. 17
( 33)


American Stock Exchange (AMEX), which is also
that most major stocks can be traded around the
located in New York City. It has approximately
clock, somewhere in the world.
1,000 listed stocks.

(NASDAQ ), is the listing that provides informa-
The Over-the-Counter Market tion on stocks that this group trades. The main dif-
ference between a NASDAQ listing and the NYSE
Despite the importance of the organized
is that few OTC stocks pay dividends, mostly
exchanges, the majority of stocks in the
because they are issued by new firms.
United States are not traded on exchanges. Instead,
The organized exchanges and the OTC market
they are traded on the over-the-counter market
may differ, but this means little to investors. An
(OTC)”an electronic marketplace for securities that
investor who opens an Internet account with a bro-
are not traded on an organized exchange.
kerage firm may buy and sell stocks in both mar-
Securities traded over the counter are listed in a
kets. When the investor places an order over the
sophisticated computer network called the National
Internet to buy shares, the broker forwards the
Market System (NMS). The members of the OTC
order to the exchange where the stock is traded and
market belong to the National Association of
the purchase is made there”whether it be on the
Securities Dealers (NASD). The National Association
of Securities Dealers Automated Quotation

Figure 12.8

Tracking Stocks With the DJIA and the S&P 500
1,400 12,000
DJIA (right axis)
1,200 1994“1999: The 10,000
S&P 500 (left axis) strongest bull market

Dow-Jones Industrial Average
of the century 9,000
S&P 500 1941“43 = 100

October 1987:
600 5,000
The worst bear
market in 50 years

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Using Graphs The Dow-Jones Industrial Average and Standard &
Poor™s 500 are two indices used to track stock prices. When did the
DJIA first surpass 10,000?
Visit epp.glencoe.com and click on
Textbook Updates”Chapter 12 for
an update of the data.

longer the case. Consequently, it is better to focus
on the percentage change of the index rather than
the number of points.

Standard & Poor™s 500
Another popular benchmark of stock perfor-
mance is the Standard & Poor™s 500 (S&P 500). It
uses the price changes of 500 representative stocks as
an indicator of overall market performance. Because
the sum of 500 stock prices would be very large, it is
reduced to an index number. Unlike the Dow-Jones,
the Standard & Poor™s 500 reports on stocks listed on
the NYSE, AMEX, and OTC markets.

Bull vs. Bear Markets
Investors often use colorful terms to describe
which way the market is moving. For example, a
bull market is a “strong” market with the prices
Performance Some investors take chances, moving up for several months or years in a row.
while others prefer a safe investment. What are One of the strongest bull markets in history began
the two most popular indicators of the market™s
in 1995 when the DJIA broke 4,000”and then
reached nearly 11,000 in 1999.
A bear market is a “mean” market, with the
prices of equities moving sharply down for several
months or years in a row. In late 1987, the DJIA
Measures of Stock Performance nearly reached the 2,700 level, and then lost nearly
700 points before it finally recovered. As you can
Because most investors are concerned about
see, these two terms take their names from the
the performance of their stocks, they often
characteristics of the animals they are named after.
consult two popular indicators.

Trading in the Future
The Dow-Jones Industrial Average
The Dow-Jones Industrial Average (DJIA), In Figure 12.6 on page 325, markets are
shown in Figure 12.8, is the most popular and widely defined according to the life of the financial
publicized measure of stock market performance on asset and whether or not it can be resold. Another
the NYSE. In 1884, the Dow-Jones corporation pub- attribute of a financial asset is time, which leads to
lished the average closing price of 11 active stocks. In a discussion of spot, futures, and options markets.
1928, coverage was expanded to 30 stocks. Since
then, some stocks have been added, and others
Spot and Futures Markets
deleted, but the sample remains constant at 30.
Because of these changes, the DJIA is no longer A spot market is a market in which a transaction
a mathematical average of stock prices. Also, the is made immediately at the prevailing price. The spot
evolution of the DJIA has obscured the meaning price of gold in London, for example, is the current
of a “point” change in the index. At one time, a price as it exists in that city. The term spot means
one “point” change in the DJIA meant that an “immediate” and is used to distinguish this market
average share of stock changed by $1. This is no from two other markets that trade in the future.

Sometimes the exchange takes place later on, however, options give one of the parties the oppor-
rather than right away. This can be arranged with a tunity to back out.
futures contract”an agreement to buy or sell at a For example, you may pay $5 today for a call
specific date in the future at a predetermined price. option”the right to buy a share of stock at a
For example, a buyer agrees to buy a specified specified price some time in the future. If the call
amount of gold at $280 an ounce from a seller, option gives you the right to purchase the stock at
who promises delivery in six months. When the $70, and if the price of the stock drops to $30, you
settlement date arrives, the buyer takes possession tear up the option and buy the stock at the going
of the gold and pays the seller $280”regardless of price. If the price rises to $100, however, you can
the market price. purchase the stock for $70. Either way, the $5 option
Futures markets are the marketplaces in which gives you the right to make the choice in the future.
futures contracts, or “futures,” are bought and If you were interested in selling instead of buy-
sold. Many of these markets are affiliated with the ing, you would have purchased a put option”the
grain and livestock exchanges that originated in right to sell a share of stock at a specified price
the Midwest. Futures markets include the New in the future. If you pay $3 for the right to sell at
York Mercantile Exchange, the Chicago Board of $50, and if the price of the stock drops to $40, you
Trade, the Chicago Mercantile Exchange, the New can require the buyer to pay the contract price for
York Cotton Exchange, and the Kansas City the stock. You would then net $47 from the sale,
Board of Trade. the $50 contract price minus the $3 paid for the
option. If the price rose to $80 instead, you would
be better off to tear up the option and sell the
Options Markets stock for $80. Either way, the $3 option gives you
Options are contracts that provide the right to the right to make the choice in the future.
purchase or sell commodities or financial assets at Options markets are the markets in which
some point in the future at a price agreed upon options are traded. Most of the exchanges that offer
today. Options are closely related to futures; futures also sell options.

