question

Gross Domestic Product

answer

the market value of all final goods/services produced in a country during a period of time (generally a year) GDP=P*Q represents output( S) only applies to things that are final sale(inc jobs and production)

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3 things to know about GDP

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does not include consumer surplus reported GDP is annualized and often seasonally adjusted real GDP is the one that counts when assessing well being (removes inflation by holding quantity constant)

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The expenditure approach

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GDP = C + I + G + NX measures what has been produced/what people want to buy

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consumption

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Spending by households Divided among consumption of services, durable goods and non-durable goods.Includes rent for rental homes and apartments AND an imputed rent for owner-occupied homes. Does NOT include purchases of new houses ('Used' houses are NEVER a part of GDP)

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Investment

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Business spending PLUS spending by consumers on NEW houses. Includes Business Fixed Investment, Inventory Investment, and Residential Investment. goods produced but not sold (aka Inventory) are included! Does NOT include 'Investing' in Stocks and Bonds, since these do not involve PRODUCTION

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Government Expenditure

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Spending on Goods and Services (roads, tanks, salaries, etc.) Doesn't include welfare or transfer payments

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Net Exports

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Exports-Imports Can be negative or positive, trade surplus or trade deficit

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Income Approach

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the total amount of income earned by households and firms in a year. 'circular flow' of GDP. Money flows to households and firms (income), who spend that income for goods (expenditures) The major sources of income represent compensation for the factors of production make 2 adjustments add taxes minus subsidies add depreciation

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Nominal GDP

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measures the value of what is produced using current prices and quantities

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Real GDP

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measures the value of what is produced using current quantities and some baseline price. This allows us to remove the effects of inflation when making comparisons inc in quantity = inc real GDP = inc in employment,health

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Real GDP in base year formula

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Real GDP in Year X = PBase Year * QuantityYear X

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Nominal GDP equation

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multiply P*Q and add each item together

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GDP per capita

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GDP/Popultion

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Why is GDP not a good measure of total production?

answer

GDP does not include things like household production or underground economies does not account for the distribution of income (income inequality), consumption of leisure, crime or quality of life issues like a clean environment

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Unemployed

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has not worked for pay within the past week AND has looked for work in the past four weeks.

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Employed

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has worked for pay (at all) within the past week. Includes underemployed

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Out of labor force

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has not looked for work in the past four weeks.

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Unemployment Rate Equation

answer

# Unemployed/ Labor Force times 100

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Labor Force Participation Rate Equation

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labor force/working age population times 100 increased with entrance of women to labor force in 1950s

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Employment to Population Ratio

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# Employed/population times 100

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Labor Force

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employed +unemployed Excludes retirees, stay-at-home parents, full- time students, discouraged workers(marginally attached)

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Working Age Population (Civilian non-institutional population)

answer

Excludes people under 16, in prison, or in the military

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rising unemployment rate

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a leading indicator of recession (before) Cyclical unemployment is pos usually rebounds back to normal after some time workers go from discouraged to unemployed

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falling unemployment rate

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lagging indicator of a recovery (after) gets a little better then worse than better workers go from unemployed to discouraged

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Frictional Unemployment

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Temporary unemployment (less than 12 months) due to reasons other than the business cycle. JOB SEARCH, props with boss, hate job always greater than 0

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Structural Unemployment

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Longer-term unemployment (greater than 12 months) due to reasons other than the business cycle. Seasonal unemployment, innovation, minimum wage, unions, efficiency wages always greater than 0

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Cyclical Unemployment

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Unemployment caused by fluctuations in the business cycle(how econ is doing) jobs created and destroyed, laid off may be pos(slump), neg(boom) or 0

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Total Unemployment

answer

Frictional + Structural + Cyclical

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Natural Unemployment

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Frictional + Structural cyclical = 0

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Economy Boom

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cyclical unemployment will be negative

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Full Employment

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actual employment = natural employment and cyclical unemployment is 0

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Reasons natural unemployment is greater than 0

answer

• Frictional Reasons - Job mismatch, location mismatch, search costs • Structural Reasons - Minimum wage, unions, efficiency wages

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Four policy reasons for unemployment

answer

Minimum Wage, unions and efficiency wages cause a surplus of labor by establishing a wage that is above equilibrium.

