The National Economy - Measures and Models

Lesson Purpose:
Success in addressing national economic goals depends partly on the ability to assess outcomes and measure progress. To perform these tasks, the discipline of economics has a variety of tools at its disposal. The Production Possibilities Frontier used in earlier lessons to illustrate opportunity costs also models trade-offs in the economy as a whole—tradeoffs in resource use or in policies designed to promote competing economic goals. Another tool, the business cycle model, depicts the course of the economy over time. Measures like GDP, GDP per capita, and CPI allow us to make objective evaluations of current and changing economic conditions.

This lesson looks at some of the models and measures commonly used to assess macroeconomic conditions and to answer questions about our progress in achieving the goals of equity, efficiency, economic freedom, growth, and full employment.

Key Terms:

Gross Domestic Product (GDP)	nominal / real	current / constant
circular flow model	business cycle	Lorenz curve
economic growth	recession	depression

Content Standards:
Standard 18:  Students will understand that: A nation’s overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy.
Benchmarks:

grade 8:

• Gross Domestic Product (GDP) is a basic measure of a nation’s economic output and income.  It is the total market value, measured in dollars, of all final goods and services produced in the economy in one year.
• When consumers make purchases, goods and services are transferred from businesses to households in exchange for money payments.  That money is used in turn by businesses to pay for productive resources (natural, human, and capital) and to pay taxes.

grade 12:

• Nominal GDP is measured in current dollars; thus, an increase in GDP may reflect not only increases in the production of goods and services, but also increases in prices.  GDP adjusted for price changes is called real GDP.  Real GDP per capita is a measure that permits comparisons of material living standards over time and among people in different nations.
• The potential level of real GDP for a nation is determined by the quantity and quality of its natural resources, the size and skills of its labor force, and the size and quality of its stock of capital resources.
• One person’s spending is other people’s income.  Consequently, an initial change in spending (consumption, investment, government, or net exports) usually results in a large change in national levels of income, spending, and output.

Session Objectives:

• Review the economic goals defined in the previous lesson, and introduce the problem of how to measure and evaluate progress in achieving those goals.  Focus on equity, efficiency, economic freedom, growth (and to some extent, full employment, which will also be addressed in the next lesson).
• Review PPF, as introduced in earlier lessons.  Provide an example of a production decision for the economy as a whole (private vs. public goods; consumption vs. investment goods, etc.)
• Explain how the PPF models the goals of efficiency, full employment, and economic growth and the trade-offs involved in targeting goals. 
• Discuss sources of economic growth (represented by an outward shift of PPF).
• Ask participants to brainstorm indicators that we could use to measure progress toward economic goals.
• Introduce and define Gross Domestic Product (GDP).  Differentiate between real and nominal values. Explain use of GDP and GDP per capita to measure economic growth. (Identify factors causing the perennial understatement of GDP.)
• Introduce / review the circular flow model.  Discuss the implications of the circular flow model for policies designed to help us achieve national economic goals.
• Derive GDP = C + I + G + (X-M) from the circular flow model.  Introduce the idea that policies may address economic growth by manipulating the variables in the equation.  Provide examples such as the crowding-out that may occur if government borrows to increase G.
• Introduce the business cycle model and discuss how it relates to goals of economic growth, stability, full employment.
• Introduce and explain the Lorenz curve model of income inequality.  Relate to the economic goal of equity.

Key Content:

• The Production Possibility Frontier is a useful tool for illustrating the trade-offs involved in addressing economic goals, and for illustrating the process of economic growth.
• Gross Domestic Product (GDP) is the final value of all goods and services produced in a country in one calendar year.
• Real GDP is the most commonly used measure of the size of an economy.
• Economic growth = increase in GDP.
• GDP = C + I + G + (X-M)
• Valid comparisons over time or among countries are based on real values. Nominal values reflect current prices; real values are adjusted to eliminate differences in price levels (inflation or deflation).
• GDP deflator = (base year/current year) X 100
• The business cycle is a descriptive (as opposed to prescriptive) model that charts the up and down movements of a nation’s economy over time.
• The Lorenz curve is a graphic representation of income inequality – or the distribution of income by population quintiles in a nation.

Mythconceptions:

• GDP measures all the transactions (sales) during a year.
• Sales of products made by foreign-owned companies operating in the U.S. aren’t counted in U.S. GDP.
• Rising income inequality in the U.S. increases poverty.
• Depressions are a natural condition of market economies (capitalism).
• Most economies function on their PPF.

Frequently Asked Questions:

• What is the difference between GNP and GDP?
• When and why did we switch to GDP ?
• Are we in danger of having another Great Depression?

Classroom Activity Options

• Review the Production Possibilities Frontier model. Suggest that most economies function within the frontier because it is difficult for an economic system to fully employ its productive resources.
• Emphasize that the national goal of economic growth is achieved by policies that encourage improvements in education (human capital), technology, resource availability, and/or population.
• Using a model of the business cycle, explain that over the long term, the economy of the U.S. grows at an average 2% annual rate, but that the rate fluctuates greatly.  Periods of rapid growth show high employment, job growth, investment spending, and rising prices.  Periods of economic contraction show rising unemployment, reduced business profits, fewer home starts and sales, and reduced personal income and retail sales. 

Handouts and Supplemental Materials

• “Composition of GDP – The ‘Footprint’ of the U.S. Economy”