Understanding Key Terms 4. Discuss two measures of stock market
1. Main Idea If the price of a type of stock goes performance.
up, what does this suggest about the quantity 5. Describe how financial assets and equities
of that stock being demanded and the quan- can be traded in the future.
tity being supplied?
Applying Economic Concepts
2. Key Terms Define equities, Efficient Market
6. Futures exchanges What is a futures contract?
Hypothesis (EMH), portfolio diversification,
Would you ever invest in such a contract? Why
stockbroker, securities exchange, seat, over-the-
or why not?
counter market (OTC), Dow-Jones Industrial
Average (DJIA), Standard & Poor™s 500 (S&P
500), bull market, bear market, spot market,
futures contract, futures market, option, call
option, put option, options market. 7. Making Generalizations Does the Efficient
Market Hypothesis affect your view of play-
3. Describe the characteristics of the major
ing the stock market? Explain.
organized stock exchanges in the United
States. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Distinguishing Fact From Opinion
Being able to distinguish fact from opinion can help you make reasonable
judgments about what others say and write. Facts can be proved by evidence
such as records, documents, or historical sources. Opinions are based on
people™s differing values and beliefs.

The stock market has been good to America. In
recent years, it has generated enormous wealth for
individuals, financing for investment, jobs for
people, and tax revenue for governments. Families
now depend on it for retirement, the education of
their children, and, increasingly, even consump-
tion. Millions day-trade Internet stocks, and mil-
lions more actively manage their mutual funds
and 401(k)s. Soon, people may be handling
Social Security investment accounts. The stock
market is insinuating itself into the everyday lives
of ordinary Americans as never before. . . .
A few years ago, only a small percentage of the
Stockbrokers at work
American population”the rich”would have been
affected by this. No longer. A quarter of households
Learning the Skill earning $10,000 to $25,000 now own equities,
The following steps will help you identify facts either directly or through defined-contribution
and opinions: pension plans such as 401(k)s. Two-thirds of all
households earning $50,000 to $99,000 hold
• Read or listen to the information carefully.
equities. And some 84% of households earning
Identify the facts. Ask: Can these statements be
over $100,000 own stocks.
proved? Where would I find information to verify
them? ”Business Week, December 21, 1998

• If a statement can be proved, it is factual. Check 1. Identify facts. How can you verify these statements?
the sources for the facts. Often statistics sound
2. Note opinions. What phrases alert you that these are
impressive, but they may come from an unreliable
• Identify opinions by looking for statements of
feelings or beliefs. The statements may contain
words like should, would, could, best, greatest, all,
every, or always.
Record a television interview. List three facts and
three opinions that were stated. Do the facts seem
Practicing the Skill reliable? How can you verify the facts? What state-
Read the excerpt that follows, then answer ments, if any, seemed to contain both fact and
the questions.
Practice and assess key social studies skills with the
Glencoe Skillbuilder Interactive Workbook, Level 2.
Section 1 • Current yield is a measure of return on bonds.
Bond ratings are widely available and can be used
Savings and the Financial System as a measure of the
bond™s risk.
(pages 313“316)
• Financial markets are
• Saving is a process that makes savings available for named for the charac-
others to invest. teristics of the assets
traded in them. Capital
• The economy has a financial system that transfers
markets have financial
savings to investors.
assets with maturities
• Financial assets are the receipts savers get when
of more than one year,
they loan funds to individuals, businesses, and
while money markets
have assets with matu-
• Financial intermediaries help facilitate the transfer rities of less than one
of funds from savers to other investors. year.
• Financial intermediaries include finance companies, • Assets traded in primary
life insurance companies, mutual funds, pension markets are those that
funds, and real estate investment trusts, or REITs. have to be redeemed by
These institutions are part of the financial system, the issuer.
even though they do not take deposits like commer-
cial banks, savings banks, or credit unions.

Section 3
Section 2
Investing in Equities, Futures,
Investment and Options (pages 328“333)
Strategies and
• Equities, or stocks, are different from financial assets
Financial Assets because equities represent ownership of a corporation
rather than a loan to it.
(pages 318“326)
• Because equity markets are reasonably efficient,
• Investors generally require most investors diversify their portfolio to protect
larger returns to compensate against risk.
for situations with greater risk.
• Many stocks are traded on organized exchanges such
• Successful investors analyze their as the NYSE, the AMEX, and a number of regional
goals, invest consistently, and avoid complexity. stock exchanges.
• 401(k) plans are popular investments that offer
• The majority of stocks are traded in a computer-
simplicity and relatively high returns. ized marketplace of organized dealers called the
• Bonds are popular financial assets. The three compo- over-the-counter market. These stocks represent
nents of bonds are the coupon, the maturity, and newer and sometimes smaller companies that
the par value. could not get listed on the NYSE.

