Hey econ students. This is Jacob Clifford. Welcome to the Macroeconomics Unit 2 Summary Video. In these videos I explain all the concepts that you need to know for your next quiz, unit exam, or final exam... but remember it's a summary video. I'm going to be going quick. If you need more help, take a look at my other videos on YouTube. This video is going to cover Unit 2 Economic Indicators and the Business Cycle. Before we jump into it, make sure that you have the study guide that goes along with this video. It'll help you identify and summarize key concepts and it gives you some questions so you can practice. So right now, pause this video download and print the study guide and start the video back up again. Let's start with a quick overview of the five big picture concepts that you need to know in Macroeconomics Unit 2. Number one, economists measure the healthy economy by looking at key economic indicators like gross domestic product, the unemployment rate, and the Consumer Price Index, which measures inflation. Number two, the circular flow model shows how households, businesses, and the government, interact. Number three, gross domestic product, or GDP, is the dollar value of all final goods and services produced within a country in one year. Number four, there are three types of unemployment: frictional, structural, and cyclical. The economy is at full employment when there's no cyclical unemployment. Number five, real GDP is adjusted for inflation and expressed in constant, or unchanging dollars. Nominal GDP is not adjusted for inflation. That's it for an overview, now let's talk about specific topics. Topic 2.1 starts with the circular flow model. It's probably not something your teacher or professor is going to have you draw on an exam, but it is going to help you understand how the economy works. It all starts with households and businesses. Households, like you and me, own the factors of production and sell them to businesses in the factor market. Businesses use those factors, or resources, to produce goods and services and sell them to households in the product market. Households pay for goods and services with money and businesses use that money to pay for the factors of production. These are called Factor Payments. For labor, households are paid wages. For land, they're paid rent. For capital, they get interest, and for entrepreneurship, they earn profit. And this is why it's called the circular flow model. It shows how goods and services, resources, and money all flow in a market economy. But a mixed economy also includes the government, which taxes individuals and businesses to buy goods and services, like fire engines, and pay for resources, like firefighters. The government provides public goods and services, like fire protection and schools, and pays transfer payments. These are government payments made to businesses or households like subsidies or public assistance, like welfare and unemployment. The government's not buying something, instead they're trying to achieve some other economic goal. So that's it this is the circular flow model. But there are two things missing. First is a financial sector where money isn't spent but instead saved and lent out to businesses households and the government. The second is other countries that buy goods and services, resources, and financial assets. We're going to learn about the financial sector and money in Unit 4 and international trade and other countries in Unit 6. Right now we're just going to look at a closed economy and ignore the rest of the world. Every economy has three economic goals. They want to grow over time, they want to limit unemployment, and they want to keep prices stable. And that's all we're really doing in this unit. We're talking about those three goals and how we measure the health of the economy. The most important measurement of economic activity and growth is gross domestic product, or GDP. GDP is the dollar value of all final goods and services produced in a country in one year. And remember there's three ways to measure GDP. There's the expenditures approach, the income approach, and the value added approach. The most important one by far is the expenditures approach. It adds up all the spending in the economy and gives you the most important equation in all of macroeconomics C + I + G + X. Think of it this way. A car produced in the United States can only be purchased by one of four entities. It can be purchased by consumers, regular people like you and me, by a business, by the government, or by someone from another country. If you add up all the spending in those four categories, you get the gross domestic product. So if you bought a new car for yourself that counts toward GDP as consumer spending. If a business buys that car, like a taxi company, that's counted towards GDP but it's called investment. Now be careful here. In this class the word investment is used completely different than how you might use it somewhere else. Investment is always business spending on physical capital like tools machines and factories. Things that businesses use to produce more stuff. It's never ever the idea of "investing" like stocks and bonds or retirement accounts. That is not investment in this class. G stands for government spending. It's like that new car was purchased by your local police department. Government spending includes public goods like infrastructure, like roads and bridges, and public services, like National Defense and education. But it doesn't include transfer payments. So subsidies or welfare are not counted in GDP because no new good or service or resource is being purchased. The last part of the equation is net exports. Exports minus imports. So if a new car was produced in United States but sold in Canada that counts as an export for the United States. Now let's slow down here for a second. There's a lot of confusion when it comes to import. Students see that negative number and they assume buying things from another country actually pulls your economy down. But that doesn't really make any sense because GDP represents domestic production. If an American buys a car from Japan that doesn't mean the US can produce less stuff. What's really going on here is some accounting. When an American buys a car produced in another country that initially counts as consumer spending but, since GDP only measures domestic economic activity, economists subtract that out. The point is, buying things from other countries is not bad for the economy. Now this is what the expenditures approach looks like in real