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Costs of Unemployment

answer

lost production, income, and human capital

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GDP deflator

answer

measures changes in prices in general

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Consumer Price Index

answer

measures the changes in prices that urban consumers pay for a typical basket of goods and services. The CPI places a greater emphasis on housing and food. The CPI is the primary measure of inflation discussed in class.

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disinflation

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inflation slows but still positive

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Unexpected inflation

answer

f inflation is unpredictable then they will be reluctant to enter into these contracts, thus reducing long-term growth.

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CPI equation

answer

Total Expenditures in Current Year/Total Expenditures in Base Year times 100

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Rate of Inflation

answer

CPI(Period 2)- CPI(Period 1)/ CPI(Period 1) times 100 or the change in CPI over the original CPI

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Real Value (Year X $'s) equation

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Nominal Value in Year Y times (CPI in Year X/CPI in Year Y)

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GDP Value from year to year

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GDP in Year Y times (CPI in Year X/CPI in Year Y)

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Issues with CPI

answer

overstates inflation bc: The Quality Bias The Substitution Bias The New Product Bias The Outlet Bias overinflating govt payments SS benefits

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The Quality Bias

answer

It ignores changes in quality - price increases may simply accompany enhancements and NOT signify 'inflation'.

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The Substitution Bias

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It ignores the law of demand - the quantities in the basket are fixed, even as relative prices change. A remedy for this is the chain-weighted CPI.

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The New Product Bias

answer

The CPI basket is updated only periodically (typically in years that end in '7'), so it fails to include new products that households buy.

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The Outlet Bias

answer

The mechanism for calculating the CPI is biased towards brick-and- mortar establishments. As more transactions occur online, where prices tend to be lower, we will observe greater differences between the CPI and 'true' inflation.

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Nominal Interest Rate

answer

Real Interest Rate + Inflation Rate

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Costs of inflation

answer

Redistribution of Income - contracts cover extended periods. Unexpected inflation changes real income. Redistribution of Wealth - transfers of wealth from savers to borrowers or vice versa due to unexpected inflation. Reduction of Real GDP - Reluctance to enter into long-term contracts leading to reduced investment and real GDP. Resources diverted away from production - Time and money spent managing money rather than production.

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The Business Cycle

answer

Periods of expansion followed by periods of recession. When the expansion reaches its top, it is called a peak. When a recession reaches its bottom, it is called a trough.

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Expansion Phase

answer

GDP inc unemployment dec inflation inc trough to peak

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Contraction Phase

answer

GDP dec unemployment inc inflation dec peak to trough

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time to double equation

answer

70/growth rate

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growth gdp per capita equation

answer

(growth in GDP y - growth in GDP x)/ growth in GDP x

question

Production Function

answer

tells us a countries output (Y) based on inputs - these inputs are broadly classified as capital (K) and labor (L). We can use the production function to explain growth rates. slope of curve = growth rate exhibits diminishing returns(output inc at dec rate) shifts of curve come from inc in tech and edu

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Economic growth occurs when

answer

when firms grow, and firms grow when they use more capital. Firms need a source of money, and the loanable funds model explains where firms get money from to be able to grow.

question

loanable funds model

answer

assumes that people and firms engage in consumption smoothing over time - this means that their consumption and investment varies less than their income. How? By borrowing and saving!

question

Net Investment

answer

Net Investment = Gross Investment - Depreciation represents increases in capital, not just replacing old capital.

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Wealth

answer

wealth is also known as equity - the difference between what you own and what you owe. It measures an amount at a point in time (a stock variable)

question

Saving

answer

he difference between what you earn and what you spend. It measures an amount for a period of time (a flow variable).

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Insolvent

answer

Insolvent means a company's equity (net worth) is negative - they owe more than they own. This will ultimately lead to bankruptcy if not corrected

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Illiquid

answer

Illiquid means the company simply does not have enough cash on hand to pay its bills. An institution can be solvent but illiquid - plenty of assets (such as loans) but not enough cash. This can be corrected by selling assets, borrowing short-term, etc.

question

3 ways firms can raise money

answer

loan- a contractual arrangement between a borrower and a savers bonds- represent debt (interest rate, maturity) but can be bought and sold on an organized market and stocks- represent fractional ownership in a company.

question

four types of financial intermediaries

answer

Commercial Banks - accept deposits from savers and use a portion to make loans to borrowers. Insurance Companies - collect premiums from individuals for things like life, auto and health insurance, and make payments to individuals who suffer a loss. Pension Funds - collect and invest retirement savings for individuals, who receive payments upon retirement. Government-Sponsored Mortgage Companies - The Federal National Mortgage Association (FNMA, or 'Fannie Mae') and the Federal Home Loan Mortgage Company (FHLMC, or 'Freddie Mac') were originated to provide liquidity to the mortgage market.

