Georgia Tech Econ 2105 Exam 1 Flashcards

**What is Gross Domestic Product (GDP)?

The market value of all final goods and services (newly) produced within a country in a year.

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The market value

of all

final goods and services

(newly) produced

within a country

in a year.

Value each product at its market price

Include all goods and services

Count only final goods and services, omitting intermediate goods

Omit resale of already-produced goods

Include all goods produced within the United States (even by foreign-owned businesses), but exclude goods produced overseas (even by American-owned businesses)

Add up the flow of output over a year

**Equation for GDP:

Y (GDP) = C (consumption) + I (investment) + G (government purchases) + NX (net exports)

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Consumption:

Investment:

Government purchases:

Net exports:

1) Consumption is household spending on all final goods and services (ex: food clothes, doctor visits, cars, rent, etc)

2) Investment is purchases of new capital, which increase the economy's productive capacity (ex: building a factory or any long-last good like office furniture, equipment, and airplanes used in a business)

3) Government purchases are government purchases of goods and services (ex: local spending on schools, state government expenditures on highways, & federal government outlays on the military)

4) Net exports is spending on exports minus spending on imports; also referred to as the trade balance

What are transfer payments?

They transfer income from one entity (the government) to another (an individual).

*This involves no new production of goods or services, so it's not counted in GDP*

What are exports?

What are imports?

Exports are goods and services that we produce domestically in the United States and sell to people and businesses in other countries.

Imports are good and services that are produced in other countries and purchased by domestic U.S. buyers (these are excluded from GDP b/c they aren't produced domestically/in the U.S.)

**GDP can be measured in ______ ways, and they are: _______________________, __________________________, and _______________________.

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Total spending, Total output, and Total income

Total spending can be measured as _____________________________, and the measurement is called _____________________________.

Y = C + I + G + NX

"Gross Domestic Product"

Total output can be measured as _____________________________, and that measurement is called _____________________________.

Sum of value added = Total sales - cost of intermediate inputs

"Value Added"

What does value added mean?

The amount by which the value of an item is increased at each stage of production; = Total sales - Cost of intermediate inputs.

Total income can be measured as _____________________________, and that measurement is called _____________________________.

Total wages + Total profits

"Gross Domestic Income"

Why do these measurements of GDP have different names?

They get different names because even though they are the same in theory, real-world measurements of each can differ because each relies on different sources of imperfect data.

Limitations of GDP

1. Prices are not values

2. Nonmarket activities are excluded

3. The shadow economy is missing

4. Environmental degradation isn't counted

5. Leisure doesn't count

6. GDP ignores distribution

Nominal GDP:

Adds up the market value of total production in a year using the current prices prevailing in that year

Nominal GDP = Price x Quantity

Real GDP:

Excludes the effects of price changes, so it isolates economic growth that's due to changes in the quantity of output produced

Real GDP = Average Price (between a couple years) x Quantity

Growth Rate Equation

(This year - Last year / Last year) x 100

Equation for % Change in real GDP:

% Change in real GDP = Change in nominal GDP - % Change in prices

Four strategies for Scaling Big Numbers

1. Evaluate what it means per person

2. Compare big numbers to the size of the economy

3. Compare big numbers to their own history

4. Use the Rule of 70 to evaluate long-run growth rates

What is the Rule of 70, and what is its equation?

The years it takes something to double

70/Annual growth rate

Circular Flow of Income and Resources

GDP per person (aka GDP per capita):

Total GDP divided by the population

What are the ingredients of Economic Growth?

Labor input, human capital, and physical capital

What is labor input?

Number of workers to transform raw materials into products and services that people want to buy

What is human capital?

The accumulated knowledge and skills that make a worker more productive

What is physical capital?

The total amount of tools, machinery, and structures that can be used in the production of goods and services

What is technological progress?

New methods for using existing resources to produce more valuable output

What is the production function?

The methods for transforming labor input, human capital, and physical capital into goods and services (outputs)

**Transforming inputs into outputs determines the total production that's possible with a given set of ingredients**

Constant returns to scale:

Doubling ALL inputs (labor input, human capital, and physical capital) leads to a doubling of all the outputs

Law of diminishing returns to scale:

When one input (labor input, human capital, or physical capital) is held constant, increases in the other inputs will, at some point, begin to yield smaller and smaller increases in output

Example: When looking at the Solow Graph Model, once physical capital gets so high, the increases in GDP (output) will get smaller and smaller (it will still increase but not by a lot)

Diminishing returns and depreciation mean that investment in physical capital is a ______________________________________.

limited source of growth

**This is b/c once the investment in physical capital get so high, the increases in GDP (aka output) get smaller and smaller**

**This is also b/c more investment in physical capital = more depreciation. Once you invest in more physical capital, that means that more will break which means that you will have to invest more money to fix them**

Catch-up growth

The rapid growth that occurs when a relatively poor country (with low capital stock) invests in its physical capital

What does technological change do?

