Definition

“Major Economic Indicators” are numbers that you can look at to try to get a picture of how well the economy is doing. Different indicators measure different parts of the economy, but their main characteristic is that they measure the same thing in the same way over time. This means that you can compare the indicators from one month, quarter, or year to each other to see if the statistic you’re interested in as improved for declined over time.

Major Economic Indicators Measuring Output

Gross Domestic Product – GDP

Gross Domestic Product, or GDP, is the measure of how many finished goods and services were produced in a country over the course of a year. This is the biggest estimator of how the economy as a whole is doing – the total value of everything that was produced, ready for consumption.

The fact that it only measures finished products is important – this means that goods that are produced to be added to a different product later are not counted. An example of this is raw steel that is later used to build a car is not counted as part of GDP, but the car itself is.

Purchase Power Parity – PPP

If you want to compare the GDP between countries, just taking the GDP from each country and multiplying by the exchange rate will not give the full picture. In Russia right now, a Big Mac costs 114 Rubles, which is only $1.53, or about 1/3 the US price ($4). To get a true measure of GDP, we want to measure the value of production “Apples to Apples”, meaning a Big Mac produced in the United States should be counting as the same value as a Big Mac produced in Russia. The Purchase Power Parity measure of GDP tries to do this, and the Big Mac Index used by the Economist is a simple example.

GDP measured with PPP says that the Big Mac produced in the USA and Russia are both worth the same amount ($4 US Dollars).

Per Capita GDP

Even when we take the GDP at PPP, we still are not really comparing how much “stronger” one economy is compared to others. An example of this is comparing the United States to China – the United States had $16,770,000,000 in GDP in 2013, while China had a GDP (PPP) of $9,240,000,000. However, this does not mean that American workers were producing 1.8 times that of Chinese workers, since this does not account for population.

Per Capita GDP is just that – dividing the GDP at PPP by a country’s population. The Per Capita GDP of the United States in 2013 was $53,041.89, while the Per Capita GDP (PPP) of China was $6,807.43 – meaning for each person in the country, the United States was producing 7.79 times as much!

Gross Output – GO

Gross Output is a new measure – just started to be taken in 2005 in the United States, that instead measures the total industrial output, including the “middle stages” of production (the raw steel and the car are both counted).

Gross Output is an important secondary measure, like the other side of GDP. One way to think about it is that GO measures the “Make” economy, while GDP measures the “Use” economy – you should look at both to get a complete picture.

This major economic indicator is fairly new, which means it is not accurately measured in most other countries yet, so it is less common to see PPP or Per Capita numbers of Gross Output.

Major Economic Indicators Measuring Prices

Inflation is the process where money is worth “less” over time. With the same Big Mac example, the sandwich costs $4 today, but was $2.32 in 1995. When we want to compare GDP, incomes, or prices across time periods, we need to control for the differences in prices and inflation.

Consumer Price Index (CPI)

The Consumer Price Index, or CPI, is the most common measurement of inflation in the United States. CPI tries to measure how much prices for the same goods is changing over time. This is done by using a “market basket” of goods – a long list of things that researchers go out and find the prices for every year, and then take the average change. For example, the cost of bread might go up by $0.05, but the cost of a flat screen TV goes down by $50. CPI researchers use a complex system to balance out price changes by how much of each item a “typical household” buys in a year, and the result is what is considered the inflation rate.

This works well when comparing prices from one year to the next, but some problems come up when comparing years that are far apart, because the “market basket” might not be changing even though what people are actually buying does. To fix this, researchers ask 14,000 families every 10 years to keep detailed records of everything they buy for 3 months. It then uses these purchases as the basis for a new “market basket”.

Producer Price Index (PPI)

The Producer Price Index, or PPI, is the other side to CPI, how the prices are changing for producers. Like CPI, PPI measures a “basket” of goods used in production. These measures are things like coal and scrap iron, as well as other intermediate goods. For example, the cost that a tire company charges a car manufacturer for a bulk order of tires could be part of the Producer Price Index.