life. For the US almost 70% of GDP is consumer spending. And notice net exports is negative. That's because the US Imports more than it exports. Again I'm going to cover all that with international trade and foreign exchange in Unit 6. The second way to measure GDP is the income approach. Instead of adding up all the spending, you add up all the income. And that should give you the same number. The best way to think about it is by going back to the circular flow model. The expenditures approach adds up all the spending by consumers, businesses, and the government. The income approach adds up all the income earned, the factor payments. The equation for the income approach is not as important as the expenditure approach but it's right here: wages plus rent plus interest plus profit equals the total income. So sometimes you might see a question talking about national income, that's just the same thing as the GDP. It's the total amount of economic activity in one year. The last way we measure GDP is called the value added approach. It adds up all the value added at each stage of the production process. So instead of just looking at the price of a new car you're adding up the value added by the mining company that mine the iron ore, the steel mill that refined the steel, and the company that put together the car. You're probably not going to see many questions about the value added approach so, for now, the most important thing is to understand there's three methods for calculating GDP and the first one's the most important one. I just covered a lot so let's make sure you're getting it. Pause this video and fill out Topic 2.1 on your study guide. And remember if you need more help take a look at my other videos on YouTube. Okay good luck. In Topic 2.2 we're going to talk about the limitations of GDP. Now this is where your teacher Professor is going to ask you a ton of questions about what counts and doesn't count towards this year's GDP. Remember that GDP doesn't include all transactions. First it has to be made this year, so buying or selling anything used doesn't count towards this year's GDP. Also GDP doesn't include intermediate goods, or goods that are used in the production of the final good. So we just add the price of the new car. Not the price of the stock radio, paint, and tires. And GDP doesn't include non-production transactions, like buying stocks and bonds. That doesn't count GDP because nothing new is produced. Also illegal or non-market transactions don't count GDP because we don't know they exist and really they're being done under the table. Now with all that in mind let's practice. Here are five transactions. Your job is to find out do they count or not count towards the United States GDP. Pause the video figure it out then I'll go over the answers. Did you get them right? I hope so. That's what makes you beautiful. Cheese ball Number one doesn't count because that's a transfer payment. Number two does count in GDP because education is a service. So remember goods and services both count in GDP. Number three counts but it's not consumer spending remember that is an example of investment. That's business spending. Number four doesn't count that's an example of a non-production transaction. Nothing was being created. Remember stocks and bonds don't count towards GDP. Now number five does count towards GDP and you might think that's consumer spending but it's actually not. That's also an example of investment. This gets to the little details of what counts and doesn't count. Yes, investment is business spending but it's also consumer spending on things that are going to last for a long time. So technically, if you buy a new house, that doesn't count towards consumer spending that's actually considered investment when the government people calculate GDP. But don't freak out about those little details. Tour teacher or professor is going to ask you general questions about what's counted and not counted in GDP. But of course you are going to have to do more practice so right now pause this video fill out Topic 2.2 inside the study guide. Okay now let's talk about unemployment. Now listen. This is your last week of unemployment insurance either you kill somebody next week or we're going to have to change your status. You got it. There's several definitions and equations you need to know for your next quiz or exam. To get an accurate idea what's going on with jobs and workers we don't want to include kids or retirees in those numbers. The labor force are the people who are at least 16 years old, have a job, or actively looking for one, and it doesn't include people in the military or in jail. The labor force participation rate is the number of people in the labor force divided by the working age population times 100. Currently in the United States that's around 62%. The unemployment rate is the number of people actively looking for a job divided by the number of people in the labor force times 100. To better explain it here's a visual from one of my YouTube videos. The total population includes everyone including little kids and old people that can't work. When you take them out that gives you the working age population. But that includes people who don't want a job like full-time students and stay-at-home moms. And when you take them out you end up with the labor force and the labor force participation rate. And it's inside the labor force that we see the number of people who are actively looking for a job but they don't have one and that gives the unemployment rate. And when that unemployment rate goes up or down that shows you what's going on with the overall economy. When you see questions on this, remember there's two things you got to watch out for: The first one is discouraged workers. These are out of work people who've given up looking for a job so they're no longer counted as unemployed because they're no longer in the labor force. So if a bunch of people stop looking for work that could cause the unemployment rate to go down making the economy look like it's doing better but it's not. The second thing you have to look out for is part-time workers. Remember that part-time workers are considered fully employed even if they're looking for another job. I think you got it so let's do a practice question just like one of the ones you're going to see on your next quiz or exam. The table below shows the number of people in each category. Answer these three questions and be sure to show your work. The labor force includes people with jobs both full-time and part-time workers and people