ECON 1110 - Macroeconomics Exam 1

Includes chapters 1-6. Economic Methods and Models, Addressing Scarcity, The Demand and Supply Model, Unemployment and Inflation, and Output and Income.

Economy

All of the decisions, or choices, made by economic agents within a given geographic area that involve the use of scarce resources.

Microeconomics

Studies the individual part of the economy: the households, firms, markets, and the various organizations that exist within the economy.

Macroeconomics

Uses measures of total economic activity, or economic aggregates, such as gross domestic product, inflation, and the national rate to gauge the performance of the overall economy.

Positive economics

Uses factual information and economic analysis to identify what is without making a value judgement.

Normative economics

Evaluates a situation with respect to what should be which requires a value judgement.

Scarcity

The basic economic problem that societies have to decide: What outputs to produce, How to produce the outputs, and who ultimately gets to consume the outputs.

Scarce Resources

• Land

• Labor

• Capital

• Entrepreneurship

Land

Natural resources (timber, water, minerals, climate).

Labor

Human effort applied to the production process.

Capital

Equipment and buildings used in production (factories, machines, computers, delivery trucks).

Entreprenuership

Ability to combine inputs and to produce an output, which requires innovating and risk-taking.

Opportunity Cost

The value of the best alternative foregone when a choice is made.

ceteris paribus assumption

When studying the relationship between two variables, the Ceteris Paribus Assumption is keeping all other variables constant to isolate the two in question. (Literally: “other things being equal/constant”)

Ceteris paribus

Latin phrase that translates as "“with other conditions remaining the same” or “all other things remain constant”.

Laissez-faire

“to let do, let pass”, let things work on their own.

Gov takes a hands off approach.

Fallacy of false cause (post hoc fallacy)

“After this therefore because of this”. Association (or correlation) does not implement causation.

The fallacy of composition

Assumed if something is true for a part, it must also be true for the whole.

The fallacy of division

Assumed if something is true for a whole, it must also be true for the part.

The sunk cost fallacy

A belief that what has already disappeared can somehow be regained through further investment of money, time, or effort.

Circular Flow Model

Production Possibilities Model (PPM)

Simple model illustrating the output choices available to society. (Usually presented as a PPF graph)

Production Possibilities Frontier (PPF)

Shows maximum output combinations of two different goods an economy can produce with available resources and technology.

Straight Line PPF

When resources has constant opportunity cost because its resources are perfectly adaptable and equally efficient at producing either good.

Bowed-Out PPF

When resources cannot produce all outputs with equal ease, increasing the opportunity cost production of one output by equal increments require giving up increasing amounts of the other output.

Graphing a PPF assumes:

• The amount of resources available for production is fixed

• The technology used in production is constant

• Available resources are fully employed

• Production is efficient

Points on PPF

• Combinations on the PPF line are achievable and efficient

• Combinations inside the PPF are achievable and inefficient

• Combinations outside the PPF are unachievable.

Economic Growth on PPF

A right shift on a PPF represents an increase in an economy’s ability to produce output.

Economic Growth on PPF of one Industry

Growth can also occur within a specific industry; not all resources and technology are used to produce all types of outputs.

Invisible hand

The pursuit of self-interest guides resources to their highest-valued use which is more likely to increase the wealth of a nation.

Capitalism

Private ownership of the factors of production.

Characteristics of capitalism

• incentives

• profit-motive

• private property

• own satisfaction

Socialism and communism

Government control of resources and government direction of production and consumption

Mixed economy

Elements of both a market economy and a planned economy.

We have businesses and firms that rise up and operate on their own, but also have government intervention in certain areas of the economy.

Role of government in businesses

Fiscal policy, monetary policy, and involvement in market failures.

Fiscal Policy

The use of the federal government’s budget for the purpose of altering economic outcomes.

Federal government giving money (subsidies or checks) or decreasing taxes.

Monetary Policy

Federal Reserve uses monetary policy to influence the money supply and credit conditions to help achieve the economy of macroeconomic goals.

It’s how the Federal Reserve (the central bank of the US) controls inflation, using interest rates.

Demand

The willingness and ability of consumers to make a purchase.

Law of Demand

Decrease in price causes increase in quantity demanded, and an

increase in price causes decrease in quantity demanded.

Demand curve

The downward facing slope.

Demand Schedule

Price and quantity demanded are inversely (negatively) related.

Inverted slope.

How much consumers are willing to pay at different price points. Demand decreases as prices increase.

Supply

Total amount of a specific good or service that producers are willing and able to offer to buyers at a set price.

Law of Supply

Increase in price causes increase in quantity supplied, and a

Decrease in price causes a decrease in quantity supplied.

Supply Curve

Upward facing slope.

Supply Schedule

Price and quantity are directly (positively) related.

Market Equilibrium

Quantity demanded is equal to quantity supplied

Market Surplus

Quantity supplied exceeds quantity demanded (When the price in a market is above the equilibrium price).

Market Shortage

Quantity demanded exceeds quantity supplied (When the price in a market is below the equilibrium price).

Price ceiling

When policymakers set a maximum legal price, to protect buyers/consumers from prices considered to be unfairly high (established below the equilibrium price).

