Indicators and market structure
Leading indicators
Economists classify some economic indicators as leading because they tend to change before the overall economy changes. In other words, they help predict where the economy may be headed. The most common leading indicators include:
- S&P 500 level
- Average weekly initial claims for unemployment
- Index of new manufacturing orders
- Number of new building permits
- Consumer confidence index
- Interest rate spread between 10 year Treasury notes and fed funds rate
Each of these indicators has a track record of moving ahead of broader economic shifts. For example, the S&P 500 began accelerating downward toward the end of the summer of 2007. According to the US National Bureau of Economic Research, the Great Recession didn’t begin until December 2007 and didn’t become a major economic problem until mid-2008. That’s why some economists describe the S&P 500 as roughly a six-month future (leading) economic predictor.
Some leading indicators are straightforward once you connect them to spending and production. Average weekly initial claims for unemployment measure how many people are newly losing their jobs. After someone becomes unemployed, they typically reduce spending on goods and services (at least until they’re re-employed). If many people file for unemployment at once, consumer spending can drop quickly, which can lead to GDP declines. The same basic idea applies to indicators tied to new orders and building permits: when businesses and households pull back on new purchases and new construction, overall economic activity often slows soon after.
The consumer confidence index measures how optimistic people feel about the economy. Higher confidence tends to be associated with more consumer spending, while lower confidence often signals reduced spending.
The interest rate spread between the 10-year Treasury note and the federal funds rate is also used to anticipate economic declines. In particular, when Treasury note interest rates fall below the federal funds rate, it can signal an upcoming recession. You don’t need to spend much time interpreting this spread in detail; test questions typically emphasize that it’s a leading indicator.
Coincident indicators
A coincident indicator helps describe the economy’s current strength. They include:
- Number of employees on non-farm payrolls
- Average hours worked
- Personal income levels
- Industrial production levels
- Manufacturing sales
- Unemployment rate
For exam purposes, the key point is what coincident indicators do: they help you gauge how strong the economy is right now.
Lagging indicators
A lagging indicator reflects the economy’s past performance. The most commonly cited lagging indicators include:
- Changes in CPI levels
- Corporate profits
- Change in labor cost per unit of output
- Average duration of unemployment*
*Keep in mind the differences between initial unemployment claims (a leading indicator), the unemployment rate (a coincident indicator), and the average duration of unemployment (a lagging indicator). Don’t worry too much about analyzing them - focus on which measure is leading, coincident, and lagging. Test writers often use similar topics (like different ways to measure unemployment) to check whether you understand these distinctions.
Balance of trade
A country’s balance of trade compares the value of everything it exports with the value of everything it imports over a period of time. It’s a separate measure from the leading, coincident, and lagging indicators above - don’t try to place it in one of those three lists.
For example, assume a country exports $450 billion of goods and services in a year and imports $525 billion. Imports were larger, so it ran a $75 billion trade deficit that year. If those figures were reversed, it would have run a $75 billion trade surplus.
For the exam, focus on the direction of the gap: imports greater than exports is a deficit, exports greater than imports is a surplus.
Currency exchange rates and the trade balance
A country’s currency exchange rate - how much its currency is worth relative to other currencies - also moves the trade balance, because it changes how expensive that country’s goods look to foreign buyers and how expensive foreign goods look to domestic buyers.
When a country’s currency depreciates (weakens against other currencies), its exports become cheaper for foreign buyers and its imports become more expensive for domestic buyers. Foreign demand for that country’s goods tends to rise, and domestic demand for foreign goods tends to fall - exports increase and imports decrease, which improves the trade balance (a deficit shrinks or a surplus grows).
When a country’s currency appreciates (strengthens against other currencies), the opposite happens: its exports become more expensive for foreign buyers and its imports become cheaper for domestic buyers. Exports decrease and imports increase, which worsens the trade balance (a deficit grows or a surplus shrinks).
Economic market structures
Economic market structures can significantly affect how prices are set and how firms compete. A structure might exist within one part of the economy (for example, pharmaceuticals) or across a broader market. You may see test questions on the basics of these four structures:
- Perfect competition
- Monopolistic competition
- Oligopoly
- Monopoly
Perfect competition
This structure has many buyers and sellers offering virtually identical products. No single participant is large enough to influence prices up or down. A common example is a farmer’s market: multiple vendors sell similar goods (like fruits and vegetables), and price is a major factor in where customers choose to buy.
Monopolistic competition
Like perfect competition, monopolistic competition has many buyers and sellers. The difference is that products are similar but not identical - each has unique characteristics. Think of the chips aisle at a grocery store: Doritos, Lays, Ruffles, Sun Chips, and many others. Consumers often have preferences for specific brands or features. Because there are many competing options, it’s difficult for any one seller to drive overall market prices up or down.
Oligopoly
An oligopoly has many buyers but only a small number of sellers (often 3-5). The limited number of sellers is usually due to high barriers to entry (it’s expensive or difficult to enter the industry). Airlines are a common example: American, Southwest, Delta, and United Airlines represent roughly 70% of the industry. With relatively few sellers, coordinating or influencing prices is easier than in markets with many competitors.
Monopoly
A monopoly has many buyers but one dominant seller. Although regulations aim to prevent monopolies, some still exist. Utility companies are a common example: in many cities, electricity is provided by a single company or government-sponsored organization. With no direct competition, price manipulation is easy, which is why the utility sector is typically heavily regulated.