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Many financial analysts use GDP as a measure of the economy’s performance. However, GDP has several shortcomings in terms of measuring economic well-being. For this assignment, you will discuss at least three such shortcomings and explain how each affects the validity of GDP as a measure of economic well-being.State at least three shortcomings of using GDP as a measure of economic well-being and explain how each affects the validity of GDP as a measure of economic well-being.Minimum 250 words and cite any sources used. Refer to attached PDF for reference.
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PART 2 Macroeconomic Analysis
11
Measuring Macroeconomic
Activity
I
n this chapter we change our focus from the microeconomic factors
influencing managers—prices, costs, and market structure—to factors
arising in the larger macroeconomic environment, such as the overall
level of income and output produced in the economy, the price level, and
the level of employment and unemployment. The latter factors are affected
by the spending decisions of individuals and organizations throughout the
economy. Thus, macroeconomic analysis focuses on the aggregate behavior
of different sectors of the economy. However, changes in the macro environment affect individual firms and industries through the microeconomic factors of demand, production, cost, and profitability.
We begin this chapter with a case that describes measures of U.S. economic activity in spring 2012. We also discuss how firms in different industries
responded to this economic data.
We then describe the framework used to measure overall economic activity or gross domestic product (GDP). We use this framework to develop the
aggregate macroeconomic model (Chapters 11–15). Next we describe commonly used measures of the price level and the level of output and employment in the economy and relate these concepts to the major issues facing
policy makers. Although managers cannot influence the macroeconomic environment, they need to understand the policies that change that environment
to determine whether they need to modify their competitive strategies.
320
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Case for Analysis
Measuring Changes in Macroeconomic Activity: Implications for Managers
At the end of May 2012, the government reported that the U.S.
GDP grew in the first quarter of 2012 at an annualized rate of
1.9 percent, which was less than the 2.2 percent growth rate
previously estimated. These and other data reflected a view of
an economy that was slowly recovering from the recession that
officially began in December 2007 and ended in June 2009.
The government reported that the number of workers applying
for jobless benefits increased by 10,000 in the previous week,
while a regional manufacturing report for the Midwest showed
slower growth in the previous month. First-quarter growth
was decreased by less inventory building by companies than
originally estimated, which meant that companies might replenish their stockpiles in the second quarter. Corporate profits
increased $11.4 billion before taxes in the first quarter of 2012
following gains of $32.5 billion and $16.8 billion in the third
and fourth quarters of 2011.1
The next day the government reported that employers
added only 69,000 jobs (seasonally adjusted) in May 2012, the
smallest increase in a year, while estimates for the two previous months were also decreased from their previous values.
Governments continued to reduce payrolls by 13,000 jobs in
May, while the number of long-term unemployed, those out of
work for six months or longer, grew from 5.1 to 5.4 million.
The unemployment rate increased from 8.1 percent in April to
8.2 percent in May 2012. A separate report showed that U.S.
manufacturing growth slowed in May with decreases in both
production and exports. The Institute for Supply Management
reported that its purchasing managers’ index decreased 1.3
points in May to 53.5, with a reading above 50 indicating that
the sector is expanding.2
This slow recovery in economic activity had a substantial
impact on all types of firms. Managers at H. J. Heinz Co.,
which makes ketchup and packaged foods, spent more on
marketing to target increasing numbers of cost-conscious customers. The company planned to expand its presence in convenience stores, clubs, and drugstores, given slower sales in
supermarkets. The company also tested smaller and cheaper
package sizes to appeal to customers with reduced incomes.