7. Compare four types of bonds that are commonly
traded in the United States.

Section 3 (pages 328“333)
Self-Check Quiz Visit the Economics: Principles
8. Explain what the Efficient Market Hypothesis
and Practices Web site at epp.glencoe.com and
means to investors.
click on Chapter 12”Self-Check Quizzes to pre-
pare for the chapter test.
9. Compare the NYSE to the other organized stock
10. Describe the nature of the over-the-counter market.
Reviewing Key Terms
11. Compare the similarities and differences between
For each of the investments below, write a brief paragraph that the Dow-Jones Industrial Average and the
describes at least three of the term™s principal characteristics. Standard & Poor™s 500.
1. Treasury bond 12. Explain how options contracts are different from
2. Treasury bill futures contracts.
3. equities
4. Treasury note
Thinking Critically
5. futures
6. Individual Retirement Account
1. Drawing Conclusions If you contacted several
7. 401(k)
local banks to get their rates paid on various CDs,
8. Roth IRA
you would find that rates vary only slightly from
9. option
one institution to another. Do you think the simi-
10. municipal bond
larities are caused by efficient markets or by other
causes? Explain.
2. Understanding Cause and Effect Explain how
Reviewing the Facts each of the following will affect saving. Use a
graphic organizer similar to the one below to
Section 1 (pages 313“316)
answer the question.
1. Explain the relationship between savings and
a. An increase in the federal personal income tax
capital formation.
is instituted.
2. Describe how financial assets are created in the
b. The United States undergoes a prolonged
free enterprise system.
period of inflation.
3. Describe five nonbank financial intermediaries in
the American economy.
Tax increase
Section 2 (pages 318“326)
4. Name four considerations important to investors.
5. Explain how a 401(k) plan works. Effect
6. Explain how current yields are computed.

Applying Economic Concepts Technology Skill
1. Risk-Return Relationship List five possible Using the Internet Scan the stock market listings in
investments a person could make if funds were the business section of your local newspaper. Assume
available. Rank the investments in order of how that you have $50,000 to invest in a stock portfolio,
much risk each entails (from highest to lowest). and select one or more stocks in which to invest.
Then rank the investments according to expected Study the information on reading the financial page
returns (from highest to lowest). What is the in the Economics Handbook in the front of this
significance of the rankings to the risk-return book. Then, in your journal, track the progress of
relationship? your stock(s) for one week or more. To help you keep
track, use the following Internet sites:
2. Financial Assets Visit a local bank or a nonbank
financial institution. Ask for its free brochure that The Dow Jones Industrial Averages®
outlines the institution™s investment opportunities http://averages.dowjones.com
such as savings accounts, certificates of deposit,
The New York Stock Exchange
money market accounts, and stock brokerage
accounts. Write a brief report describing the
American Stock Exchange
financial assets the institution generates or trades.
3. Market Efficiency What does the Efficient
Market Hypothesis mean to you as an investor, Chicago Board of Trade
especially with respect to the composition of your http://www.cbot.com
stock portfolio? After you have completed the activity, write a one-
page paper in which you explain what types of infor-
Math Practice mation people should have before they invest in
stocks. Share your results with the rest of the class.
Complete the following table by filling in the correct
data in the blank spaces.

Total Income Consumption Saving Distinguishing Fact from Opinion Read the
following statements. Identify each as a
a. $2,000 $1,800 statement of fact or a statement of opinion.
Then, explain the reasoning behind your
b. $2,500 $1,000
c. $7,000 “$500
1. A share of stock is a unit of ownership in a
d. $10,000 $10,000
2. Market analysts™ predictions are of little
e. $12,500 $400
3. Junk bonds are excellent investments
because they have high yields.
Thinking Like an Economist 4. The United States is not the only govern-
ment to sell bonds.
How do you think the Internet will affect future
5. Financial intermediaries take part in every
competition among stockbrokers for individual
financial transaction.
investors™ business?
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Economic Performance
Economic Instability
The Fed and Monetary Policy
Achieving Economic Stability

As you read this unit, learn how the study
of economics helps answer the following

Why is the price of a used car not
added to the nation™s gross
domestic product?
Why does your dollar buy less
than six cents worth of the goods
and services it bought 100 years In the United States, macroeconomic
policies are used to stimulate the
ago? nation™s overall economic growth.

To learn more about macroeconomics through infor-
mation, activities, and links to other sites, visit the
Economics: Principles and Practices Web site at
A growing economy
means an expanding
economy, one that continues to
provide more people with what
they want or need. In Chapter 13,
you will learn how the nation™s
economic growth is the key to a
better future for everyone. To
learn how statistical measures are
used to monitor the economy™s
performance, view the Chapter 20
video lesson:
Measuring the Economy™s

Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 13”Chapter Overviews to pre-
view chapter information.

Any final product manufactured within
the United States is included in the
country™s GDP.
Measuring the Nation™s Output
Main Idea Product, net national product, national income,
Gross Domestic Product (GDP) and Gross National personal income, disposable personal income, house-
Product (GNP) are two important measures of hold, unrelated individual, family, output-expenditure
economic performance. model, net exports of goods and services
Reading Strategy
Graphic Organizer As you read the section, complete
After studying this section, you will be able to:
a graphic organizer similar to the one below by iden-
1. Explain how Gross Domestic Product (GDP) is
tifying what calculations are necessary to go from
2. Describe the limitations of GDP.
+ “ = GNP 3. Understand the importance of GDP.

Applying Economic Concepts
Key Terms
Gross Domestic Product Read to find out why GDP is
Gross Domestic Product, national income accounting,
the most important measure of overall economic
intermediate products, secondhand sales, nonmarket
transactions, underground economy, Gross National

he report in the cover story may be of only
Cover Stor y passing interest to many people, but it is
vitally significant news for economists. This is
because Gross Domestic Product (GDP)”the dollar
GDP Growth amount of all final goods and services produced
within a country™s national borders in a year”is the
Revised Up to single most important measure of the economy™s
4.3 Percent overall economic performance. When GDP does
well, the rest of the economy usually does well.
Torrid consumer
Economists devised national income accounting”a
spending helped the
system of statistics and accounts that keeps track of
nation™s economy
production, consumption, saving, and investment”to
grow at a brisk Home sales rise
nual rate of 4.3 track overall economic performance. This data
at becomes part of the National Income and Product
percent bust
. . [The] economy™s ro
ginning of the year. . Accounts (NIPA) kept by the U.S. Department of
above expectations.
st-quarter pace was far
fir Commerce. The NIPA is like a statistical road map that
spending, which contin
. . . [R]obust consumer 6.7 tells Americans where they are and how they got there.
, rose at an annual rate of
power economic growth
to ent
in a decade, the governm
rcent, the best showing
GDP”The Measure of National
said. s
ted that inflation remain
The GDP report indica at an
tied to the GDP rose
low. An inflation gauge first
1.2 percent in the
annual rate of just ents
r new homes and apartm GDP is a measure of national output. This
quarter. . . . Spending fo ter, the
ent rate in the first quar means that Japanese automobiles pro-
increased at a 15.4 perc
best showing in a year. duced in Kentucky, Indiana, Ohio, or Tennessee
June 25, 1999
”The Washington Post, count in GDP even if investors who own the

