Six Key Economic Variables

1. Six Key Economic Variables Real Gross Domestic Product The UK Trade Cycle / Business Cycle Unemployment Rate Inflation Rate Interest Rate Level of the Stock Market Exchange Rate

2. Six Key Economic Variables • You can get a very good idea of the pulse of economic activity by looking at only six key economic variables: six variables that together give a very large chunk of the significant information about the macroeconomy. These six variables are: • Real Gross Domestic Product • The Unemployment Rate • The Inflation Rate • The Interest Rate • The Level of the Stock Market • The Exchange Rate

3. 1. Real GDP • The first key quantity is the level of realGross Domestic Product, called "real GDP" for short, and often referred to as just "GDP." • Let's unpack the definition of real GDP word-by-word. • Real GDP divided by the number of workers in the economy is our best readily-available index of the status of the economy: how well the economy is doing as a social mechanism for producing goods and services that people find useful: the necessities, conveniences, and luxuries of life.

4. Real GDP per Worker, UK Click on image for further details

5. The UK Trade Cycle / Business Cycle • The tendency of economies to move, over time, through periods of boom and slump, and occurs when real GDP moves away from its trend path. The trade cycle is the fluctuations in the rate of economic growth that take place in the economy.

6. The UK Trade Cycle / Business Cycle • These fluctuations appear to occur around every five years and have probably occurred ever since economies have occurred! It is the aim of all governments to try to dampen the effects of the trade cycle and get more balanced long-term growth, but so far they have had limited success.

7. The UK Trade Cycle / Business Cycle • The peak of the trade cycle is usually referred to as a boom, and the trough as a recession or depression. • A period of negative economic growth at the trough of the trade cycle. A recession is usually defined as two consecutive quarters of negative economic growth.

8. The UK Trade Cycle / Business Cycle Click on image for further details

9. Cyclical Unemployment • Cyclical unemployment is unemployment that occurs in conjunction with the business cycle where there is insufficient demand to support full employment.

10. Cyclical Unemployment Click on image for further details

11. 2. The Unemployment Rate • The second key quantity is the unemployment rate. • The unemployed are all people looking actively looking for jobs who have not yet found one (or not yet found one that they find attractive enough to take rather than continue to look for a better). • The number of unemployed divided by the total labor force - the unemployed plus those people at work - is the unemployment rate.

12. The Unemployment Rate • An economy with no unemployment would not be a good economy. Just as an economy needs inventories of goods - goods in transit, goods in processes, goods in warehouses and sitting on store shelves - in order to function smoothly, so an economy needs "inventories" of jobs-looking-for-workers ("vacancies") and of workers-looking-for-jobs ("the unemployed"). An economy in which each business grabbed the first person who came in the door to fill a newly - open job and in which each worker went and took the job associated with the first help-wanted sign that he or she saw would be a less productive economy.

13. The Unemployment Rate • We want workers to be somewhat choosy about what jobs they take - to be willing to think that "this job pays too little", or "this job would be too unpleasant", or "when the employers find out how unqualified I am to do this they will be very unhappy." • We want employers to be somewhat choosy about which workers they hire. Such frictional unemployment is an inevitable part of any process that will make good matches between workers and firms - match workers qualified to do jobs with jobs that use their qualifications.

14. The Unemployment Rate • But there are recessions, and depressions, during which unemployment is definitely not "frictional." The market economy's matching of the supply of workers willing and able to work with businesses that could put their skills and labor-power to making useful goods and services breaks down. In the United States and in Germany during the Great Depression the share of workers unemployed rose to between one-quarter and one-third: between twenty-five and thirty percent. • The unemployment rate is perhaps the best indicator of how well the economy is living up to the potential created by the current level of technology and the current stock of productive capital.

15. UK Unemployment Click on image for further details

16. 3. The Inflation Rate • The third key quantity is the inflation rate: a measure of how fast the overall level of money prices is rising. If the inflation rate this year is five percent, that means that this year things-in-general cost five percent more - in money terms, in terms of the symbols printed on dollar bills, not in sweat or toil.

17. The Inflation Rate • A very high inflation rate - more than twenty percent a month, say - can cause massive economic destruction, as the price system breaks down and the possibility of using profit-and-loss to make rational decisions about what should be produced vanishes. Such hyperinflations are one of the worst economic disasters that can befall an economy.

18. The Inflation Rate • Moderate inflation rates - more than ten percent a year, say - are very unsettling to consumers and to business managers. • This leaves economists scratching their heads to some degree: moderate rates of inflation should not do too much damage to consumers' investors' and managers' ability to figure out what the best use of their financial resources is. Yet all such groups appear strongly averse to inflation, and they vote: politicians in the industrialized economies have learned over the past generation that expressing a lack of commitment to low and stable inflation gets them a quick ticket out of office.

19. UK Inflation Click on image for further details

20. 4. The Interest Rate • The fourth key quantity is the interest rate. Economists speak of "the" interest rate because different interest rates move up or down together. • But in actual fact there are a very large number of different interest rates, applying to loans that mature at different times in the future, and to loans of different degrees of risk.

21. The Interest Rate • Those people or business enterprises who think that they could make good use of additional financial resources now borrow. Those business enterprises or people who have no sufficiently productive or utilitarian use for their financial resources today lend. • When interest rates are low - money is "cheap“ -investment tends to be high, because businesses find that even less-profitable investments will still generate the cash flow needed to pay the interest and repay the principal sum borrowed.

22. UK Interest Rates Click on image for further details

23. 5. The level of the stock market • The level of the stock market is the key economic quantity that you likely hear about most - you most likely hear about it every single day on the news. • The level of the stock market is an index of expectations of how bright the economic future is likely to be. When the stock market is high, average opinion expects economic growth to be rapid, profits high, and unemployment relatively low in the future.

24. The level of the stock market • When the stock market is low, average opinion expects the economic future to be relatively gloomy.

25. FTSE100 Click on image for the latest data

26. 6. The Exchange Rate Definition: The price of one currency in terms of another currency. For example, the exchange rate between the £ and the $ may be £1=$1.65. This means that you need to pay a price of £1 to get every $1.65. Exchange rates can be fixed or floating. Fixed means that they stay at the same value as set by the government. Floating means that they fluctuate day to day according to the market. More generally the term can also refer to the price at which any good is being traded for another good.

27. The Exchange Rate • The exchange rate governs the terms on which international trade and international investment takes place. • For example, when the dollar is appreciated, the value of the dollar in terms of other currencies is high: this means that foreign-produced goods are relatively cheap to American buyers, but that American-made goods are relatively expensive for foreigners. When the dollar has depreciated the opposite is the case: American goods are cheap to foreign buyers--thus exports from America are likely to be high or at least about to rise - but Americans' power to purchase foreign-made goods is limited.

28. The Exchange Rate Click on image for further details