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Investment (demand for loanable funds equation)

answer

investment = demand line investment stimulates economic growth private savings(S) + public savings (T-G) + international borrowing (M-X) public saving pos = budget surplus, neg = budget deficit

question

Private savings equation

answer

S= Y- C- T

question

Factors that shift loanable funds D curve

answer

INCENTIVE TO INVEST CHANGE Better Incentives => Increases Demand Worse Incentives => Decrease Demand

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Factors that shift loanable funds S curve

answer

Incentive to save changes Better Incentives => Increases Supply Worse Incentives => Decreases Supply govt budget deficits and surpluses: budget deficit it means that public savings are negative. The government has to borrow money to finance the deficit. The result is an increase in the demand for loanable funds Budget Surpluses (POS PUBLIC INCOME ) thus lead to a lower real interest rate and higher quantity of loanable funds and thus are good for economic growth.

question

public savings

answer

=T-G

question

The Ricardo-Barro Effect

answer

This effect posits that people observe budget deficits and respond by saving more (perhaps anticipating future tax increases?). As such, the market could return to equilibrium (initial real interest rate and quantity of loanable funds). In reality, the effect might not exist, and if it does it probably isn't strong enough to get us back to equilibrium. Ignore this effect on the exam unless you are specifically asked about it.

question

Crowding Out Effect

answer

govt borrowing inc real interest rate and quantity of loanable funds inc but firms and households invest less bad for econ growth

question

The Aggregate Expenditure Model

answer

Short-run model Prices and wages are fixed - firms respond to changes in macroeconomic conditions by changing output, not prices and wages. Two goals: 1. Define macroeconomic equilibrium (AE = GDP) or D=S 2. Explain short-run fluctuations in GDP (holds price level and inflation rates constant in short run) 45 line keynesian cross

question

Aggregate Expenditure

answer

AE = C + PI + G + NX C = Consumption PI = Planned Investment G = Government Expenditures NX = Net Exports (= Exports - Imports) represents spending (D)

question

Marginal Propensity to Consume

answer

C= S-Y-T MPC= change in consumption/ change in disposable income(y)

question

Marginal Propensity to Save

answer

S=Y-C-T MPS= change in saving/ change in disposable income(y)

question

Induced Consumption

answer

the amount that your consumption increases (above autonomous consumption) when GDP increases.

question

Autonomous Consumption

answer

the amount of consumption that is independent of GDP SLOPE OF CONSUMPTION DOES NOT HIT ORGIN BC AUTONOMOUS CONSUMPTION AUTOMATIC SPENDING

question

Actual (total) Investment equation

answer

I = PI + UI

question

AE model in equilibrium

answer

GDP(Y)=AE UI=0

question

AE model left of equilibrium

answer

YA < Y* Y < AE UI<0 must dig into inventory

question

AE model right of equilibrium

answer

Y > AE UI > 0

question

MULTIPLIER EQUATION

answer

Multiplier (M) = 1/1-MPC= 1/MPS The change in GDP > change in AE because of the multiplier effect

question

CHANGE IN GDP EQUATION

answer

Δ GDP = Shock * Multiplier MPS

question

AUTONOMOUS EXPENDITURE

answer

It is the vertical distance between the old and new AE line and is equal to the initial shock.

question

shift AE by causing a shift in a component of AE (what causes shocks)

answer

Shocks to consumption: Changes in disposable income (change in taxes, change in pay), changes in household wealth (stock, real estate), changes in expected future income (consumer sentiment), changes in interest rates, Borrowing (borrowing today must eventually be repaid, so lower C today). Shocks to planned investment: (changes a lot with the business cycle): Changes in expected future profits, changes in interest rates, changes in tax policies, changes in retained earnings (not happening today!). Shocks to government purchases: fiscal policy (later) Shocks to net exports: exchange rates (later). When a countries currency depreciates (becomes cheaper) it makes THEIR goods less expensive and the other countries goods relatively more expensive. Exchange rates are a function of differences in inflation and growth rates (among other things) between the two countries.