plants live outside the United States. On the other housing, apartments, and buildings for commercial
hand, production in U.S.-owned plants that are purposes. In the second column, the final goods and
located in Mexico, Canada, or other countries is services produced in the year are listed. The next two
not counted in GDP. columns show the quantity produced and the aver-
age price of each product. To get GDP, multiply the
quantity of each good by its price and then add the
Computing GDP results, as is done in the last column of the table.
Government statisticians use scientific sam-
The measurement of GDP is fairly easy to grasp.
pling techniques along with other methods to esti-
Conceptually, we only have to multiply all of the
mate both the quantity and the prices of the
final goods and services produced in a 12-month
individual products. In addition, since the report-
period by their prices, and then add them up to get
ing process includes such extensive data, GDP
the total dollar value of production.
estimates are made only quarterly, or every three
Figure 13.1 provides an example. The first col-
months. The figures are revised for months after
umn contains three categories of products used in
that, so it takes several months or years to dis-
the NIPA. These are goods, services, and structures.
cover how the economy actually performed.
The third category”structures”includes residential

Figure 13.1

Estimating Gross Domestic Product
Quantity Price Dollar Value
Product (millions) (per 1 unit) (millions)

Automobiles 6 $20,000 $120,000
Replacement Tires 10 $60 $600
Shoes 55 $50 $2,750
¦* ¦* ¦* ¦*

Haircuts 150 $8 $1,200
Income Tax Filings 30 $150 $4,500
Legal Advice 45 $200 $9,000
¦* ¦* ¦* ¦*

Single Family 3 $75,000 $225,000
Multifamily 5 $300,000 $1,500,000
Commercial 1 $1,000,000 $1,000,000
¦* ¦* ¦* ¦*

Total Gross Domestic Product = $9 trillion
Note: *¦ other goods, services, and structures

Using Tables Gross Domestic Product is the dollar value of all final goods, services, and structures
produced within a country™s borders in a year. How is the dollar value for each of the products
on the table calculated?

Underground Economy

Excluded From GDP Although there is no consensus on the size of the underground economy, estimates
suggest that it is between 5 and 15 percent of the recorded GDP. What activities make up the under-
ground economy?

Some Things Are Excluded person or group to another, no new production is
When the Department of Commerce analyzes created. Although the sale of a used car, house,
production data, it faces several decisions con- clothes, or compact disc player may give others
cerning what should and what should not be cash that they can use on new purchases, only the
included in GDP. original sale is included in GDP.
One case involves intermediate products” Nonmarket transactions”transactions that do
products used to make other products already not take place in the market”are excluded because
counted in GDP. If you purchase replacement tires they are so difficult to measure. GDP does not take
for your automobile, for example, these tires are into account the value of services when you mow
counted in GDP. However, if you purchase a new your own lawn or perform your own home main-
car, the tires are not counted separately because tenance. These activities are counted only when
their value is built into the price of the car. they are done for pay outside the home. The largest
Intermediate products are eliminated from group of nonmarket transactions excluded from
GDP so they are not counted twice, which would GDP includes the services that homemakers pro-
make GDP seem larger than it actually is. Some vide. If homemakers received pay for the cooking,
goods such as flour, sugar, and salt are included in cleaning, laundering, child care, and other house-
GDP if they are bought for final use by the con- hold chores they normally perform, billions of dol-
sumer. For example, if you buy flour to make a pie, lars would be spent every year for these services.
the flour counts in GDP. If you are a baker who Many other activities take place in the market,
buys the flour to make pies for sale, only the value but they are excluded from GDP because they are
of the pies are counted. illegal and not reported. Unreported legal and
Another decision involves the exclusion of illegal activities such as gambling, smuggling,
secondhand sales”the sales of used goods. When prostitution, drugs, and counterfeiting are part of
products already produced are transferred from one the so-called underground economy.

Presidential elections are often influenced by the
INFOBYTE health of the economy. In 1992, President George
Bush lost a very close election to Bill Clinton, in
part because people were still suffering from the
GDP Due to the increased level of globalization short but sharp GDP downturn in 1991. Had the
in the economy, the GDP calculation has replaced economy been healthy, many political analysts
Gross National Product as the accepted measure-
believe that Bush would have been reelected.
ment of national output. GDP differs from GNP in
We can examine smaller parts of GDP”housing,
that GDP is an international measure of a country™s
consumer spending, and even the price increases
annual output regardless of who owns the
detailed in the cover story”if we want more detail,
resources. GNP, on the other hand, is an interna-
but the total measure is the standard followed most
tional measure of a country™s income, regardless of
closely. For these reasons, GDP is the single most
where the factors of production are located.
important economic statistic compiled today.

