Economics Unit 2 Test

Business cycle

Recurring increases and decreases in the level of economic activity over periods of years; consists of peak, recession, trough, and expansion phases.

Real GDP

Real Gross Domestic Product: the value of all final goods and services produced within a country in a given year, adjusted to eliminate the effects of price changes (inflation or deflation).

Nominal GDP

Nominal Gross Domestic Product: total economic output in dollars calculated using the unadjusted current market prices prevailing in the year the output was produced. 

Unemployment

The economic state in which individuals who are part of the labor force, available for work, and actively seeking employment are unable to find jobs.

Inflation

An increase in the general overall level of prices in an economy over a period of time, which declines the purchasing power of money.

Modern economic growth

The historical period beginning with the Industrial Revolution characterized by sustained, long-term increases in Real GDP per capita (output per person).

Savings

Income that is not spent on current consumption expenditures, serving as the source of funds for economic investment.

Investment

The allocation of economic resources toward creating future value; divided into financial investment and economic investment.

Financial investment

The purchase of financial assets—such as stocks, bonds, or mutual funds—to gain a financial return or profit without directly creating new physical capital assets. 

Economic investment

Direct spending on newly produced capital goods—such as factories, machinery, tools, equipment, software, and housing—that expand the economy's future production possibilities.

Expectations

The anticipations or predictions held by consumers, workers, and business owners regarding future economic conditions, which guide current financial decisions.

Economic shocks

Sudden, unexpected deviations between actual economic occurrences and what was anticipated by households and firms.

Demand shocks

Unexpected fluctuations in the aggregate spending demand of buyers across the economy.

Supply shocks

Unexpected disruptions or shifts in the economy's productive capacity, resource costs, or physical availability of goods and services.

Inventory

Goods that have been produced but remain unsold.

Sticky prices

Inflexible prices that respond slowly or sluggishly to changes in market demand or supply in the short run.

Flexible prices

Prices that adjust rapidly and freely to shifts in supply and demand, maintaining market clearing without inventory surges or output adjustments.

National income accounting

The techniques and metrics used by government agencies (such as the BEA) to measure the overall performance and aggregate output of an economy.

Gross Domestic Product (GDP)

The total market value of all final goods and services produced annually within a nation's physical borders.

Intermediate Goods

Goods or services purchased for further processing, manufacturing, or resale rather than for end consumption.

Final Goods

Goods and services produced for final use by consumers, businesses, or government units, rather than for resale or further processing.

Multiple Counting

The error of wrong fully overstating GDP by including the value of intermediate goods along with final goods rather than measuring only final output or value added.

Value Added

$\text{Sales Revenue}-\text{Cost of Intermediate Goods Purchased}$

The market value a firm adds to a product at its specific stage of production.

Expenditures Approach

The method of calculating GDP by adding up all expenditures spent on final goods and services by households, businesses, governments, and foreign buyers

• (GDP = C + I_g + G + X_n).

Income Approach

The method of calculating GDP by adding up all incomes earned by resource suppliers in producing those goods and services (wages, rents, interest, profits, indirect business taxes, and net capital consumption adjustments).

Personal Consumption Expenditures (C)

Total spending by domestic households on durable goods, nondurable goods, and services.

Durable good

A consumer good with an expected life (use) of three or more years.

Nondurable good

A consumer good with an expected life (use) of less than three years.

Service

An (intangible) act or use for which a consumer, firm, or government is willing to pay.

Gross Private Domestic Investment (I_g)

Total spending by private firms on physical capital equipment, machinery, residential construction, research and development, and net changes in inventory stocks. 

Net Private Domestic Investment

The addition to the nation’s stock of capital during a year.

• Gross private domestic investment - consumption of fixed capital

Government Purchases (G)

Total expenditures by federal, state, and local governments on final goods, services, and public capital facilities, excluding transfer payments.

Net Exports (X_n)

Exports minus imports (X - M), measuring foreign spending on a nation's domestic production.

National Income (NI)

Total income earned by resource owners for their contributions to production;

Consumption of Fixed Capital

An estimate of the amount of capital worn out or used up (consumed) in producing the gross domestic product; also called depreciation.

Net Domestic Product (NDP)

The nation’s total output available for consumption or additions to the capital stock.

Gross domestic product - the part of the year’s output that is needed to replace the capital goods worn out in producing the output

Personal Income (PI)

The earned and unearned income available to resource suppliers and others before the payment of personal taxes.

Disposable Income (DI)

Personal income less personal taxes; income available for personal consumption expenditures and personal saving.

Price Index

A benchmark ratio comparing the price of a market basket of goods in a given year relative to the price of an identical basket in a designated base year.