Since the “intermediate” goods are all wholesale, or from one manufacturer to another, the PPI used to be called the “Wholesale Index”. The PPI also has a problem with its measurement – because the economy is constantly evolving, the intermediate goods that are part of the measurement are also always changing, but these changes might not be reflected in the PPI measurement.

Employment Cost Index (ECI)

The ECI tries to measure how much the cost of labor moves over time. This measures the pay for all employees in the United States, along with other compensation costs (like health insurance and pension plans). Measuring how the ECI moves compared to the CPI can give some indication if workers are getting “richer” or “poorer”.

Major Economic Indicators Measuring Labor

Measuring jobs is important – everyone’s eyes are always on the unemployment rates and how many jobs are created every year. However, it is important to remember what exactly these rates are so you know how to interpret them.

Unemployment Rate

The unemployment rate measures the total percentage of the active workforce that currently doesn’t have a job. This might sound simple, but it can be fairly complicated.

For example, the “Active Workforce” is anyone between the ages of 16 and 65 who is either working and is actively looking for a job, which is measured by a survey asking people how many hours they looked for a job in the last week. This means if someone does not have a job, but was visiting family last week, they are not counted as “unemployed”. This also means that workers who have temporarily given up looking for a job because they have been looking for so long without any luck are also not counted as “unemployed (these people are called “discouraged workers”). Anyone over 65 who still is looking for a job is also not counted. These last three groups together are called “marginally attached”.

Another important factor is that if you have a job, but you’re looking for a new one, you are not counted either. This means that if you can find a part-time job working for 3 hours a week, you are not counted as unemployed (you are counted as “working part time for economic reasons”). When you add “marginally attached” and “working part time for economic reasons”, the group of people looking for a job can double:

Payroll Employment

Payroll Employment measures how many people are working on salary, plus how the average amount of hours the average hourly employee is working. The movement in payroll employment tells us how many jobs have been created. This is important because when the economy starts to improve, many “marginally attached” workers will re-join the “active workforce”, which means the unemployment rate can go up even if more jobs are being created. Looking at payroll employment, and comparing it with the unemployment rate, can give a much stronger picture of how the labor market is moving.

Productivity

“Productivity” is a major economic indicator that measures how much each worker is producing. As workers produce more, they become more valuable. However, when a company suddenly lays off many workers, this can also increase productivity. The reason is that the remaining workers might be working harder because they are afraid to lose their jobs, or because the people who are laid off are usually the least productive (the employees that companies can “afford to lose” the most).

This means that a spike in productivity during a recession is probably a bad sign (the graph on the right show a huge boost in 2009 and 2010, when workers were being laid off in the recession), but a spike in productivity during an expansion is a sign that the economy is growing strongly.

Getting Data On Major Economic Indicators

These are the best places to get data on these indicators:

St. Louis Federal Reserve Bank Economic Research Center (http://research.stlouisfed.org) – Interactive graphs for thousands of data series, you can build your own charts from nearly any set of economic data you want! All data series is also exportable to excel.

US Department of Commerce Bureau of Economic Analysis (BEA) (http://www.bea.gov) – The research organization that builds GDP and production data for the United States, some interactive tables but most data is for export to excel.

Department of Labor Bureau of Labor Statistics (BLS) (http://www.bls.gov) – Research organization that gathers price and employment data for the United States, many quick tables and data you can export to excel.

World Bank Open Data (http://data.worldbank.org) – Excellent resource for getting major economic indicators from nearly every country around the world. This has less diverse data for the US than the other two sources, but is great for general indicators.

The Economist’s Big Mac Index (http://www.economist.com/content/big-mac-index) – This is a great tool to get a rough estimation on Purchase Power Parity across hundreds of countries around the world, and shows currency exchange rates in comparison, with an interactive map.

The stock market determines prices by constantly-shifting movements in the supply and demand for stocks. The price and quantity where supply are equal is called Market Equilibrium, and one major role of stock exchanges is to help facilitate this balance. We can use the stock market to give some great supply and demand examples with buyers and sellers who want different prices.

