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 GDP is denoted as Y

Measuring GDP

 Production method (or value added method) = the sum of the
incremental value added at each stage of the production process

 Income method = the sum of the income generated from the sale of
domestically produced goods and services

o The income method is almost identical to the production method
 Expenditure method = the sum of expenditures on all domestically

produced goods and services
 Each method will provide the same answer

Components of GDP

 GDP = consumption + investment + government purchases + net exports
 Y = C + I + G + NX
 Consumption = any goods and services purchased by households

o Consumption is divided into services (e.g. medical care, education),
durable goods (e.g. cars) and non-durable goods (e.g. food, clothes)

o Excludes purchases of new houses
 Investment = new fixed capital (e.g. machinery, factories, offices, etc),

new inventory (goods that are produced but not sold) and new
residential houses

o Excludes depreciation of goods or purchases of financial securities
(e.g. shares – this is merely a transfer of assets and no goods and
services are produced from buying and selling shares)

 Government purchases = government spending on consumption and
investment items

o Excludes transfer payment (e.g. Centrelink benefits) as no goods
and services are receive in return for these payments

 Net exports = Exports – imports
o Spending on imports is excluded as GDP is only concerned with

spending on domestically produced goods and services

Example: A cotton farmer sells cotton to a fabric wholesaler for $5. The
wholesaler then processes it and sells it to a clothing retailer for $8. The
clothing retailer sews a shirt with the cotton, which they sell to
customers for $10. What is the GDP (Y) of this shirt?

Production method: Y = value added at each stage of the production
process = $5 + ($8 – $5) + ($10 – $8) = $5 + $3 + $2 = $10

Income method: Y = sum of income generated at each stage of the
production process = $5 + ($8 – $5) + ($10 – $8) = $5 + $3 + $2 = $10

Expenditure method: Y = money spent on the final product = market
value = $10

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o After a contraction, the unemployment rate will not immediate rise
because discouraged workers re-enter the labour force (until they
find work, they are unemployed) and business are reluctant to re-
hire workers as they want to be confident that the expansion of the
business cycle is not just temporary before hiring more workers
(this lag may take 1–2 years)

 Frictional Unemployment
o Short term unemployment due to the fact that it takes time for

employees to find the right job and employers to find the right
employees (mismatch of workers)

o Frictional unemployment includes seasonal unemployment –
unemployment due to seasonal factors, such as weather and other
calendar-related events (e.g. ski instructors, employees at a beach
resort, companies which sell Christmas products)

o Some frictional unemployment is good as it means that workers
and firms are taking their time to match the right workers with the
right jobs

 Structural Unemployment
o Unemployment arising from the persistent mismatch between

the skills and characteristics of workers and the requirements
of jobs arising from the changing structure of the economy

o Structural unemployment is for a longer term than frictional
unemployment as it takes time for workers to learn new skills

o Factors that cause structural unemployment include technological
change, minimum wage, trade union power and efficiency wage

 Full employment/natural rate of unemployment = when there is 0
cyclical unemployment

o There will always be some frictional and structural unemployment
o Natural rate of unemployment is also known as the non-

accelerating inflation rate of unemployment (NAIRU)
 Long-term unemployment = a person is classified as long-term

unemployed if they have been unemployed for one year or more

Costs of Unemployment

 Unemployment has negative personal and social impacts
 The size of the impact depends on the duration of the unemployment (the

longer people are unemployed, the more they lose their skills and
workplaces contract and thus it is harder for them to get a job)

 Costs of unemployment to the economy as a whole:
o Loss of GDP (people have less money to buy things)
o Loss of human capital (skills deteriorate when people are

not using them)
o Retraining costs
o Costs to government (due to unemployment benefits)
o Opportunity cost of funds being directed towards unemployment

 Costs of Unemployment to the unemployed:

o Loss of income

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