Macroeconomics Final - UVA ECON 2020 (Lee Coppock)

1st Rotunda Principle

Trade creates value.

2nd Rotunda Principle

Incentives affect behavior.

3rd Rotunda Principle

The three sources of economic growth are resources, technology, and institutions.

Trade

Voluntary exchange

-helps both sides

-positive-sum game

-differences are beneficial

Scarcity

The limited nature of society's resources, given society's unlimited wants and needs.

Economics

The study of how people allocate their limited resources to satisfy their nearly unlimited wants.

Macroeconomics

The study of the overall aspects and workings of an economy.

Opportunity cost

The highest-valued alternative that must be sacrificed in order to get something else.

Economic thinking

Requires a purposeful evaluation of the available opportunities to make the best decision possible.

Marginal thinking

Requires decision-makers to evaluate whether the benefit of one more unit of something is greater than its cost.

Markets

Bring buyers and sellers together to exchange goods and services.

Comparative advantage

The situation where an individual, business, or country can produce at a lower opportunity cost than a competitor can.

Thomas Sowell

Wrote "A Conflict of Visions" - constrained vs. unconstrained vision.

Unconstrained vision

We have the resources necessary to satisfy everybody.

Constrained vision

We have unlimited desires but limited resources.

Law of Demand

All else equal, quantity demanded falls when price rises, and rises when price falls.

Market system

An economy based on voluntary exchange via markets for individual goods and services.

Factors that influence demand

1. Price

2. Consumer income

3. Price expectations

4. Tastes and preferences

5. Price of related goods

6. Many others

Law of Supply

All else equal, quantity supplied rises when price rises, and falls when price falls.

Factors that influence supply

1. Price

2. Cost of inputs/resources

3. Technology

4. Supply shocks

5. Price expectations

6. Many others

Equilibrium

When plans of buyers match plans of sellers.

Friedrich Hayek

Wrote "The Use of Knowledge in Society."

Positive statement

Can be tested and validated; it describes "what is."

Normative statement

An opinion that cannot be tested or validated; it describes "what ought to be."

Ceteris paribus

Concept under which economists examine a change in one variable while holding everything else constant.

Endogenous

Variables that can be controlled for in a model.

Exogenous

Variables that cannot be controlled for in a model.

Production Possibilities Frontier (PPF)

A model that illustrates the combinations of outputs that a society can produce if all of its resources are being used efficiently.

Law of increasing relative cost

The opportunity cost of producing a good rises as a society produces more of it.

Specialization

When one entity has comparative advantage over others, allowing trade to create additional growth.

Absolute advantage

The ability of one producer to make more than another producer with the same quantity of resources.

Consumer goods

Produced for present consumption.

Capital goods

Help produce other valuable goods and services in the future (tools).

Investment

Process of using resources to create or buy new capital.

Reverse causation

When causation is incorrectly assigned among associated events.

Competitive market

Exists when there are so many buyers and sellers that each has only a small impact on the market price and output.

Imperfect market

Market in which either the buyer or the seller has an influence on the market price.

Monopoly

Exists when a single company supplies the entire market for a particular good or service.

Quantity demanded

Amount of a good or service that buyers are willing and able to purchase at the current price.

Demand schedule

Tabe that shows the relationship between the price of a good and quantity demanded.

Demand curve

Graph of the relationship between prices in the demand schedule and quantity demanded at those prices.

Market demand

Sum of all the individual quantities demanded by each buyer in the market at each price.

Normal good

Consumers buy more as income rises.

Inferior good

Purchased out of necessity rather than choice.

Complements

Two goods used together. When the price of a complementary good rises the demand for the related good goes down.

Substitutes

Two goods that are used in place of each other. When the price of a substitute good rises, the quantity demanded falls and the demand for the related good goes up.

Quantity supplied

Amount of a good or service that producers are willing and able to sell at the current price.

Supply schedule

Table that shows the relationship between the price of a good and the quantity supplied.

Supply curve

Graph of the relationship between the prices in the supply schedule and the quantity supplied at those prices.

Market supply

Sum of the quantities supplied by each seller in the market at each price.