GNP”The Measure of National
Limitations of GDP
Increases in GDP are desirable because they When economists measure income rather
indicate that more people have jobs and earn an than output, they use Gross National
income. GDP alone, however, tells nothing about Product (GNP)““the dollar value of all final goods,
the composition of output. If GDP increases by $10 services, and structures produced in one year with
billion, for example, we know that production is labor and property supplied by a country™s residents.
growing and we likely would view the growth as a GNP is based on GDP, but there are differences
good thing. However, we might feel differently if between the two. While GDP measures the value of
we discover that the extra production took the all the final goods and services produced within U.S.
form of military nerve gas stockpiles rather than borders, for example, GNP measures the income of
schools, libraries, and parks. all Americans, whether the goods and services are
Additionally, GDP tells little about the impact of produced in the United States or in other countries.
that production on the quality of life. The construc- To go from GDP to GNP, it is necessary to add all
tion of 10,000 new homes may appear to be good payments that Americans receive from outside the
for the economy. However, if the homes threaten a United States, then subtract all payments made to
wildlife refuge or destroy the natural beauty of an foreign-owned resources in the United States.
area, the value of the homes may be viewed differ- Figure 13.2 shows the relationship between GDP
ently. In practice, GDP does not take into account and GNP. Notice that GNP is the smaller of the two
quality of life issues, so it is helpful to be aware of figures. This is because the United States paid out
such matters to gain a better understanding of GDP. more income to factors of production from the rest
of the world than it received; this is not the case for
all countries. In a closed economy”one with no
An Overall Measure of Economic Health foreign sector”GDP equals GNP.
Despite its limitations, GDP is still our best
measure of overall economic health. Because it is a
Net National Product
measure of the voluntary transactions that take
GNP is the first of five income measures
place in the market”and because voluntary trans-
included in the National Income and Product
actions are only made when both parties feel they
Accounts (NIPA). The second measure is net
are better off”a larger GDP indicates that more
national product (NNP), or GNP less depreciation.
people are better off than before. If GDP does not
Depreciation represents the capital equipment that
grow, people may become unhappy and dissatis-
has worn out or become obsolete over the year.
fied with government or its leaders.

Figure 13.2

The National Income and Product Accounts
(in billions of current dollars)

Gross Domestic Product (GDP) $8,799.7

Plus: Payments to American citizens who employ resources outside the U.S. + 270.3
Less: Payments to foreign-owned resources employed inside the U.S. - 292.9

Gross National Product (GNP) $8,777.1

Less: Capital consumption allowances and adjustments (depreciation) - 932.0

Net National Product (NNP) $7,845.1

Less: Indirect business taxes and subsidies - 594.1

National Income (NI) $7,251.0

+ 2,214.7
Plus: Transfer payments to persons, personal interest income, and
Social Security receipts
- 2,115.0
Less: Undistributed corporate profits, corporate income taxes, and
Social Security contributions

Personal Income (PI) $7,350.7

- 1,136.0
Less: Personal taxes and nontax payments

Disposable Personal Income (DI) $6,214.7

Source: Survey of Current Business, June, 1999 (data for first quarter)

Using Tables The National Income and Product Accounts show the
relationship between GDP and five measures of the nation™s income.
What is the main difference between GDP and GNP?
Visit epp.glencoe.com and click on
Textbook Updates”Chapter 13 for
an update of the data.

National Income Personal Income
The third measure is national income (NI). The fourth measure of the nation™s total income
National income is the income that is left after all is personal income (PI)““the total amount of
taxes except the corporate profits tax are sub- income going to consumers before individual
tracted from NNP. Examples of these taxes, also income taxes are subtracted. To go from national to
known as indirect business taxes, are excise taxes, personal income, four adjustments must be made.
property taxes, licensing fees, customs duties, and First, income that does not go to the consumer
general sales taxes. must be subtracted from national income. One

such type of income is retained earnings, also Economic Sectors and Circular
known as undistributed corporate profits. These
are the profits that corporations keep to reinvest
in new plants, offices, and equipment. It is useful to think of the economy as being
The second type of income that must be sub- made up of several different parts, or sectors.
tracted consists of corporate income taxes, which is These sectors receive various components of the
a form of income to government. The third item national income, and they use this income to pur-
subtracted is Social Security contributions from peo- chase the total output. Sectors, described below
ple™s paychecks. After these three types of income and illustrated in Figure 13.3, are critical links in
have been subtracted from national income, transfer the circular flow of economic activity.
payments in the form of unemployment insurance,
Social Security, medicaid, and several other forms of
Consumer Sector
assistance must be added back in.
The largest sector in the macro economy is the
consumer, or private, sector. Its basic unit, the
Disposable Personal Income
household, is made up of all persons who occupy a
The fifth and smallest measure of income is house, apartment, or room that constitutes separate
disposable personal income (DI)”the total living quarters. A household includes related family
income the consumer sector has at its disposal members and all others”such as lodgers, foster chil-
after personal income taxes. This is an important dren, and employees”who share the living quarters.
measure because it reflects the actual amount of As long as the person or persons occupy a separate
money the consumer sector is able to spend. place of residence, a household also can consist of an
At the individual level, a person™s disposable unrelated individual”a person who lives alone even
income is equal to the amount of money received though he or she may have family living elsewhere.
from an employer after taxes and Social Security The concept of a household is broader than that of a
have been taken out. The $586.89 net pay on the family”a group of two or more persons related by
check in Figure 9.9 on page 241, plus the $3.20 of mis- blood, marriage, or adoption who are living together
cellaneous deductions, is disposable personal income. in a household.
The $3.20 is part of disposable income because All three definitions have value to the United
the deduction was for something other than FICA States Bureau of the Census. The definition of the
or taxes. The wage earner could even choose to have household is especially useful because the demand
more salary withheld to cover contributions to a for durable goods, such as stoves, water heaters, fur-
credit union or charity or to buy savings bonds. naces, and refrigerators, is more closely tied to the
However, these contributions would not lower a per- number of households than to the number of fami-
son™s disposable personal income”they are merely lies. Also, many households, even when made up of
one way of allocating disposable income. persons not related by blood, marriage, or adoption,
tend to behave as a single economic unit.
Shown as “C” in Figure 13.3, the consumer sector
receives its income in the form of disposable per-
sonal income. In a sense, the consumer sector
The number of
A Growing Female Workforce receives the income that is left over after all of the
women in the labor force has virtually doubled since depreciation, business taxes, and FICA payments are
the early 1960s. From 1960 to 1997, the number of made, plus the income received in transfer payments
women in the workforce increased from 37.7 percent
that are added back in.
to 59.8 percent. The increase is a result of women
having more education than ever before and delay-
Investment Sector
ing child rearing until they are established in their
careers. The second sector of the macro economy is the
business, or investment, sector, labeled “I” in