Base year

The year with which other years are compared when an index is constructed; for example, the base year for a price index.

Macroeconomics three foundational statistics

• Real Gross Domestic Product (Real GDP): Measures the total dollar value of all final goods and services produced within a country's borders during a specific time period, corrected for price changes (inflation or deflation). 

• Unemployment: Refers to the state in which individuals who are capable of working and actively seeking work are unable to find employment. 

• Inflation: An increase in the general, overall level of prices across the economy. Inflation decreases the purchasing power of money. 

When did modern economic growth begin

With the First Industrial Revolution in Great Britain around the 1760s before spreading to other nations. 

• Economic growth has not occurred evenly worldwide, resulting in major cross-country differences in standard of living.

Financial institutions

Institutions like banks, mutual funds, and insurance companies collect household savings and route them to businesses for economic investment.

Demand shocks under flexible prices

• Output / Sales Reaction - Remains constant 

• Economic Impact - Sales volume stable; no output disruption 

Demand shocks under sticky prices

• Output / Sales Reaction - Fluctuates (rises or falls) 

• Economic Impact - Inventory changes, output cuts, layoffs, recessions 

Prices are ___ in the short run

Sticky (inflexible)

Prices are ___ in the long run

Flexible

Why are prices inflexible in the short run?

• Consumers prefer price stability

• Businesses want to avoid retaliatory price wars

• Wage/salary contracts account for roughly 70% of business costs

Financial transactions

• Public Transfer Payments: Government payments like Social Security, welfare, or unemployment benefits (no current output produced in return). 

• Private Transfer Payments: Personal monetary gifts or student allowances. 

• Financial Asset Transactions: Sales of stocks and bonds (represents transfer of paper ownership). 

Excluded transactions from GDP

• Financial transactions

  • Public Transfer Payments: Government payments like Social Security, welfare, or unemployment benefits (no current output produced in return). 

  • Private Transfer Payments: Personal monetary gifts or student allowances. 

  • Financial Asset Transactions: Sales of stocks and bonds (represents transfer of paper ownership). 

• Secondhand sales

Secondhand Sales

Sales of used goods (e.g., selling a used car to a friend), as these were counted in the GDP of the year they were originally produced. 

The two approaches to GDP calculation

1. Expenditures approach

2. Income approach

Expenditures approach formula

GDP= C + I_g + G + X_n (CIGNA)

• Personal Consumption Expenditures (C) + Gross Private Domestic Investment + Government Purchases + Net Exports (X_n)

Income approach formula

Compensation of Employees +

Rents +

Interest +

Proprietors' Income +

Corporate Profits +

Taxes on Production and Imports -

Net Foreign Factor Income +

Consumption of Fixed Capital (Depreciation) +

Statistical Discrepancy

Net Domestic Product (NDP) formula

GDP - Consumption of Fixed Capital (Depreciation) 

National Income (NI) formula

NDP - Statistical Discrepancy + Net Foreign Factor Income 

Personal Income (PI) formula

NI - Taxes on Production and Imports - Corporate Income Taxes - Social Security Contributions - Undistributed Corporate Profits + Transfer Payments 

Disposable Income (DI) formula

PI - Personal Taxes

Nominal GDP formula

Output of unit x Price of unit

GDP Price Index formula

(Cost today/Cost in Base Year) x 100

GDP Price Index formula (when given GDP)

Nominal GDP/Real GDP x 100

Percent change formula

Change in price/Original Price x 100

Price index in hundredths formula

Price index/100

Real GDP formula

Nominal GDP/Price Index (expressed in hundredths)

• Nominal GDP/ (Price Index/100)

Price index for base year is always

100

Exclusions of GDP

• Nonmarket Activities: Omits productive unpaid labor (housework, child care, DIY repairs). 

• Leisure & Psychic Income: Ignores the economic value of increased leisure time and work satisfaction. 

• Improved Product Quality: Often understates utility gained from technological quality improvements. 

• The Underground Economy: Excludes unreported cash income and illegal activities

• Environmental Externalities: Fails to deduct social costs of environmental damage, pollution, and resource depletion. 

• Composition and Distribution of Output: Does not reveal how output is distributed across households or whether goods are socially beneficial vs. harmful. 

• Noneconomic Well-Being: Omits factors such as crime rates, health, and peace. 

Gross output (GO)

Measures the sum of total sales across all stages of production, distribution, and final retail sales.

Which sector exhibits the highest degree of price flexibility

Agriculture

How to calculate combined value added

1. Calculate each firm's Value Added individually (Sales-Input Cost)

2. Add them together to get the combined total.

Which sector exhibits the highest degree of price stickiness

Services