Inputs

Resources used in the production process.

Equilibrium price

Market clearing price, at which quantity supplied equals quantity demanded.

Law of supply and demand

The market price of any good will adjust to bring the quantity supplied and quantity demanded into balance.

Shortage

Occurs whenever the quantity supplied is less than the quantity demanded.

Surplus

Occurs whenever the quantity supplied is greater than the quantity demanded.

Gross Domestic Product (GDP)

The market value of final goods and services produced in a country in a year (Output). (Used goods and financial assets are not counted).

Ways to increase income (GDP)

1. Produce more output

2. Produce a more valuable output

GDP used to measure:

1. Living standards

2. Economic growth (changing in living standards)

3. Business cycles (contractions and expansions)

Services

Output that provides benefits without a tangible product.

Intermediate goods

Goods that firms repackage or bundle with other goods for sale at a later stage.

Final goods

Goods sold to final users.

Short-comings of GDP

1. Non-market production: household work, volunteer work.

2. Underground activity

3. Environmental impacts

4. Liesure time

Per capita GDP

GDP per person.

Inflation

Growth in the overall level of prices in an economy. (4% average).

Real GDP

GDP adjusted for inflation.

Economic growth

Percentage change in real per capita GDP. (US has 3% annual average).

Recession

Short-term economic down turn.

Great Recession

December 2007 - June 2009

Business cycle

Short-run fluctuation in economic activity.

Economic expansion

Phase of business cycle where economy grows faster than usual.

Economic contraction

Phase of business cycle where economy grows more slowly than usual.

Gross National Product (GNP)

Output produced by workers and resources owned by residents of a nation.

Consumption (C)

Purchase of final goods and services by households, excluding new housing.

Durable vs. Non-durable

Non-durable consumption goods are consumed over a short period, durable goods over a long period.

Investment (I)

Private spending on tools, plants, and equipment used to produce future output.

Government spending (G)

Spending by all levels of government on final goods and services.

Net exports (NX)

Exports minus imports of final goods and services.

Nominal GDP

GDP measured in current prices, not adjusted for inflation. (Average annual growth rate of 3%)

GDP calculation

GDP = C + I + G + NX

Price level

Index of the average prices of goods and services throughout the economy.

GDP deflator

Measure of price level that includes prices of the final goods and services included in GDP.

Unemployment rate (u)

The percent of the labor force that is unemployed. (6% average in US since 1960).

Three types of unemployment

1. Structural unemployment

2. Frictional unemployment

3. Cyclical unemployment

Structural unemployment

Caused by changes in the industrial make-up (structure) of the economy (creative destruction).

Frictional unemployment

Caused by delays in matching available jobs and workers. (Can be decreased by making information more available. Can be increased by hiring/firing regulations).

Cyclical unemployment

Caused by economic downturns.

Natural rate of unemployment (u*)

The typical rate of unemployment when the economy is growing naturally (without cyclical unemployment).

Full employment output (Y*)

The output level when unemployment is equal to the natural rate.

Labor force

People who are employed or actively seeking work (non-institutionalized, civilian, 16+).

Labor force participation rate

The portion of the population in the labor force

Unemployment insurance

Government program that reduces the hardship of joblessness by guaranteeing that unemployed workers receive a percentage of their former income while unemployed.

Discouraged workers

Those who are not working, have looked for a job in the past 12 months and are willing to work but have not sought employment in the past 4 weeks.

Underemployed workers

Those who have part-time jobs but would prefer to work full-time.

Consumer Price Index (CPI)

Based on the consumption patterns of a typical consumer (price of "typical basket of goods".

Problems with inflation:

1. Future price uncertainty

2. Price confusion

3. Money illusion

4. Tax distortions

5. Wealth redistribution

6. Menu costs

7. Shoe leather costs

Future price uncertainty

Makes people reluctant to sign long-term contracts.

Price confusion

Suppliers can't discern the source of price increases. Results in misallocation of resources.

Money illusion

People misinterpret nominal changes as real changes. (Raises in wage vs. accounting for inflation).

Cause of inflation

Money supply growth.

Deflation

Occurs when overall prices fall.