Figure 13.3

Circular Flow of Economic Activity
Wages, salaries, & tips able
GDP* GNP* Dividends Income
Proprietor™s income Social
Corporate income taxes

Retained earnings

y contributions

Personal taxes
Indirect business taxes
Investme n t

Capital consumption allowance

e xpenditures Businesses

Government purchases of goods and services Government

Transfer payments
Personal saving Consumer
Personal consumption expenditures

*GNP equals GDP in a closed economy.

Using Charts The three sectors of the economy”Business, Government, and Consumer”combine
in purchase thethe nation™s total output. What expenditures combine to make up gross
to purchasing nation™s total output. What expenditures combine to make up gross domestic
domestic product?

Government Sector
Figure 13.3. It is made up of proprietorships, part-
The third sector is the public sector, which
nerships, and corporations. It is the productive
includes all local, state, and federal levels of gov-
sector responsible for bringing the factors of pro-
ernment. Shown as “G” in Figure 13.3, the govern-
duction together to produce output.
ment sector receives its income from sources such
The income to the investment sector is the depre-
as indirect business taxes, corporate income taxes,
ciation that is subtracted from GNP and the
Social Security contributions, and personal income
retained earnings subtracted from NI. The business
taxes from the consumer or household sector. If
sector can treat depreciation as a form of income
the figure had a foreign sector, then customs duties
because it is a non-cash expense that never leaves
would also be part of the sector™s income.
the firm.

Foreign Sector According to this model, the consumer sector
spends its income on the goods and services used
The fourth sector of the macro economy is
by households. These personal consumption expen-
the foreign sector, usually identified as “F,” but
ditures include groceries, rent, books, automobiles,
not shown in Figure 13.3. This sector includes
clothes, and almost anything else people buy.
all consumers and producers outside the United
The investment, or business, sector spends its
States. Unlike the other sectors, the international sec-
income on plants, offices, equipment, inventories,
tor does not have a source of income specific to it.
and other investment goods. These expenditures
Instead, this sector represents the difference
represent the total value of capital goods created in
between the dollar value of goods sent abroad and
the economy during the year.
the dollar value of goods purchased from abroad. If
The government sector spends its income on
the two are reasonably close, the foreign sector
many categories, including national defense,
appears to be fairly small, even when there are large
income security, interest on the national debt,
numbers of goods and services being traded.
health care, roads, and education. The only major
government expenditure not included in total out-
The Output-Expenditure Model put is transfer payments, because this money is
used by others to buy goods and services that are
The circular flow in Figure 13.3 is complete
part of total GDP.
when the output-expenditure model is
The foreign sector also buys many goods and
introduced. The output-expenditure model is a
services”tractors, computers, airplanes, and agricul-
macroeconomic model used to show aggregate
tural products”that make up GDP. In return, it
demand by the consumer, investment, govern-
supplies such products as Japanese cars, Korean
ment, and foreign sectors. When this is written as
shirts, and Brazilian shoes to be consumed at
GDP C I G F home. For this reason, the foreign sector™s pur-
the equation becomes a formal output-expenditure chases are called net exports of goods and services,
model used to explain and analyze the economy™s a term that refers to the difference between the
performance. United States™s exports and its imports.

Checking for Understanding 5. Explain the importance of GDP.
1. Main Idea Explain the difference between
Applying Economic Concepts
GDP and GNP.
6. Gross Domestic Product What effect do you
2. Key Terms Define Gross Domestic Product, think the computer industry has had on the
national income accounting, intermediate GDP? Use examples, if available, to support
products, secondhand sales, nonmarket trans- your claim.
actions, underground economy, Gross
National Product, net national product,
national income, personal income, disposable
personal income, household, unrelated indi-
7. Making Generalizations What would be
vidual, family, output-expenditure model, net
the effects of a decline in GDP?
exports of goods and services.
8. Summarizing Information Why is GDP not a
Reviewing Objectives proper measure of the total income earned
3. Describe how GDP is measured. by U.S. citizens?
4. List the limitations of GDP. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Using a Spreadsheet
People use electronic spreadsheets to manage numbers quickly and easily.
Formulas may be used to add, subtract, multiply, and divide the numbers in
the spreadsheet. If you make a change to one number, the totals are recalcu-
lated automatically for you.

Learning the Skill signifies multiplication: (B2*C3) D1 means you want
to multiply B2 times C3, then add D1.
To understand how to use a spreadsheet, read the
following descriptions of several spreadsheet
•A spreadsheet is an electronic worksheet. It is
made up of numbered cells that form rows and
columns. Each column (vertical) is assigned a let-
ter or number. Each row (horizontal) is assigned a
number. Each point where a column and row
intersect is called a cell. The cell™s position on the
spreadsheet is labeled according to its correspon-
ding column and row”Column A, Row 1 (A10);
Column B, Row 2 (B2) and so on. See the diagram