Supply of Stock

Supply refers to the total number of stock holders who would be willing to sell their shares at any price. For example, lets say we have 10 shareholders, each of which would be willing to sell their share at a certain price:

All these sellers value their share differently. The shareholders on the left would be willing to take a much lower price for their shares than the sellers on the right. If we look at the whole market for shares, as the price goes up, the total number of shares supplied also goes up.

At a market price of $10, only 1 share will be supplied, but at a price of $25, 5 shares would be supplied.

Click Here for our full article on Supply

Demand For Stock

Demand refers to the total amount of stock potential buyers would be willing to buy at any price. We can use a similar example to the one above. Imagine we have 10 people who want to buy 1 share each, but are only willing to pay a certain price:

Unlike supply, this means that as the price goes up, fewer people are willing to buy a share. For example, if the price per share was $30, only 4 people would be willing to buy (the 4 on the right side who would be willing to pay $30 or more). If we look at the total demand as a graph, it slopes downwards:

Click Here for our full article on Demand

Market Equilibrium

Market Equilibrium is the point where the supply and demand meet. All the potential buyers and sellers trade until there is no-one left who agrees on a price. In a graph, you can see the equilibrium point as where the supply and demand meet.

With our example of buyers and sellers, we can see the exact point where the market reaches equilibrium.

At a price of $27 (actually anywhere between $25.50 and $27.50) and a quantity of 5, the supply equals demand and the market is balanced. From a practical standpoint, these are the buyers and sellers who made a trade.

The buyers who wanted the stock the most, and the sellers who were the most eager to get rid of it, made their trade. For the other buyers, no seller was willing to sell their stock low enough for them to want to buy.

The next-lowest seller wants $28 for their stock, but the next-highest buyer will only pay $25, so no more trades will happen.

Efficient Equilibrium

This example makes sense, but why didn’t we have 8 trades instead of 5? If all the highest and lowest buyers and sellers were linked directly, a lot more trades could take place.

Unfortunately, there are some big problems with this. The biggest problem is information. The lowest seller, who sold for somewhere between $10 and $12, can now see that someone else just sold their share for over $35. All the sellers would only try to sell to the highest buyers, and all the buyers would only try to buy from the lowest sellers.

Producer, Consumer, and Total Surplus

If the potential buyer who is willing to pay $38 wants to make a good deal, they will first try to buy from the person who only wants $10. This way they start with an extra value of $28 – the difference between how much they were willing to pay and how much they actually had to pay. We call this bonus the Consumer Surplus:

Consumer Surplus = Highest Price a buyer is willing to pay – Price they actually pay

On the other side, the sellers want to make the most profit they can, so the seller who would take $10 at the minimum would much rather sell to the high buyer for $38, making themselves an extra $28. We call this bonus the Producer Surplus:

Producer Surplus = Price a seller actually sells an item for – Lowest price they would sell for

However, we can’t have it both ways. Since the buyer and seller both don’t want to lose out, there will be negotiations and the final sale price will fall somewhere in the middle. In a good system, we will get the maximum amount of these bonuses as possible – we want the biggest Total Surplus. We call the pricing and trading system that gives the most total surplus “efficient.“

Total Surplus = Consumer Surplus + Producer Surplus

Lets compare the two trading systems – the one where the most number of trades happen (but every trade has a different price) with the one where supply and demand are equal at one price. We will assume that the buyers and sellers in the first system are paying the average of their two prices, and splitting the surplus evenly.

Now let’s compare this to the system where everyone is trading at the same price:

The total surplus under this system is $73 – nearly 3 times as high!

Supply And Demand Examples – Making Trades For The Most Surplus

This might be good for the people who made their trades, but it’s also important to see how these prices are found in the first place.

Think of it like all the buyers and sellers are making limit orders. Where sellers are setting a limit sell order at their prices, and the buyers are setting limit buy orders at their prices.