Joy Global Inc., a U.S. mining-equipment maker, said that the
economic uncertainty could keep American mining companies from completing expansion projects and that international
companies might not develop new operations.3 Armstrong
World Industries, a flooring manufacturer in Lancaster, PA,
reported that it would hire more factory workers but only when
home sales increased and nonresidential business stopped cutting back. The company was hurt by both cuts in school funding in the United States and weaker sales in Europe.4
In mid-June 2012, a measure of consumer sentiment from
the University of Michigan and Thomson-Reuters decreased
for the first time in 10 months and hit its lowest level since
December 2011. The owner of an upscale spa and salon in
Arlington, Texas reported that his customers were wary even
when the economic news was good, given the mixed signals
on the economy over the previous years. The chief executive
of Harting Inc., an Illinois-based manufacturer of industrial
connectors, noted a drop in demand for makers of machine
tools used in factories around the world. U.S. business was
slowing, while business in China and Europe was considered to be “non-existent.” The recessions in many European
countries and the possible fiscal cliff in the United States—
tax increases and government spending cuts that might occur
automatically as a result of the 2011 budget agreement—
contributed to overall uncertainty. One economist noted that
the U.S. economy was in “low-altitude orbit but threatened by
uncontrolled meteors of euro crises and fiscal cliff that might
knock it out of orbit.”5
1
3
Neil Shah and Kate Linebaugh, “First-Period U.S. Growth Was
Slower Than Thought,” Wall Street Journal (Online), May 31,
2012.
2
Josh Mitchell, “Grim Jobs Data Upend Debate at Fed, in
Campaign,” Wall Street Journal (Online), June 1, 2012.
Shah and Linebaugh, “First-Period U.S. Growth Was Slower
Than Thought.”
4
Michell, “Grim Jobs Data Upend Debate at Fed, in Campaign.”
5
Ben Casselman and Phil Izzo, “Recovery Slows as Global Risks
Rise,” Wall Street Journal (Online), June 15, 2012.
321
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322
PART 2 Macroeconomic Analysis
Measuring Gross Domestic Product (GDP)
Gross domestic product
The comprehensive measure of
the market value of all currently
produced final goods and services
within a country in a given period
of time by domestic and foreignsupplied resources.
Circular flow
The framework for the aggregate
macroeconomic model, which
portrays the level of economic
activity as a flow of expenditure
from consumers to firms or
producers as consumers purchase
goods and services produced by
these firms. This flow then returns
to consumers as income received
from the production process.
Just as we have the framework of demand, supply, and markets to understand
the impact of microeconomic variables on managers’ competitive strategies, we
need a framework to understand the variables influencing the overall level of
economic activity. The most closely watched measure of economic activity is
gross domestic product (GDP), the market value of all currently produced
final goods and services within a country in a given period of time by domestic
and foreign-supplied resources. The framework underlying GDP is the circular
flow, which is derived from market transactions. All of these transactions are
exchanges of income for goods and services between demanders (consumers
or households) and suppliers (producers or firms). In market transactions, consumers use a certain amount of their income to pay producers an amount equal
to the market price of the goods and services times the quantity purchased, and
the consumers receive the goods and services in return. Thus, there is a flow of
expenditure from consumers to producers and a flow of goods and services in
the opposite direction, from producers to consumers. Producers then use this
revenue from the sale of the products to pay for the inputs used in producing
the goods and services. Thus, there is a flow of income from firms to households
who own these inputs and a flow of real resources from households to firms.
Households use this income to again purchase other goods and services—hence,
the name circular flow.6
The Circular Flow in a Mixed, Open Economy
Mixed economy
An economy that has both a private
(household and firm) sector and a
public (government) sector.
Open economy
An economy that has both
domestic and foreign sectors.
Figure 11.1 illustrates the circular flow in a mixed, open economy. A mixed
economy has both a private (household and firm) sector and a public (government) sector, whereas a private economy has only the household and firm sector.
An open economy has domestic and foreign sectors, whereas a closed economy
has only a domestic sector.
Figure 11.1 shows the household and firm sectors of the economy. Firms sell
currently produced goods and services in the domestic markets in the top part of
the figure, and households use part of their income on consumption expenditures
(C) for these products. These expenditures by households become revenue for the
firms. This revenue is used to pay the firms’ expenses of production. These transactions occur in the resource markets in the bottom part of Figure 11.1, where firms
purchase all of the inputs (labor, machinery, land, and so on) used to produce their
goods and services. These payments to the factors of production occur as wages,
rent, interest, and profits, which then become income (Y) to the household sector.