A1 B1 C1 D1 E1
The computer highlights the cell you™re working in.
A2 B2 C2 D2 E2
A3 B3 C3 D3 E3 Practicing the Skill
A4 B4 C4 D4 E4
Study the spreadsheet on this page.
A5 B5 C5 D5 E5
1. Which cell is highlighted? What information is found
in the cell?
• The computer highlights the cell you are in. The
2. What formula would you type in which cell to
contents of the cell also appear on a status line at
calculate the average life expectancy of both males
the top of the screen.
and females in Sri Lanka?
• Spreadsheets use standard formulas to calculate
3. What formula would you type in which cell to find the
numbers. To create a formula, highlight the cell
total GNP per capita of the countries listed?
you want the results in. Type an equal sign ( ) and
then build the formula, step by step. If you type
the formula B4 B5 B6 in cell B7, the values in
these cells are added together and the sum shows
up in cell B7.
• To use division, the formula would look like this: Use a spreadsheet to enter your test scores and
your homework grades. At the end of the grading
A5/C2. This divides A5 by C2. An asterisk (*)
period, input the correct formula and the spread-
sheet will calculate your average grade.
GDP and Changes in the
Price Level
Main Idea Key Terms
GDP is calculated at existing prices and adjusted for inflation, price index, base year, market basket, consumer
inflation to make comparisons over time. price index, producer price index, implicit GDP, price
deflator, current GDP, real GDP, GDP in constant dollars
Reading Strategy
Graphic Organizer As you read the section, complete
After studying this section, you will be able to:
a graphic organizer similar to the one below by
1. Explain how a price index is constructed.
explaining the ways in which these economic
2. Describe three price indices.
measures differ from one another.
3. Understand the difference between real and
current GDP.
Applying Economic Concepts
Market Basket Read to find out how economists use
the market basket, consisting of items most frequently
purchased by consumers, to construct the consumer
price index.

Cover Stor y
ost people are surprised to discover how
hard the government works to collect
and process data. The scene described
Eyes on the Price in the cover story dealing with gathering informa-
tion on inflation is just one such example.
Trenton, N.J.”The hos- Inflation is a rise in the general price level. It is
pital™s finance director important to track inflation because it distorts the
relentlessly unhelpful,
economic statistics that we keep. To see how this
she is still no match
t BLS keeps tabs happens, compare the GDP in Figure 13.1 with
bina Bloom, governmen
the GDP in Figure 13.4. Assume that the second
gumshoe. me
ow the exact prices of so
Mrs. Bloom wants to kn table was compiled one year after the first, and
™s changed,” the woman
spital services. “Nothing that the inflation rate during that year was 10 per-
ho e
r?” Mrs. Bloom asks. “W
ell, do you have the ledge cent. The second and third columns in each table
“W rs.
s,” the woman insists. M
ven™t changed any price show that the product composition and quantity
ha hind
ies the woman from be
oom™s fast talk finally pr
Bl that a of output was the same for both years. In other
e numbers. It turns out
her desk, and she gets th 53.80 words, there was no real change in the amount of
very room now costs $7
semi-private surgery reco goods and services produced.
s than a month ago.
a day”or four cents les ,
success for Mrs. Bloom The fourth and fifth columns in each table,
Chalk up another small oy-
of Labor Statistics empl however, do not match. Looking at columns 4
one of about 300 Bureau the
rmation that is fed into and 5, you™ll notice that everything costs more in
ees who gather the info
monthly Consumer Price the second table than in the first one. This makes
l, January 1, 1997 GDP rise by 10 percent, or $900 billion, revealing
”The Wall Street Journa

Figure 13.4

Estimating Gross Domestic Product
Quantity Price Dollar Value
Product (millions) (per 1 unit) (millions)

Automobiles 6 $22,000 $132,000
Replacement Tires 10 $70 $700
Shoes 55 $55 $3,025
¦* ¦* ¦* ¦*

Haircuts 150 $10 $1,500
Income Tax Filings 30 $160 $4,800
Legal Advice 45 $220 $9,900
¦* ¦* ¦* ¦*

Single Family 3 $80,000 $240,000
Multifamily 5 $330,000 $1,650,000
Commercial 1 $1,100,000 $1,100,000
¦* ¦* ¦* ¦*

Total Gross Domestic Product = $9.9 trillion
*¦ other goods, services, and structures

Using Tables Inflation can distort the value of Gross Domestic Product from one year to the next.
Compare the total gross domestic product in this chart to that in Figure 13.1. What accounts for
the higher total?

the effects of inflation. The problem is that the dol- Second, select the market basket”a representa-
lar value of the final output appeared to go up tive selection of commonly purchased goods and
without any changes in the quantity of goods and services. Then, record the price of each item in the
services produced. market basket. Finally, total the prices. The total
represents the base-year market basket price and is
assigned a value of 100 percent.
Constructing a Price Index Figure 13.5 shows a price index for a representa-
tive market basket with a large number of items.
To remove the distortions of inflation, econ-
Because 1982“84 is used as the base period, the
omists construct a price index”a statistical
prices in the base-year column are lower than those
series that can be used to measure changes in prices
today. The total of the market prices”$1,792.00”is
over time. A price index can be compiled for a spe-
assigned a value of 100 percent, which is the index
cific product or for a range of items.
number for that year.
It is fairly easy to construct a price index. First,
In order to track inflation, we have to track the
select a base year”a year that serves as the basis of
price of the goods and services in the market basket
comparison for all other years. The price index
at regular intervals, and then compare them to the
expresses the price of goods and services in a given
base year. In Figure 13.5 for example, the cost of the
year as a percentage of the price of those goods dur-
market basket in 1998 is $2,920.96”or 163 percent
ing the base year.

higher than in the base year. By May of 1999, prices to their 1982“84 base-year prices. Some of the
had increased to 166.2 percent of base-year prices. items are surveyed in all the areas, while others are
sampled in only a few.
Information on consumer price changes is col-
Major Price Indices lected by Bureau of Labor Statistics employees, as
described in the cover story on page 350. The BLS
Price indices can be constructed for a number
compiles the index monthly and then publishes it
of different purposes. Some measure changes
for the economy as a whole. There also are separate
in the price of a single item. Some measure the price
indices for 28 selected areas across the nation.
changes of imported goods, while others do the
same for agricultural products. Different base years
are often used for each, but this is not important Producer Price Index
since index numbers for an individual series are only
The producer price index measures price changes
compared with other numbers in the same series.
paid by domestic producers for their inputs. It is
based on a sample of about 3,000 commodities and
Consumer Price Index uses 1982 as the base year. The Bureau of Labor
The consumer price index (CPI) reports on Statistics reports the producer price index every
price changes for about 90,000 items in 364 cate- month. Although it is compiled for all commodities,
gories. Prices for the goods and services currently it also is broken down into various subcategories
sampled are taken from 85 geographically distrib- that include farm products, fuels, chemicals, rubber,
uted areas around the country and are compared pulp and paper, and processed foods.