that are unemployed. It doesn't include discouraged workers or kids so the labor force is 200 people. The labor force participation rate is the number of people in the labor force which is 200 divided by the working age population, not the total population. So it's 200 divided by 250 time 100 so 80%. So 80% of the people who are eligible to work are either working or looking for a job. The unemployment rate is the number of people unemployed, which is 30, divided by the labor force, which is 200, times 100 so 15%. I promise you you're going to see questions just like that on your next quiz or exam. Now the other thing you have to know is the three types of unemployment. Frictional unemployment is when people are between jobs so someone who just got out of college and looking for their first job or someone who's switching to a new job. They have skills and there's jobs for them but they just haven't found a job yet. Structural unemployment is when people don't have skills and there's no job for them because the structure of the labor market has changed. These are people like VCR repair men. They don't have a job because people don't use VCRs. Another cause of structural unemployment is technology. Some jobs become obsolete because machines just do it better. The last one is cyclical unemployment and that's unemployment due to a recession. Thee economy is doing poorly so people are buying less stuff and businesses need less workers so they lay off those workers. That is cyclical unemployment. Now to help you remember the three types of unemployment I'm going to give you a trick that I learned this summer. It's called the unemployment dance. Let's start with frictional unemployment. Frictional unemployment put your hands like this, put them together rub them together. Like that. That is frictional unemployment. You're creating friction. These are people between jobs. You got to dance it out! Structural unemployment happens because of technology so now, boom, do the robot. Wooo! And cyclical unemployment happens because there's ups and downs in the economy so here we go. Here comes cyclical unemployment. Woooo baby. I know it's dumb but it's going to help you remember the different types of unemployment. Frictional unemployment is between jobs. Structural unemployment happens because machines, and cyclical unemployment happens because the economy is going in the crapper. There's one more thing you have to remember in this topic. It's the natural rate of unemployment. No matter what the economy we will always have the first two types of unemployment. We're always going to have some frictional unemployment, with workers between jobs, and we're always going to have some structural unemployment, as industries change and evolve. So the economy is doing great and at full employment when we only have frictional and structural unemployment. That's called the natural rate of unemployment. It's the amount of unemployment that exists when there's no cyclical unemployment. In the United States that natural rate is around 4 or 5% so if we have 4% unemployment we're actually doing great. We have no cyclical unemployment. It'll make more sense by going back to the graph we learned in Unit 1, the production possibilities curve. Question, what type of unemployment do we have when the economy is right here? Now you might have said cyclical unemployment but you're wrong. It's not just cyclical, it's all three. When the economy is doing poorly and we have a recession we're going to have frictional, structural, and cyclical. If the economy is here and we're doing great, then we're at full employment and we still have frictional and structural unemployment. So that means we can be out here when there's really low frictional and structural unemployment and the economy is overheating. So we can draw another line that represents 0% unemployment even though that's not the goal and it's not even really possible. But the point is we can be beyond full employment with really low frictional and structural unemployment but again the economy is overheating and eventually we're going to have higher inflation. I'm going to be explaining all that in the next unit, for now just understand that the goal is to have the natural rate of unemployment not 0% unemployment. Now other countries might have a higher natural rate because policies like offering more unemployment benefits to people who are out of work. Paying people more money when they lose their job increases friction unemployment as people take longer to find jobs. So the number of the natural rate might change from country to country but the idea is the same. Before you fill out your study guide, do me a favor. If these videos are helping you learn and love economics, please consider subscribing to my YouTube channel. It's a great way to thank me for helping you and it tells other students that I'm making good stuff. Okay now it's time to practice. Pause this video and fill out your study guide for Topic 2.3. If you can answer those questions you totally understand unemployment. So far we've talked about how to measure economic growth, with GDP, and unemployment, with the unemployment rate. Now we're going to talk about how to measure inflation. Remember one of the goals of every economy is to keep prices stable. Not to prevent inflation. It's okay and expected if prices go up a little bit over time. What we don't want is massive spikes in inflation or even lower prices, deflation. The most common measurement of inflation is the Consumer Price Index, or CPI. Economists take a market basket of commonly purchased goods and services and track it over time to see what happened to prices. The equation for CPI is the value of the market basket of the current given year divided by the value of that same market basket in the base year times 100. This pops out an index number that tells you how prices change relative to the base year. For example if the value of a market basket today is $25 and the value in the base year is $20 then the CPI is 125. This means that prices increased 25% since the base year. So if the CPI is 90 that means prices decreased 10% since the base year and the base year is always 100. By the way, this is what CPI looks like in real life with 1982 being the base year. You can see that prices go up over time and you can also see they've actually been going up faster in the last few years. But right here you can see it's increasing at a slower rate which is called disinflation, prices are still going up but just not as fast. Make sure you know those three terms. Inflation