures, equipment, and residential housing to get the investment portion of GDP.]

  2. what is the level of net exports?

    [Net exports equal a minus $500 ($1,000 - 1,500).

    Net exports are exports minus imports. In this case, the economy has a balance of trade deficit.]

  3. what is the level of government spending in the calculation of GDP?

    [Government spending equals $2,100 ($800 plus $1,300).

    Government spending is equal to the sum of federal spending on goods and services and state and local spending on goods and services. Social security payments are transfers of income from tax payers to social security recipients and do not represent the production of goods and services.]

  4. calculate the level of gross domestic product.

    [GDP equals $11,100 billion [$8,000 + 1,500 + 2,100 – (500)].

    GDP equals consumption spending plus government spending on goods and services plus investment spending plus net exports.]

  1. If GDP has increases by 6 percent and inflation is 2 percent, what has happened to real GDP?

    [Real GDP increased by 4 percent. If nominal GDP has increased by 6 percent and prices have increased by 2 percent, than real GDP has increased by the difference – 4 percent.]

  2. If GDP increases by 3 percent and real GDP decreases by 2 percent, what has happened to the average price level?

    [Price must have decreased by 5 percent, in this case an instance of deflation. If nominal GDP increases by 3 percent while the amount of output decreases by 2 percent, then prices must have decreased by 5 percent. (This instance is an unusual combination of deflation and rise in output.)]

Other Questions for Students

  1. If gross domestic product increases by 3 percent over a year, are we better off? Why or why not?

    [Perhaps we are better off, but just barely. Part of the answer depends upon what is happening to prices and what is happening to population. If prices and population together are rising by more than 3 percent per year, than we, on average, are worse off. We have fewer goods and services per person. Prices over the last year have gone up at a 1.5 percent rate and population is rising by about 1 percent per year. Thus we need a rise in GDP of at least 2.5 percent to make real GDP per person increase]

  2. If consumers begin to purchase computers manufactured in the U.S. instead of those manufactured abroad, what will happen to real GDP? Will the answer be different if consumers are simply increasing their spending and not reducing their spending abroad?

    [Consumption spending will remain the same; however, imports will decrease. Real GDP in the U.S. will increase as production increases. In the second instance, consumption spending increased, but imports do not change. Real GDP does change, as consumption rises.]

  3.  

    Why are wages and profits not included in gross domestic product?

    [Gross domestic product includes all of the production of goods and services in a year. Production of consumption, investment, government, and net export goods is included. Therefore, wages are not added to the total amounts of production when calculating GDP. But, production also generates income. Every dollar that is spent on goods and services eventually becomes income to someone - the workers, the owners, and the lenders. An alternative way of calculating GDP is to add all of the incomes earned by all participants in the economy.]