Figure 13.5

Constructing the Consumer Price Index
Price Price Price
Base Period Second Period May
Item Description (1982“ 84) (1998) (1999)
1. Toothpaste (7 oz.) $1.40 $1.49 $2.25
2. Milk (1 gal.) 1.29 1.29 1.79
3. Peanut butter (2 lb. jar) 2.50 2.65 3.73
4. Light bulb (60 watt) .45 .48 .65
..... ...... ..... ..... .....
364. Automobile engine tune-up 40.00 42.00 64.75
Total Cost of Market Basket: $1,792.00 $2,920.96 $2,978.30
Index Number: 100% 163.0% 166.2%

Using Tables The Bureau of Labor Statistics measures items in terms
of their 1982“84 base-period prices. As time goes by, prices change,
giving the new market basket a different total value. How is the new
price index computed? Visit epp.glencoe.com and click on
Textbook Updates”Chapter 13 for
an update of the data.

World Real GDP, Annual Percent Change

Average, 1970“1996

1970 1975 1980 1985 1990 1995 2000
Source: International Monetary Fund projections

Critical Thinking
WORLD OUTPUT 1. Sequencing Information In what year did
Real GDP is gross domestic product after adjust- real GDP growth show its greatest
ments for inflation. The expansion of real GDP is
expected to continue the above trend after the 2. Making Comparisons Compare the growth
year 2000. rates of the 1980s with those of the 1990s.
Which decade showed more consistent

Implicit GDP Price Deflator have been if prices had not changed from what
they were in the base year.
The implicit GDP price deflator is an index of
average levels of prices for all goods and services in
the economy. It is computed quarterly and has a Converting GDP to Real Dollars
base year of 1992.
How would you convert current GDP to GDP in
Because GDP is a measure of the final output of
real (inflation-adjusted) dollars? First, divide the
goods and services and covers thousands of items
current GDP by the deflator, then multiply by 100
instead of hundreds, many economists believe it is
(since the deflator is really a percent). Or:
a good, long-run indicator of the price changes that
consumers face. The deflator is only compiled GDP in current dollars
Real GDP 100
quarterly, however, so it cannot be used to measure implicit GDP price deflator
monthly changes in inflation.
To illustrate, the GDP estimate for the first quar-
ter of 1999 was $8,799.7 billion. The GDP deflator
Real vs. Current GDP for that period was 113.47. In other words, prices in
1999 were 113.47 percent higher than in 1992. To
To compare GDP over time, you need to dis-
calculate, divide current GDP by the deflator and
tinguish between changes in GDP because of
multiply by 100:
the effects of inflation and changes in GDP that
represent increases in production and income. $8,799.7 billion
Real GDP 100 $7,755.1 billion
When GDP is not adjusted to remove the effects of 113.47
inflation, it is called current GDP, or simply GDP.
When the distortions of inflation have been The amount of $7,775.1 billion, then, is the dol-
removed, it is called real GDP or GDP in constant lar value of all goods and services produced, if
dollars. This measure reflects what the GDP would measured in 1992 prices.

Comparing GDP in Different Years Inflation
Converting current dollar amounts to real dol-
lars is useful for making comparisons. For example,
the current GDP estimate for the first quarter of
1999 was slightly larger than the $8,681.2 billion
GDP for the fourth quarter of 1998. Was this
increase caused by an actual increase in the quan-
tity of goods and services produced? Or was some
of the increase in GDP caused by inflation?
We can find out by converting the 1998 fourth
quarter GDP to 1992 dollars through the same
procedure described above. The only change is that
we have to use the GDP price deflator for the 1998
fourth quarter:
$8,681.2 billion
Real GDP 100 $7,677.7 billion

In terms of constant 1992 dollars, real GDP in the
last quarter of 1998 amounted to $7,677.7 billion.
Comparing Prices As long as we have infla-
Because the 1999 real or constant dollar GDP
tion, we must be careful when comparing prices
amount of $7,755.1 billion was greater than the 1998
from different eras. How can we compare a
real dollar amount, there was a real increase in GDP price today with a price from an earlier period?
that was not due to inflation.

Checking for Understanding market basket of goods and services that high
school students typically consume, what
1. Main Idea Would there be a difference
would you select?
between the rate of growth in real GDP and
the rate of growth in real GDP per person?
Explain. (Real GDP per person includes
adjustments for changes in the population.)
2. Key Terms Define inflation, price index, base 7. Making Comparisons What do you think a
year, market basket, consumer price index,
typical market basket 20 years ago might
producer price index, implicit GDP price defla-
have included that we do not use today?
tor, current GDP, real GDP, GDP in constant
What do you think a future market basket
might have that we do not include?
3. Explain why a market basket is used when- 8. Making Predictions Suppose you were told
ever a price index is constructed.
that you would earn $60,000 a year in
4. List three major price indices. 2008. Explain why this information would
tell you little about the standard of living
5. Describe the difference between real and
you might enjoy. What other information
current GDP.
would you need to have before you could
Applying Economic Concepts evaluate how well you might live in 2008?
6. Market Basket If you were to construct a
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.


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