South-Western College Publishing - Economics  
GDP is Up, But...
Subject Economic Fluctuations and Growth
Topic Productivity and Growth
Key Words Gross Domestic Product, Corporate Profits
News Story

Gross Domestic Product increased by 6 percent in the fourth quarter of 1998. This growth is impressive given that the economy is in an eight-year old expansion. Not everything is rosy however. After-tax corporate profits fell 1 percent from the previous quarter and, for 1998, profits have fallen 2.2 percent. The contrast between surging sales and lagging profits raises questions about the continued strength of the economy.

Profits are still at respectable levels especially compared with the levels of the 1980s expansion. However, profits in 1996 and 1997 were increasing by approximately 10 percent per year.

The decrease in the profit rate is not attributable to rising costs. The low levels of commodity prices and energy as well as low interest rates have generated considerable savings for corporations. Significant productivity increases have offset last year's increase in wages. The squeeze on profits is supposedly the result of competitive forces that are preventing firms from raising or even holding prices. Average prices charged by nonfinanical corporations actually fell last year.

The weakness in overseas economies has generated lots of idle capacity in foreign countries. In order to keep these factories operating, overseas firms have slashed prices. American manufacturers must match price decreases in order to stay competitive. Some overseas idle capacity may be causing domestic problems. Factory orders fell by 2.5 percent in February, the biggest monthly drop in four years.

Asian and European economies are still weak and this weakness will continue to hold earnings down. Adding to profit woes is the likelihood that costs will increase. Energy prices have already reversed direction and the tightness in the labor market will put continued upward pressure on wages.

(Updated May 1, 1999)

Questions
1. What are the four phases of the business cycle?
2. What happens to aggregate production over the business cycle?
3. What happens to employment over the business cycle?
4. How do profits typically behave over the business cycle?
5. What are some reasons given in the article for the decline in profits?
Source Sylvia Nasar, "G.D.P. Growth Fails to Carry Profits With It", The New York Times, April 1, 1999.

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