Technological change increases GDP per person for any level of capital per person.

**You are able to produce more output with less input when you have a technological change**

What does technological progress rely on?

Technological progress relies on new ideas.

Why can ideas generate unlimited growth?

1. Can be freely shared

2. Don't depreciate with use

3. May promote other ideas

Why do institutions matter for economic growth?

They provide the framework that creates the right incentives for people to invest in physical and human capital and generate new ideas and products.

Property rights:

Without property rights and a trusted enforcement, no one creates wealth

Government stability:

Corruption and political instability discourage investment and innovation by reducing the potential benefits from such investments

Efficiency of regulation

Excessive red tape can make it hard to invest or innovate

Government policy to encourage innovation

Government policy can support development of new ideas by:

1. Increasing the marginal benefit through intellectual property laws

2. Decreasing the marginal cost by subsidizing research and development

What is capital stock?

The total quantity of capital at a point in time

What is depreciation (capital)?

The decline in capital due to wear and tear, obsolescence, accidental damage, and aging.

What is labor productivity?

The quantity of goods and services that each person produces per hour of work.

What are property rights?

Control over a tangible or intangible resource.

Working-age population:

Noninstitutionalized civilians age 16 and over (doesn't count those that are institutionalized or in the military)

NILF + Labor Force

Not in the labor force + Labor force

Not in the labor force (NILF)

People that are neither employed not unemployed. They don't have a job and they aren't looking for one either.

Examples: Retired, in school, taking care of a child or other family member, or too unwell to work. Could also be people who have given up on finding a job b/c it was too hard.

Labor force

Working-age population that either has a job or would like a job. They are people that are AVAILABLE to produce goods and services.

Employed + Unemployed

E + UE

Employed

People with jobs

To be considered employed:

1) Must be part of the working-age population (16)

2) Must work at least 1 hour a week

3) Must be compensated in some way for that work

Self-employed is still counted & so is when people are temporarily absent from their job whether they are paid or not

Unemployed

People without jobs who are trying to get a job

To be considered unemployed:

1) Must be part of the working-age population (16)

2) Must be not currently working

3) Must be actively searching for work

4) Must be able to accept a job if it were offered

Labor Force Participation Rate

The share of the working-age population that is either employed or unemployed.

(Labor Force/Working-age population) x 100

or (Labor Force/Labor Force + NILF) x 100

or (E+UE/E+UE+NILF) x 100

Unemployment Rate

The share of the labor force that's unemployed.

(Unemployed/Labor Force) x 100

or

(UE/UE + E) x 100

Equilibrium unemployment rate:

The unemployment rate to which the economy tends to return in the long run (typically between 4% and 5%)

Alternative measures of unemployment might also include:

1) Underemployed

2) Marginally attached

3) Involuntarily part time

What does underemployed mean?

Someone who has some work but wants more hours or whose job isn't adequately using their skills.

What does marginally attached mean?

Someone who wants a job, and who has looked for a job within the past year, but who isn't counted as unemployed b/c they aren't currently searching for work.

**Not included among the unemployed or the labor force, but is included in U-5, which is a broader measure of unemployment**

**U-5 = (Unemployed + Marginally Attached/Labor Force + Marginally Attached) x 100

What does involuntarily part time mean?

Someone who wants full-time work and is working part time b/c they haven't found a full-time job.

**Used in a broader measure of unemployment called U-6**

**U-6 = (Unemployed + Marginally Attached + Involuntarily Part Time/Labor Force + Marginally Attached) x 100

Causes of Unemployment:

1) Frictional unemployment

2) Structural unemployment

3) Cyclical unemployment

What is frictional unemployment?

Unemployment due to the time it takes for employers to search for workers and for workers to search for jobs.

Sources:

1) Job search resources

2) Skills mismatch

3) Unemployment Insurance and other income support

What is structural unemployment?

Unemployment that occurs because wages don't fall to bring labor demand and supply into equilibrium.

Sources:

1) Efficiency wages - higher wages paid to encourage greater worker productivity

2) Institutional causes:

-Unions

-Job protection regulations

-Minimum wage laws

What is cyclical unemployment?