This income is used to finance further consumption in another round of the circular flow. We show only the flow of income and expenditure in Figure 11.1, not the
flow of goods, services, and resources, which occurs in the opposite direction of
the arrows in the figure.
Figure 11.1 also incorporates investment expenditure (I) by the firm sector,
spending by all levels of government (G), and the foreign sector (export spending,
6
Income and expenditure are flows that occur over a period of time. This flow concept differs from the
stock of wealth or debt that may result from this process. If consumers save some of their income, this
action adds to their stock of wealth or the amount of financial assets they have at a point in time. If
consumers’ expenditure exceeds their income, they have to borrow the difference, and their stock of debt
increases. Stocks (wealth and debt) are measured at a point in time, whereas flows (income, expenditure,
and saving) are measured over time.
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CHAPTER 11 Measuring Macroeconomic Activity
323
FIGURE 11.1
Foreign Sector
X
M
Domestic Markets for
Currently Produced
Goods and Services
C
Revenue
I
G
Household Sector
TP
S
Government Sector
Borrowing
Borrowing
TB
Firm Sector
GDP and the Circular Flow
The circular flow is the framework
that forms the basis for the aggregate
macroeconomic model of the
economy.
C = consumption spending
I = investment spending
G = government spending
X = export spending
M = import spending
Y = household income
S = household saving
TP = personal taxes
TB = business taxes
Borrowing
Financial Markets
Y
Income:
Wages,
Rent,
Interest,
Profit
Expenses
Resource
Markets
X, by foreign residents on domestically produced goods and services and import
spending, M, by domestic residents on foreign goods and services). We are measuring GDP using the expenditure or output approach when we add consumption (C), investment (I), government (G), and net export expenditure (F)—which
is export spending (X) minus import spending (M)—as shown in the top half of
Figure 11.1. These components equal the aggregate expenditure (E) on the output produced in the economy, or E = C + I + G + X − M.
The economic activity in Figure 11.1 can also be measured by the earnings or
income approach, which focuses on the flow of income in the bottom half of the
figure. Given the circular flow, aggregate expenditure (E) on the output in the
economy must equal the income (Y) earned from producing this output, or E = Y.
Thus, throughout the remainder of this text, we use the terms aggregate expenditure, output, and income interchangeably.
Figure 11.1 also shows the three major uses that households make of their
income. They first pay personal taxes (TP) to support government activities. This
leaves them with disposable income (Yd), which they either spend on consumption goods and services (C) or save (S). The amount of income that is saved typically flows to the financial markets (banks, stock and bond markets, and other
financial institutions), where it forms a pool of assets that can be borrowed by
either firms or governments to finance investment expenditure (I) or government expenditure (G). Thus, government expenditure (G) is financed through
personal taxes on households (TP), business taxes on firms (TB), and borrowing.
Households may also borrow from the financial markets to finance consumption
expenditure (C). However, households, on balance, are net savers. Analyzing the
factors that affect all of the variables in Figure 11.1 and determining their impact
on managers’ strategies are the major goals of the remaining macroeconomic
chapters in this text.
M11_FARN0095_03_GE_C11.INDD 323
Expenditure or output
approach
Measuring overall economic activity
by adding the expenditure on the
output produced in the economy.
Aggregate expenditure
The sum of consumption,
investment, government, and
net export spending on the total
amount of real output produced
in an economy in a given period
of time, which equals the income
generated from producing and
selling that output.
Earnings or income
approach
Measuring overall economic activity
by adding the earnings or income
generated by selling the output
produced in the economy.
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324
PART 2 Macroeconomic Analysis
Managerial Rule of Thumb
Spending Patterns
The overall macroeconomic environment in which firms operate is influenced by aggregate spending
decisions of consumers, businesses, governments, and the foreign sector. Changes in these spending
patterns can have a substantial effect on a firm’s competitive strategies because they alter the economic environment in which that firm does business. ■
National Income Accounting Systems
National income
accounting system
A system of accounts developed for
each country, based on the circular
flow, whose purpose is to measure
the level of economic activity in
that country.
National Income and
Product Accounts
The U.S. national income
accounting system, operated by
the Bureau of Economic Analysis
(BEA) in the U.S. Department of
Commerce.