In the example with the most trades taking place, the stock exchange is taking all the lowest limit buy orders and pairing them with the lowest limit sell orders to make the most trades happen. However, this system can never be fully fair to all the buyers and sellers. Look at the image showing who made their trades in this system. The buyer who would have been willing to pay $14 doesn’t get to buy anything, but the buyer who was willing to pay $12 did. The seller would obviously rather sell to the person offering $14 than the person offering $12 too.

This means that for both one buyer and one seller, a better trade could be made, increasing the Total Surplus, so these buyers and sellers would be better off making their deal outside the stock exchange entirely so they can get a better deal.

However, lets go back to our $38 buyer and our $10 seller.

Both of these would also be better off making a deal with each other outside the stock exchange, since they could settle at a price between their values and have a huge surplus to split with each other. This will happen again with the $15 seller and $34 buyer where they are both making a bigger surplus by trading with each other and abandoning their limit prices entirely. Since the highest buyers and the lowest sellers are pairing off to make their own deals, the lower buyers and the higher sellers no longer have a partner willing to take their price. We arrive back to the same supply and demand system where all the trading is done at around the same price as we had for our equilibrium, and with the same Total Surplus.

Supply And Demand Examples – Bid And Ask Prices

This creates a system of Bidders and Askers. When you get a quote on HowTheMarketWorks, you’re seeing the most the highest buyer is willing to pay as the Bid Price, and the least a seller is willing to sell for as the Ask Price.

This is an example of a quote for Amazon (AMZN). There are three prices shown: the Bid Price, the Ask Price, and the Last Price, and this is the exact situation we have already seen with our buyers and sellers above!

The Last Price tells us what happened the last time a buyer and seller agreed on a price. They traded at $25.70.

The Ask Price tells us how much the next-lowest seller wants for their share. He wants at least $28.00.

The Bid Price tells us how much the next-highest buyer would be willing to pay for a share. He will pay up to $25.00.

This also impacts you when trading. If you’re trying to buy stock with a Market Order, you will get the Ask Price, or how much the current sellers want for their stock. If you try to sell with a Market Order, you will get the Bid Price, or how much current buyers would be willing to pay for your shares.

Comparing Economic Systems

There are many different economic systems that try to result in more equality or faster growth. The structure of a country’s economy has a lot to do with the country’s politics and the values of its population. However, the economy of every country also changes over time, and how it falls between these broad categories will often change with it.

Market Economies

“Market Economies” are economic systems where production is determined by a system of prices and profits. This is also called the laws of Supply and Demand. These economies are subject to relatively little direct control by a government or economic planner, allowing people and businesses to try to distribute resources to maximize wealth. Market economies also have a certain level of income inequality. This is partially because profit is a large motivator behind how resources are allocated, higher profits and higher income usually result in higher income compared to everyone else.

Capitalism

Capitalism is a type of Market Economic System. Under a pure capitalist economy, there is little or no direct government regulation of the economies. Instead, the economy is regulated by the “invisible hand” of the markets. Companies that are inefficient or unpopular simply lose business to their competition. This should give companies incentive to always innovate. This also applies to the environment and business practices. If consumers do not like companies that heavily pollute or engage in worker exploitation, they will take their business to other companies. In contrast, companies that put emphasis on environmental stability would attract the business of consumers who value the environment. This also applies to prices. Companies with high prices will quickly lose business to companies with lower prices. The balance between prices and values (worker exploitation, the environment) should then reflect the population’s values as a whole.

The labor market is also dictated by the market. This means that workers get hired and are paid both according to their productivity. Their “replacement cost”, or how many other workers the firm can hire who are just as productive, is also a major factor. This gives incentives to workers to obtain new skills and renegotiate their salaries as they become more productive.

Criticisms of Capitalism

There are many movements emphasizing the problems with the capitalist economic system. One major problem is how the economy copes with large monopolies, or companies that are able to put all of their competition out of business. If a company has a monopoly, customers are not able to switch to a competitor if they do not like the company’s business practices. It also removes much of the incentive to keep prices low and to innovate.