Unemployment that is due to a temporary downturn in the economy.

Costs of Unemployment:

1) Lower wages and worse career opportunities

2) Permanent joblessness can arise from periods of high unemployment

3) Lower tax revenue and higher government spending

4) Unemployment is isolating and painful

5) Long-term unemployment is associated with worse outcomes

6) Children whose parents experience unemployment suffer

What is efficiency wage?

A higher wage paid to encourage greater worker productivity.

What is hysteresis?

When a period of high unemployment leads to a higher equilibrium unemployment rate.

What is long-term unemployed?

People who have been unemployed for six consecutive months or longer.

What is a discouraged worker?

Type of marginally attached person that gives up looking for work because they don't believe there are jobs available for them.

What is inflation?

Inflation is a generalized rise in the overall level of prices.

**It can also be described as a rise in the cost of living**

**As a result, inflation is also a decline in the purchasing power of money**

What is Consumer Price Index (CPI)?

An index that tracks the average price consumers pay over time for a representative "basket" of goods and services.

**CPI is the inflation measure that is most relevant to a consumer's life**

**The base level year that CPI starts at is scaled down to equal exactly 100**

How to measure inflation:

1) Find out what people buy and construct a representative basket of goods and services

2) Collect prices from the stores where people do their shopping

3) Tally up the cost of the basket of goods and services

4) Calculate the inflation rate: The annual percentage increase in the average price level

Equation: Inflation rate = (Price level this year - Price level last year /Price level last year) x 100

OR

Inflation rate = (CPI this year - CPI last year/CPI last year) x 100

What is a real variable?

A variable that has been adjusted to account for inflation.

What is a nominal variable?

A variable measured in dollars (whose values may fluctuate over time).

How do you convert nominal variables into real variables?

You can do this by applying the inflation adjustment formula:

Today's dollars = Another time's dollars X (Price level today/Price level in another time)

How to calculate the percent change in real value:

Percent change in real value = Percent change in nominal value - Percent change in prices

How to calculate the real interest rate:

Real interest rate = Nominal interest rate - Inflation rate

What is money illusion?

Money illusion is the (mistaken) tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts.

**Money illusion creates nominal wage rigidity (reluctance to cut nominal wages)**

Different Measure of Inflation:

Consumer Prices:

1) Cost of living adjustments → consumer price index (CPI)

2) A target for monetary policy → personal consumption expenditure deflator

3) Forecasting underlying inflation trends → Core inflation (excluding food and energy)

Business Prices:

1) Cost of inputs → producer price index (PPI)

2) Estimating the price of all output and hence real GDP → GDP deflator

What is GDP Deflator & GDP Deflator Equation?

A price index that tracks the price of all goods and services produced domestically.

GDP Deflator = (Nominal GDP/Real GDP) x 100

Inflation overstates the cost of living because of...

1) Unmeasured quality improvements

2) New products

3) Substitution bias

What is money?

Money is any asset regularly used in transactions.

It is:

1) Medium of exchange

2) Unit of account

3) Store of value

What are the costs of inflation?

Expected inflation:

1) Menu costs for sellers

2) Shoe-leather costs for buyers

Unexpected inflation:

3) Confuses the signals that prices send (Producers don't know if the unexpected rising in prices is due to increased demand or a burst of unexpected inflation)

4) Redistribution (Redistributes from savers and lenders towards borrowers b/c when they make a contract they have to use an expected inflation rate, and if the inflation rate is higher than what was expected, the borrowers end up paying less. If the inflation rate was less than expected, the borrowers have to pay more, which makes the lenders more money)

What is the inflation fallacy?

The mistaken belief that inflation destroys purchasing power.

**Inflation leads to the rise of all prices, which includes the rise of wages. So the prices of items you buy will rise, but so will your income, leaving purchasing power mostly unchanged**

What is deflation?

A generalized decrease in the overall level of prices.

What is hyperinflation?

Extremely high rates of inflation.

What is nominal interest rate?

The stated interest rate without a correction for the effects of inflation.

What is real interest rate?

The interest rate in terms of changes in your purchasing power.

Real interest rate = Nominal interest rate - Inflation rate

What are menu costs?

The marginal cost of adjusting prices that firms have to pay.

**This is a cost of expected inflation**

What are shoe-leather costs?

The costs incurred trying to avoid holding cash. This cost occurred from people having to run around town to spend their money quickly before it lost its value.

**This is a cost of expected inflation**