means prices are going up. Deflation mean prices are going down, and disinflation means prices are still going up but at a slower rate. The CPI is great but sometimes it over or underestimates what's actually going on with prices. For example there's the substitution bias. If the price of beef increases, the CPI might continue to assume that people are buying beef but in reality they switched to buying chicken instead. In that case the CPI is overestimating inflation because it's saying people are paying those high prices even though they're not. The big idea here is that all three measurements I've talked about GDP, unemployment rate, and the CPI, they're not perfect. Each of them have limitations that economists have to keep in mind. Now trust me, CPI is one of those concepts that you're going to have to sit down and practice so pause this video fill out Topic 2.4 on your study guide, good luck. In topic 2.5 we dive deeper into the problems with inflation. Most importantly make sure you know who is helped and hurt by unanticipated inflation. The people that are hurt are lenders that lend at a fixed interest rate and people with fixed incomes like retirees. If your grandpa earns $2,000 a month from his retirement accounts and there's unanticipated inflation that's going to erode his purchasing power so he's definitely going to get hurt by inflation. The people who benefit from anticipated inflation are borrowers that borrow at a fixed interest rate. So if you take out a loan at a 10% fixed interest rate and inflation's expect to be 2% but it pops up to 8% you're paying back those dollars with a lower purchasing power. Now's a good time to point out that this stuff is not just academic. You need to understand inflation because someday you're going to have a job and you're going to negotiate your salary. If there's a 2% increase in inflation then you know you have to ask your boss for at least a 2% increase in your wage. To make better decisions you have to understand inflation and how it's going to change in the future and that's why you're taking a macroeconomics class. "The man's logic is sound" This topic was super short so right now pause this video and fill out the section for Topic 2.5. Now in 2.6 we're still talking about inflation. In addition to the CPI there's something else you have to calculate called the GDP deflator. Instead of just looking at a market basket, it looks at the value of everything, the nominal GDP, and compares that to the GDP, adjusted for inflation, the real GDP. And the equation is very similar to the CPI. It's a value of a market basket that includes everything, the nominal GDP, divided by that value adjusted for inflation, the real GDP, times 100. And just like the CPI it pops out an index number that tells you what's going on with prices compared to the base year. But unlike the CPI, it's not just looking at a market basket it's looking at the prices for all goods and services in the economy. And the reason it's called a "deflator" is because it removes the inflation or deflates the nominal GDP. Just remember the nominal GDP distorts economic activity by including inflation. We use the deflator to show what's really going on and get the real GDP. But your teacher or professor is not going to ask you questions like "what's the GDP deflator?" They're going to have you use the GDP deflator. So here are two practice questions. Pause the video see how you do. Good luck. This is why you have to know the equation. Just plug in the numbers $300 divided by $250 times 100 gives you 120. So prices increased 20% since the base year. And you need to be able to take that equation use some algebra solve for x. So if the real GDP is $160 billion you multiply that times the GDP deflator of 120 divided by 100 gives you the nominal GDP of $192 billion. Again you got to trust me, like the CPI, the GDP deflator is one of those things you're going to be calculating on your next quiz or exam. And it's not enough to just watch me do it. You're going to have to practice. So when you're done watching this video and filling out the study guide, make sure to take a look at the multiple choice questions I have in the ultimate review packet. And when you're ready, do the free responses. Try them on your own then look at a video where I go over all those answers. But right now, pause this video and fill out Topic 2.6 on your study guide. The last topic in this unit talks about business cycles and you already know something about them because you understand the idea of cyclical unemployment. This is where you see the easiest graph in the course. But, like the circular flow model, it's not something you're going to draw on exam. Instead it shows you what's going on in the economy. The economy goes up and down over time and there's four phases to the business cycle. There's a trough when the economy is at its lowest, then there's expansion, or what's called a recovery, There's a peak, when the economy is at its height, then there's a recession, also called a contraction. And this trend line represents the idea of full employment or our potential GDP when there's no cyclical unemployment. But the actual GDP might be higher or lower than that potential GDP. The big takeaway here is that any point in time the economy can only be in one of three places. It can have a recession, or a negative output gap, when there's all three types of unemployment and the actual GDP is less than the potential GDP. It can be at full employment where the actual GDP is equal to potential GDP so there's only frictional and structural unemployment and no cyclical unemployment and that means we have the natural rate of unemployment. Or it can have an inflationary gap, or a positive output gap, when there's still some unemployment but it's really low frictional and structural unemployment and the economy is overheating. The actual GDP is greater than the potential GDP and all that spending is going to lead to higher inflation. Remember these three situations. In the next unit we're going to draw each one of them on different graphs and then start talking about how to fix the economy. For now, understand the economy goes up and down over time but it can only be a one of three places. Okay that's it for this topic. Right now pause this video fill out Topic 2.7 on your steady guide. Okay that's it for Macroeconomics Unit 2. It was an easier unit, only a few equations you have to know and few concepts. You're going to be fine. We're going to move on to harder stuff in the future. Thanks for reading :) Util next time!