Economists and forecasters use a national income accounting system to measure economic activity in real-world economies that is based on the circular flow
concept. In the United States, these accounts are called the National Income and
Product Accounts and are produced by the Bureau of Economic Analysis (BEA)
in the U.S. Department of Commerce.7 This accounting system uses the market
prices of goods and services to weigh the relative value of all output produced.
Thus, if the price of a pound of coffee is twice that of a loaf of bread, production of
the pound of coffee will receive twice the value in the national income accounts.
On the income side, the national income accounts include payments to all factors
of production, including wages, rents, interest, and profit.
As we noted previously, the overall measure of economic activity in the United
States, GDP, is the market value of all currently produced final goods and services
over a period of time within the borders of the United States, whether produced by
American or foreign-supplied resources.8 GDP estimates are prepared quarterly by
the BEA and published on its Web site (www.bea.gov) and in its monthly journal,
the Survey of Current Business. The estimates are based on data gathered from
surveys of households, businesses, and governments and from tax and regulatory
reports submitted to various government agencies. These data may be collected
weekly, monthly, quarterly, or annually.
Because there is a need to get the GDP estimates published as soon as possible,
the initial or advanced estimate, which is published at the beginning of each quarter
during the year for the quarter just completed, is followed by a series of revisions
in the two subsequent months based on data not originally available. These preliminary and final estimates are followed by annual revisions in the three succeeding years and a benchmark revision on a periodic five-year schedule. The five-year
benchmark revisions are made consistent with a data series carried back to 1929.9
7
For a comprehensive discussion of the National Income and Product Accounts, see J. Steven Landefeld,
Eugene P. Seskin, and Barbara M. Fraumeni, “Taking the Pulse of the Economy: Measuring GDP,” Journal of
Economic Perspectives 22 (Spring 2008): 193–216.
8
GDP differs slightly from the measure used previously in the National Income and Product Accounts, gross
national product (GNP), which is the value of all currently produced final goods and services over a period
of time using resources of U.S. residents, no matter where produced. GNP includes and GDP excludes
the income of U.S. residents and corporations earned abroad (interest, dividends, and reinvested profits)
minus the earnings of foreign residents on their investments in the United States. The National Income and
Product Accounts assume that these net earnings measure the net contribution of U.S.-owned investments
abroad to the production of goods and services in other countries. GDP, therefore, is the value of goods
and services produced within the United States, while GNP is the value of goods and services produced by
residents of the United States. The United States switched to the GDP accounting system in 1992 to make
the National Income and Product Accounts consistent with the national income accounting systems of
other industrialized countries. The difference between the two measures is extremely small, approximately
one-half of 1 percent of GDP in 2001. Throughout this text, we will use the current GDP accounting system.
9
This discussion of the National Income and Product Accounts is based primarily on U.S. Department of
Commerce, Bureau of Economic Analysis, Concepts and Methods of the U.S. National Income and Product
Accounts (Chapters 1–9), November 2011. Available at http://www.bea.gov/methodologies/index.htm#na.
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CHAPTER 11 Measuring Macroeconomic Activity
325
Characteristics of GDP
GDP is the value of economic activity—a monetary measure of economic activity that includes only final goods and services and excludes market transactions
that do not relate to the current production of goods and services. In the United
States, GDP is calculated in dollar terms, whereas local currencies are used for
other countries. As we noted above, market prices are used to weight the different
goods and services included in GDP, so the value of GDP is a function of both the
prices and the quantities of the goods produced in a given time period.
GDP includes the final goods and services (sold to end-users), but not any
intermediate goods and services (used in the production of other goods and services). Although it might be possible to count all final goods and services produced
in a given time period, it would be difficult to determine which goods and services
are consumed by their end-users and which are used in the further production of
other goods and services. Thus, to calculate GDP, government statisticians use the
value-added approach. In this approach, only the value added in each stage of
production (raw materials to semifinished goods to final products) is counted for
inclusion in GDP. If the value of all intermediate and final goods was included in
the GDP, there would be substantial double-counting of the nation’s …
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