Americans in Action

Much of the work of economists involves predicting how the economy will grow in the future. However, forecasts are often wrong. Why is this so? A New York Times columnist contended that The economy has too many complicated moving parts, and despite all the sophisticated forecasting techniques, too little is known about how the parts interact Yet the great majority persist In their optimism, magnifying the positive data and minimizing the [negative] And now, optimistic forecasting Is swamping a minority view that the current recession ... could endure, dooming the economy to contraction or very sluggish growth for months or years."

President Bush meets with congressional leaders about the economy.

Measuring Growth

As the ¿Americans in Action feature makes clear, the economy is complex. Another fact becomes clear from this feature. The economy does not perform smoothly at all times. Sometimes it grows, but sometimes it falters. How do economists decide which period the economy is in? How do government leaders decide what to do about these changes in economic performance? Tn this section;, you will learn the answers to these questions.

One measure of an economy's performance is whether or not it is growing. When the economy grows, businesses are producing more goods and services, and they hire more worker's. As a result, people have more money and buy more.

The gross domestic product (GDP) is a measure of the economy's output. Remember that GDP is the dollar value of all final goods and services produced in a country in a year. All the dollars spent on cars, apples, CDs, haircuts, movies, and everything else bought and sold in the country go into the GDP.

Even if the country produces the same amount of goods and services from one year to the next, the gross domestic product could go up simply because prices increase. That

Chapter 23 Government and the Economy

would make it seem that the economy was growing even though it really did not. To avoid being misled in this way, another measure, real GDP, is used. Real GDP shows an economy's production after the distortions of price increases have been removed. This eliminates the false impression that output has gone up when prices go up.

^¿•■^r'ljtASEff Explaining Why do economists use real GDP to chart an economy's production?

Business Fluctuations

The economy tends to grow over time, but it does not grow at a constant rate. Instead, it goes through alternating periods of growth and decline that we call the business cycle. The graph on this page tracks the typical ups and downs in business activity, The line on the graph tracks real

GDP. When the line moves upward, real GDP is growing. A downward slope shows a decline in real GDP


An economic expansion takes place when real GDP goes up. It doesn't matter whether the economy is growing by a litde or by a lot. As long as the real GDP is higher from one period to the next, the economy is expanding. At some point, real GDP reaches a peak, or the highest point in an expansion. Then it starts to decline.

Expansions arc normally longer than recessions. The longest recent expansion lasted from March of 1991 until March of 2001 > exactly 10 years.


A rcccssion takes place when real GDP goes down for six straight months, although most last longer than that. On the business cycle graph, the recessions

The Business Cycle


Analysing Graphs

The business cycle is marked by alternating phases of recession and expansion. What happens after real GDP reaches a peak?


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