Econ Exam 2

Sole proprietorship

a firm owned by a single individual and not organized as a cooperation

Partnership

a firm owned jointly by two or more persons and not organized as a cooperation

Corporation

a legal form of business that provides owners with protection from losing more than their investment should the business fail

Asset

anything of value OWNED by a person or a firm (sole proprietorships and partnership)

Liability

something you OWE (cooperation)

Pros and Cons of limited liability

benefit but expensive to organize and might get taxed twice

Number of firms

¾ are sole proprietorships

Most revenue and profit

Cooperations

Why has international trade increased drastically?

Falling shipping and transportation costs

Improved technology makes it easier to shipt

Tariff

a tax imposed by a government on imports (a bad thing)

Imports

good and services bought domestically but produced in other countries (into)

Exports

goods and services produced domestically but sold in other countries (out)

Exports > imports

trade surplus

Imports > exports

trade deficit

Imports = exports

balanced trade (super rare)

What does GDP represent?

total economy

For last 20-30 years, what has the economy been?

trade deficit (didn’t destroy economy)

In 1970, what percent did international trade make up of GDP?

about 10% (it has increased 3x since then)

What are the top three exporting countries?

China, United States, Germany

How many exports does China have?

12.1% of world exports

Comparative Advantage

the ability of an individual, a firm, or a country to produce a good/service at a lower opportunity cost than competitors

Opportunity Cost

the highest-valued alternative that must be given up to engage in an activity

Absolute Advantage

the ability to produce more of a good/service than competitors when using the same amount of resources

Autarky

a situation in which a country does not trade with other countries (have to produce both goods)

Terms of trade

the ratio at which a country can trade its exports for imports from other countries

What do you do when the question is about how many hours it takes to produce something?

reverse comparative advantage

Where does comparative advantage come from?

climate and natural resources

relative abundance of labor and/or capital

technological differences

External economies

reductions in a firm’s costs that result from an increase in the size of an industry

Ex: making compute software in Pueblo in comparison to California (starting businesses where there’s competition)

What happens when a country loses its comparative advantage in a good?

Income will be higher from the goods it has a comp advantage at producing

Can consume the goods other countries are relatively good at making, at a lower cost

Purpose of a tariff

protect domestic jobs

Quotas

gov’t imposed limit on the quantity of a specific good being imported

a form of trade restriction used to control the volume of trade between countries

Business cycle

alternating periods of economic expansion and economic recession

Expansion

the period of a business cycle during which the total production and total employment are increasing

Recession

the period of a business cycle during which total production and total employment are decreasing

Economic growth

the ability of an economy to produce increasing quantities of goods and services (most important measure of economy)

Inflation rate

the percentage increase in the price level from one year to the next

Gross domestic product (GDP)

the market value of all final goods and services produced in a country during a period of time, typically one year

“Market Value”

the price (dollar amount) that each good or service is sold for

monetary terms

“Final goods and services”

a good or service purchased by a final user

don’t use intermediate goods/services —> double counting

“During a period of time”

one year typically

GDP Equation

y = C + I +G + NX

Consumption

spending by households on goods/services, not including spending on new houses

What does consumption include?

services

nondurable goods

durable goods (expected to last >3 years)

Investment

spending by firms on new factories, office buildings, machinery, and additions to inventories, PLUS spending by households and firms on NEW houses

What does investment include?

business fixed investment

residential investment

changes in business inventories

Government Purchases

spending by federal, state, and local governments on goods and services

What does gov’t purchases include?

government consumption and investment

does not include transfer payments (social security checks, food stamps, etc)

Net Exports

value of exports - imports (can be negative or positive)

What is the biggest component in C, I, G, NX?

Consumption (around 70-60%)

Why are there shortcomings to measuring GPD?

household production: childcare, cleaning, etc

underground economy

Underground economy

buying and selling of goods/services that is hidden from the gov’t to avoid taxes or regulations, or because the goods/services are illegal

How much of GPD isn’t accounted for (underground economy)?

10%

Nominal GDP

the value of final goods and services evaluated at current-year prices (with inflation)

Real GDP

the value of final goods and services evaluated at base-year prices (without inflation)

GDP Deflator

Nominal GDP/Real GDP (100)

What is the GDP deflator in the base year?

100

How do you find the percent increase in GDP?

current year - previous year all divided by previous year

Personal income

income received by households; includes transfer payments but excludes firms’ retained earnings

Disposable personal income

personal income minus personal TAX payments; this measures the amount that households are able to spend or save

Where does most of people’s income come from?

wages (over 50%)

Adam Smith

we act in rational, self-interested ways and are guided by an “invisible hand”

What does the government provided court system protect?

our private property rights

Why does the government grant patents and copyrights?

to encourage research and development

What does free trade mean?

there is little gov’t intervention

Where does the government revenue come from?

social insurance taxes

individual income taxes

What does the government spend their money on?

transfer payments (50%)

Consumer Price Index (CPI)

a measure that examines the weighted average of prices of a basket of consumer goods and services

CPI Equation

how much it costs to purchase things in current year/base year (100)

What is the value of CPI in base year?

100

How do you calculate CPI percentage change?

current year-previous year all divided by previous year (100)

Substitution Bias

consumers may change their purchasing habits from goods that has increased in price

Increase in quality bias

difficult to separate improvement in quality from increase in price (ex: cars or computers)

New product bias

the basket of goods used to change only every 10 years (no its every 2 years); there is a delay to new goods

Outlet bias

CPI used to only survey prices at traditional retail outlets, now it minimizes this bias by surveying people about where they actually buy products

How much does CPI overstate true inflation?

0.5-1 percent