This economic system can also be difficult for workers. If a worker starts with low skills, it can be very hard to save the time and money to build new skills to increase their income. This means that low-skill workers can be trapped with no way to increase their skills. This leads to greater income inequality as the rich can get richer because they have the means to do so. At the same time, more and more workers with low skills means that their “replacement cost” is very low, pushing wages farther down.

Market Socialism

“Socialism” is not a clear economic system itself, but “Market Socialism” is a form of a Market Economy that places emphasis on equality. The main characteristic is that the “means of production”, meaning factories, farms, and resources, are at least partially “collective”, meaning everyone in the economy gets some part of the ownership. However, people still decide what kind of business they want to start, and companies still decide their levels of production and what exactly to produce.

This economic system sometimes says that the profits of a company should be shared with all the members of a society, instead of just investors. Instead, all revenue that is more than costs is distributed between everyone in the economy (called a “Social Dividend”). Under the current economic system in the United States, profits are either directly re-invested in companies, or distributed to the company’s stock holders as dividends. Other times the profit is instead distributed only to the workers in the factory which earned the profit, giving workers and managers a bigger incentive to work harder and continue to innovate. In both cases, there is an incentive to earn more profits, either for the sake of everyone in the economy or just for the workers who are earning them.

Workers in Market Socialism are paid only according to their productivity, and not their replacement cost. As part of the “Social Dividend”, workers are given some degree of ability to build new skills (sometimes including free education).

Criticisms of Market Socialism

The biggest problems with this economic system are practical. Some overseeing agency needs to be responsible to distribute the social dividend, which has a high chance of being corrupted or playing favorites. There is also a huge disagreement about how it should be distributed between the population (see: the socialist calculation debate). It is difficult to decide how much of the “profits” should be re-invested in growth and how much should be distributed back to all the workers. In a pure capitalist economic system this is determined by the “invisible hand” – companies that re-invest more generally grow more, but it does not apply in a socialist system.

There is another problem with full employment. Since workers are paid according to their production only, with no consideration of replacement cost, each worker costs more in a socialist system than a capitalist system. This means for the same production, fewer people have jobs and unemployment is higher. This also means that the profits for the same level of production will be smaller, which means less is available for re-investment. While the lowest-skilled workers will certainly be better off in a Market Socialism economic system than a pure Capitalist economic system, it is not clear if the lower re-investment and lower profits would make middle-income workers better or worse off. It is clear, however, that fewer people would be working in total, and people who are not working but are still earning a “social dividend” are not as beneficial to the economy as people who are working and producing.

Market Economies In The World

In the real world, most countries are some form of market economy (especially in North America and Europe). However, none is a full “capitalist” economic system or fully “Market Socialist”. Instead, all countries fall somewhere in the middle.

This means that even countries that call themselves “capitalist” do have controls to prevent monopolies from getting too powerful. They also do put taxes on profits and people with high incomes to pay for social programs, like unemployment benefits, universities, and environmental protection, which is a form of the “social dividend”. However, they also allow people and companies to keep profits to use as they want, and allow some level of income inequality. The balance between “capitalism” and “market socialism” does vary between countries, with some countries having higher taxes, regulations, and social benefits than others.

Command Economies

Command Economies describe economic systems where a central planning agency determines what and how much is produced. The planner also determines how much of each resource is allocated to each person in the economy. Money and currency generally play very small roles in this type of economic system.

Feudalism

Feudal economic systems describes much of the world before 1800. The primary source of economic activity is farming, with any industrial production limited to Cottage Industry. A feudal system is comprised of an elite class, making up kings, lords, and knights, ruling over a large peasant class who are responsible for farming. The peasant class usually had no rights of their own, and were not permitted to leave the estate of their lord without permission.

