Real GDP

Potential GDP
Output gaps
Business Cycles
Real GDP: Money value of final goods & services
produced using CONSTANT prices.
Changes in real GDP reflect QUANTITY changes

Nominal GDP: Money value of final goods & services

produced using CURRENT PRICES.
Potential GDP (Full employment GDP): is the money
value of final goods & services that CAN be produced
when all economy`s factors of production are used in
FULL AT THE NORMAL LEVEL OF UTILIZATION.
Level of utilization of resources :
Below the normal level, thus during recession & slow
down , the actual real GDP is LESS than the Potential
GDP
Above the normal level, when economy intensifies
the use of all its factors of production & runs extra
shifts, accordingly it EXHAUSTS its resources. In this
case on the short run, actual GDP EXCEEDS Potential
GDP( usually the price level increases greatly)
GDP Gap:
Is the difference between Potential GDP & Actual
GDP

Business cycle refers to the ups & downs of actual real

GDP ( which is the indicator for economic activity)
Primarily some of the main macroeconomic
objectives are:

(Primarily) maximize rate of growth of real GDP in

the short run.
Maximize Potential GDP by technical advancements
& continuous development in the long run.
Governments try to get rid of output gaps in the short
run.
This slide is only for class
explanation
Output 2008= Qx2008.Px2008+Qy2008.Py2008…
=$500bn
Output 2009=
Qx2009.Px2009+Qy2009.Py2009..=$600
Output 2009=
Qx2009.Px2008+Qy2009.Py2008..=$570
How severe is recession?
2 methods can be used:
Okun Gap : actual real GDP- Potential GDP
The higher the size of the okun gap the severer is the
recession.
Lucas Wedge : the $ value of lost output due to the
recession.
The higher the value of the lucas wedge the severer is
the recession.
UNEMPLOYMENT
U rate = unemployed / labor force x 100

Unemployed are people willing, capable to work,

searching for jobs & are registered officially as being
unemployed.

Labor force = employed + unemployed (in less

developed economies , usually from 15 to 65 as an age.
Natural (normal) rate of U
In any economy , at any time, there is the NORMAL
RATE OF U ( even at potential GDP). This includes:

1-Structural U: due to the mismatch between the

qualifications of the unemployed & that of the vacant
job.
2-Frictional U : due to the normal labor turnover eg.
Temporary quitting a job & waiting to join the other.

In RECESSIONS there is frictional U & structural U &

CYCLICAL U, due to the recession.
How to measure inflation
WE use some indices, as:

1-Consumer price index (CPI): measures the cost of

living for a person who consumes basic necessities of
life only.
CPI is not a comprehensive measure for inflation.

An index number that describes the general price level

would be comprehensive.
2-Recently ,counties focus on ``CORE INFLATION``:
it includes all items in the CPI, however it excludes
the products that experience severe price fluctuations
ex. fuel prices.
GOVERNMENT BUDGET =
 Taxes - Government spending
If T > G there is a gov. budget surplus

If G > T there is a gov. budget deficit

CURRENT ACCOUNT =
 1- Exports of goods & services & interest receipts…

 VERSUS
 2- Imports of goods & services & interest
payments…

If 1 > 2 there is a surplus in the current account

If 2 > 1 there is a deficit in the current account
Macroeconomic Policies
If the gov. gives the highest PRIORITY to fighting
RECESSION, it adopts LOOSE POLICIES to
encourage spending:

1-Loose Fiscal Policy: a- increasing gov. spending.

 &/or b- decreasing taxes
 thus the gov. can create a gov. budget
deficit
2-Loose MONETARY policy:

 By DECREASING THE
 INTEREST RATE

However this policy usually increases the rate of

inflation in the short run( ie TRADEOFF between
fighting RECESSION & U and FIGHTING INFLATION
If the gov. sets the highest PRIORITY to fighting
INFLATION, it adopts TIGHT policies to decrease
spending.

1-A TIGHT FISCAL Policy means: a- decreasing gov.

 spending
 &/or b- increasing TAXES
 thus it can create a gov. Budget
 SURPLUS
2- A tight monetary policy means INCREASING THE
INTEREST RATE( so that spending would be
discouraged & savings would be encouraged).

However this policy usually leads to recession & U in

the short run (ie TRADEOFF between fighting
INFLATION & RECESSION).
IN case of STAGFLATION
 STAGNATION + INFLATION
 RECESSION + U + INFLATION, the gov. has to
set priorities on the short run, either to fight
recession & U OR to fight inflation.