Policy makers do this to protect consumers (=average people) from corporate price gouging.

Price floor

When policymakers set a minimum legal price, to protect sellers in the particular market. (established above the equilibrium price).

Changes in Demand and Supply

A change in price leads to a change in quantity and a movement along a given demand or supply curve.

If a non-price factor that influences demand or supply changes, the curve shifts to the right or left.

Demand Shifts Factors

• A change in tastes and preferences

• A change in income (direction depends on if product is normal or inferior)

• A change in the price of a related good or service (direction depends if product is a substitute or complement)

• A change in the number of buyers in the market

• A change in the expectation of buyers

Normal goods

increases in income lead to increases in demand, and vice versa. (direct; positive)

Inferior goods

demand decreases when income increases, and vice versa. (inverse; negative)

Complements

demand decreases following an increase in the price of a complementary product, and vice versa. (inverse; negative)

Substitutes

demand increases following an increase in the price of a substitute product, and vice versa. (direct; positive)

Labor Force

Includes people over the age of 16 who are working or actively seeking employment and excludes military members and those who have been institutionalized.

People employed + unemployed (people seeking work) - military

Employed classifications

A respondent must meet only ONE of the four:

• Worked for pay for at least 1 hour

• Worked at least 1 hour as self-employed in their own business, profession, trade or farm

• Were absent temporarily from their job, business, or farm, whether or not for paid time off, OR

• Worked without pay for at least 15 hours in a business or farm owned by a family member

Unemployed classifications

A respondent must meet ALL of the three:

• Currently unemployed

• available to work, AND

• actively looking for a job in the last 4 weeks

Discouraged workers

People who are marginally attached to the labor force; they are willing and able to work but have not actively searched for work in the past 4 weeks.

Unemployment rate

(Unemployed/Labor Force) * 100

Cyclical unemployment

When there is a downturn in overall economic activity that such the number of job seekers exceeds the number of jobs available.

Frictional unemployment (short term)

When people with skills demanded in the labor market leave one job search to another.

Structural unemployment (long term)

When there is a mismatch between skills or location of job seekers.

When people are unemployed because there’s no longer a need for their skillset.

Seasonal unemployment

When people are out of work because the demand for labor drops during specific times of the year.

(Example: retail needs less workers in spring than late fall and winter)

Full employment

The unemployment rate is equal to the noncyclical rate, or natural rate, of unemployment.

[U = U_N and U_C = 0]

Natural rate of unemployment (U_N)

When the economy is operating at it’s potential, the unemployment rate is equal to the noncyclical, or natural rate, of unemployment.

U_N = [Frictional Unemployment + Structural Unemployment]

Inflation

Increase in the general price level over time, or the average of all prices.

Purchasing Power

The amount of goods and services that a specific amount of money can buy.

CPI

Consumer Price Index: how economists measure the purchasing power of consumers (aka “the price that consumers pay on a selection of goods, like gas, housing, groceries, etc.”). It’s generally seen as a good indication of inflation.

Real Income Formula

Real Income_t = (Nominal Income_t / CPI_t) * 100

Annual Inflation Rate Formula

Annual Inflation Rate = (CPI_t - CPI_t-1 / CPI_t-1) 100

(current - earlier/earlier) * 100

GDP (Gross Domestic Product)

GDP is the total market value of all final goods and services produced in a country in a year.

Measuring GDP

The four components of GDP are: Personal consumption expenditures (C), gross private domestic investment (I), government consumption expenditures and gross investment (G), and the net exports of goods and services (NX).

GDP = C + I + G + NX

Personal consumption expenditures (C)

(PCE or C) By far, is the largest component of GDP.

Gross private domestic investment (I)

(GDPI = I) Includes business spending on new structures, equipment, and intellectual property products.

Government consumption spending and gross investment (G)

(G) Includes spending by all government entities. Does NOT include outlays for transfers such as social security or stimulus checks.

Net exports (NX)

Net exports is the difference between exports (EX) and imports (IM).

[NX = EX = IM]

Exports (EX)

Exports are outputs produced in the US and purchased by foreigners. (Exports are made in the US, but EXIT the country)

Imports (IM)

Imports are outputs produced in other countries and purchased in the U.S

Trade Surplus

When exports exceeds imports; net exports will be positive (exports > imports).

Trade Deficit

When imports exceeds exports; net exports will be negative.

Double Counting

GDP adds only the prices of final goods and services to avoid the problem of double counting.

Spending Not included in GDP

Sales of previously sold final goods and purely financial transactions.

Deprecation

When an asset declines in economic value over time (“consumption of a fixed capital“)

Net domestic product (NDP)

NDP = GDP - Depreciation

Net Investment (Net private domestic investment)

Net private domestic investment = Gross private domestic Investment (I) - Depreciation

Disposable (Personal) Income (DI)

The income available to households for spending or saving.

The amount money people have left over to save or spend after paying to live (paying bills, paying gas to get to work, paying for groceries to eat).

Calculating Economic Growth Rate

%Change in Real GDP = (Current GDP - Earlier GDP / Earlier GDP) * 100