Profits are generally very small and are kept by the ruling classes, with re-investment limited only to what is necessary to keep the population alive and working. There may also be a merchant class that lives in cities and engages in trade, but these are the “special” cases and do not comprise a large part of the economy.

All production was determined by the lords and kings, which instructed the peasant class on what to produce. This generally was what kinds of crops to harvest, but also included the instructions to the cottage industry producers on what kind of products to make. This resulted in the most extreme income inequality, with the rich owning everything and the poor left as little more than slaves.

Feudal societies generally do not exist today, apart from some small pockets in extremely under-developed parts of the world.

Communism

Communist economic systems are also known as “non-market socialism”. The factories and materials are “owned” entirely by everyone in the economy. The central planning agency determines how much of each item is produced, and who gets the finished products. For example, the central planning agency would decide how many shoes are produced, and then distribute the shoes to all the people it determines needs them the most.

People are paid a certain amount by the government, and then are allowed to buy only certain types of items. If they want something that they do not have permission to buy, they need to request permission. The central planner then takes the requests and uses them to determine which factories are producing how much of each item. Since the central planner is deciding how much of each item is being produced, they generally also choose what kinds of work people do. In theory, this is based on people’s strengths – strong, healthy workers might be manual laborers, while very smart people would be researchers. People are given a set of jobs to choose from based on what the economy needs the most of at that time.

The strength of Communism is that the central planning agency can try to distribute all resources to obtain absolute peak efficiency, producing what is needed of every item and using any extra resources for development and social benefit. The hope is that with careful planning, there will be less wasting of resources, and instead of profits being distributed, all savings goes directly towards growth. There is also strength in equality – theoretically all people are equal in a communist economic system, and prosper equally with growth.

Criticisms of Communism

Communism is generally not popular in the West because of the high value placed on individual freedoms. In a communist system, people cannot decide what kinds of companies to start, companies cannot choose their levels of investment or production, and people generally cannot decide what they can purchase. Historically, communist economic systems arose out of countries that were previously Feudal, meaning the majority of the population (the peasant class) did not previously have a history of personal freedoms to begin with. This meant that the restrictive nature of the central planning was not a new burden.

Communism is also characterized by shortages of many “popular” goods, and surpluses of “junk”. This happens because people need to ask the central planner to increase production of a good, and it can take months or years before those goods to be produced. Until the new goods are produced, it is in a shortage. If the population wants an improved version, or it has fallen out of style, by the time the goods are produced, it is “junk” by the time it comes out of the factories. This usually leads to large black markets of illegally-traded goods.

In the real world, communist economic societies also have big problems with corruption. Factory managers and workers have a high incentive to try to sell goods on the black market before sending it to the central planner, which can make the “official” shortages worse. Central planners themselves are easily corrupted, since they have the power to distribute more goods to their own friends and family. Individual workers also can have a hard time to find motivation to work harder. In a market socialist economic system, workers can be motivated both by individual profits and by the social dividend. However, in a communist system, the individual profit is removed entirely, and the social dividend does not increase by much with the extra effort of one single worker.

Command Economies In The World

Full command economies are fairly rare in the world today. An example of a purely Communist economic system is North Korea. Other countries, like Cuba, still maintain a central planning agency, but have begun to introduce more elements of market economies.

How Economic Systems Relate To Development

The paths that countries take towards development out of a Feudal-type economy based in agriculture has a lot to do with what type of economic system they use. Generally speaking, feudal economies that experience a gradual increase in strength of the Merchant classes based in cities will develop into Capitalist economies. If power is seized by the Peasant classes, either through revolution or a military coup, the economy has generally started development under Communism.

Countries that develop with capitalist economic systems eventually feel pressures from the people to add protections to prevent exploitation and control the power of monopolies. The United States would have been considered a Capitalist economic system until 1900, when laws began to be passed to limit monopoly power, enforce minimum wages, and protect the environment. These protections have become stronger over time.

By contrast, Cuba, which was a market economy until 1950, underwent a Communist revolution in large part in reaction to the extremely strong control monopolies (like the United Fruit Company).