Indicators and market structure

Leading indicators

Economists consider certain economic indicators to be leading, predicting where the economy is headed. These are the most common leading indicators utilized by economists:

• 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

All of these items have a history of predicting changes in the economy. The S&P 500, for example, began experiencing accelerating declines towards 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 wasn’t a significant economic problem until mid-2008. That’s why some economists refer to the S&P 500 as a six-month future (leading) economic predictor.

The forecasting nature of some indicators should be intuitive. Average weekly initial claims for unemployment detail the number of people just losing their jobs. Once unemployed, people tend to spend less on goods and services (until they’re re-employed). When a mass of people reports unemployment at once, it’s likely to lead to quick GDP declines. The same concept applies to indicators involving new goods orders or building permits.

The consumer confidence index measures people’s general optimism regarding the economy. The more confident the average consumer is, the more likely they’ll spend their money (and vice versa).

The interest rate spread between the 10-year Treasury note and the federal funds rate is a good predictor of economic declines. In particular, when Treasury note interest rates fall below the federal funds rate, it indicates an upcoming recession. Don’t worry too much about interpreting this indicator; test questions typically focus on the fact that it’s a leading indicator (and not much else).

Coincident indicators

A coincident indicator provides some insight into 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

Don’t put too much effort into knowing what these indicators cover. Test questions typically focus on how they inform us about the current economic strength.

Lagging indicators

A lagging indicator provides insight into 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 - just know which is leading, coincident, and lagging. Test writers are known to pick on similar topics (e.g., the various ways to measure unemployment) to determine if you understand the differences.

Economic market structures

Economic market structures can have a significant impact on the dynamics of an economy. These structures can exist in a particular part of the economy (e.g., in the pharmaceutical sector) or across the entire economy. You may encounter some test questions on the basics of these four structures:

• Perfect competition
• Monopolistic competition
• Oligopoly
• Monopoly

Perfect competition
This market structure involves many buyers and sellers of virtually identical products. No “big” players dominate the market with the power to influence prices upward or downward. A typical example is a farmer’s market. The vendors offer the same products (e.g., fruits and vegetables), and their prices are the primary factor determining demand (the farmer with the cheapest goods gets the most business).

Monopolistic competition
Like perfect competition, a monopolistic competition structure involves many buyers and sellers. However, the products in the market have unique characteristics, although they are mostly similar. For example, think about the last time you strolled down the chips aisle at your grocery store. You probably could find Doritos, Lays, Ruffles, Sun Chips, etc. Consumers tend to have preferences for specific products within this market structure. Price manipulation (e.g., one vendor driving prices of all chips up or down) is challenging due to the large number of products or services available.

Oligopoly
An oligopoly market structure involves many buyers but a limited amount of sellers (typically 3-5). The limited number of vendors is generally due to a considerable market entry cost. The airline industry is a good example. American, Southwest, Delta, and United Airlines represent roughly 70% of the industry. Imagine how difficult and costly it is to start an airline business to compete with the four major carriers. Because of the limited number of vendors, price manipulation (of their goods and services) is easier.

Monopoly
Monopolies involve many different buyers, but only one seller dominates the market. While government regulations are in place to prevent monopolies, some still exist. For example, utility companies typically maintain monopolies in their local areas. In most cities, people obtain electricity from only one company or government-sponsored organization. Price manipulation is very easy because monopolies have no competition; this is why the utility sector is highly regulated.