question

Countercyclical Policy

answer

Countercyclical' means that we will STIMULATE the economy when it is below potential GDP (growing too slowly), and CONTRACT the economy then it is above potential GDP (growing too fast).

question

two tools that policy makers have at their disposal for stimulating or contracting the economy:

answer

Monetary Policy - the FED controls the money supply (and thus Interest Rates). o Lower Interest Rates STIMULATE the economy by increasing Aggregate Expenditures. o Higher Interest Rates CONTRACT the economy by lowering Aggregate Expenditures. • Fiscal Policy - the Federal Government (Congress and the President) can alter tax policies and spending. This is much more of a blunt instrument since it takes much more time to enact Fiscal Policy than Monetary Policy. o Lower Taxes and Increased Spending STIMULATE the economy. o Higher Taxes and Decreased Spending CONTRACT the economy.

question

Aggregate Demand and Aggregate Supply

answer

Two goals: 1. Explain macroeconomic equilibrium (BOTH short-run and long-run) 2. Explain fluctuations in GDP AND PRICE LEVELS Because prices are allowed to fluctuate, the Aggregate Demand and Aggregate Supply model can be used to explain BOTH Short-Run and Long-Run equilibrium. SR EQ= AD+ SRAS LR EQ= ALL 3

question

price level inc or dec in Aggregate Demand and Aggregate Supply model

answer

surprise = movement Change in current price level (unexpected inflation) = movement along Change in anything else causes shift. Increase = shift right, decrease = shift left.

question

Aggregate Demand

answer

Composed of demand from households (here and abroad), firms and government. Downward sloping for three reasons: 1. Wealth Effect - when p decreases, you can buy more. It's like having greater wealth. 2. Interest Rate Effect - if prices go up, you must hold more cash for transactions. Less savings increases interest rate, which reduces consumption and investment. 3. International Trade Effect - As prices rise, US goods become more expensive (and imports become less expensive). Net Exports falls, thus reducing aggregate demand.

question

Shifts of AD:

answer

Anything that shifts AE shifts AD. Examples include government stimulus, consumer sentiment, interest rates. This includes change in expected future prices.

question

Long-Run Aggregate Supply (LRAS)

answer

Does not depend on price level (vertical)! Shifts of LRAS: Changes in capital, labor, technology, education and health. LRAS indicates potential (natural) GDP - resources are fully employed. When actual GDP = Potential GDP, the economy will have the natural rate of unemployment (which, recall, is NOT zero!).

question

Short-Run Aggregate Supply (SRAS)

answer

Upward sloping for two reasons: We assume that the wage the firm pays / the price the firm charges do not change ('sticky'), but other wages/prices do. 1. Sticky wages - when price levels increase more than the expectations built into the current SRAS (but remember, YOUR firm's prices and wages stay the same), the wages you pay have become relatively cheaper. It's like a pay cut since the real wage declines. SRAS increases. 2. Sticky prices - We believe that prices are sticky for two reasons: A. Menu Costs and B. Long-term Contracts. Again, when price levels increase your product has become relatively cheaper. Consumers buy more, so you increase production.

question

Real Wage equation

answer

Real Wage = Nominal Wage/CPI times 100

question

Shift of SRAS:

answer

1. Anything that causes LRAS to shift. If LRAS shifts so does SRAS. 2. Changes in inflation expectations (different from unexpected inflation above). More inflation means decrease SRAS. 3. Change in price of important input (i.e. oil, labor)

question

Static Version of AD/AS Model

answer

Static means we keep LRAS constant.

question

Stagflation

answer

GDP growth is stagnant while prices are rising

question

when is CPI calculated

answer

monthly

question

When unemployment rate is < natural unemployment rate real GDP _____ than potential GDP and output gap is _____

answer

real GDP greater than than potential GDP output gap is positive

question

GDP holds _____ constant

answer

prices

question

CPI holds _____ constant

answer

quantity

question

Growth of real gap per person

answer

growth of real GDP minus growth of population

question

Depreciation formula

answer

Value of product already owned (10 tow trucks valued at 750,000) minus ( market value of all firms products minus gross investment)

question

Price level

answer

average level of prices

question

When does real GDP per person grow

answer

whenever real GDP grows

question

Gross Investment definition

answer

the total amount spent on new capital

question

net investment definition

answer

the change in the value of capital

question

The components of aggregate expenditure that are influenced by real GDP are

answer

consumption expenditure and imports

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