ECN204

Midterm review

Recession

Negative rate of growth, output and living standards decline

Business cycle

Recurring increases and decreases in the level of economic activity over periods of years

Real GDP

Measures value of final goods and services produced WITHIN the borders of a country during a specific time period

Nominal GDP

Totals the dollar value of all goods and services produced within a country using their prices during the year they were produced

What does nominal GDP not account for that real GDP does?

Price changes

Why are high unemployment rates undesirable?

It indicates that a nation is not using a large portion of its most important resource

Saving

Occurs when current consumption is less than current income/output

Investment (economic)

Resources are devoted to increasing future output - building new production technologies or paying for the production of newly created capital goods that will increase future output

Shocks

Situations where one outcome is expected to happen but something else happens instead

Positive demand shock

When an actual demand is higher than expected

Negative demand shock

When an actual demand turns out to be lower than expected

What are inflexible prices known as?

Sticky prices

GDP per person measures

the amount of output per person if total output were equally divided among everyone

What are the main statistics used by economists to assess the health of an economy?

Real GDP, unemployment, inflation

Rule of 70

Used to estimate the number of years it will take for an exponentially growing metric to double in value.

Final goods

Goods/services purchased for final use and not for resale or further processing ex gasoline

Intermediate goods

Products purchased for resale or further processing or manufacturing

Value added

Value of products sold - value of inputs used to produce that product

Two types of nonproduction transactions

Financial transactions (public transfer payments, private transfer payments, stock-market transactions) and second-hand sales

Expenditures Approach to calculate GDP

Sum of all money spent in buying final goods and services

Income Approach to calculate GDP

Income derived or created from producing final goods and services

What does expenditures approach add up?

Personal consumption expenditures, Gross investment, Government purchases, Net exports

Personal consumption expenditures (C)

All expenditures by households on goods and services such as durable goods (ex stoves, fridge), nondurable goods (food, clothes, gasoline) or services

Gross investment (Ig)

Machinery, equipment, tools by firms, construction

Net investment

Gross investment - depreciation

Government purchases (G)

Expenditures for goods and services, publicly owned capital

Net exports (Xn)

Exports - Imports

GDP formula

C + Ig + G + Xn

Personal income

The total income, both earned and unearned, available to individuals before taxes

Disposable income

The remaining income after personal income taxes are deducted from PI

Nominal GDP

GDP measured in terms of the price level at the time of the measurement (unadjusted for inflation)

Real GDP

Reflect changes in the price level, shows the change in a country’s output of goods and services

Price index of a specific year

Price of market basket in specific year / price of same market basket in base year

Real GDP formula

Nominal GDP / Price Index x 100

GDP Deflator

Nominal GDP / Real GDP x 100

Reasons for GDP understating total output

Nonmarket activities, Underground economy, Improved product quality

Nonmarket activities

Stay-at-home parenting or self-repair work completed

Underground economy

Illegal drugs, jobs done for cash and no tax paid

What are other factors that cause GDP to overstate national wellbeing?

Growth of GDP can bring negative by-products like pollution/congestion, social costs are not deducted, environmental degradation, improvements in society, non-economic sources of wellbeing are not included

What do economists define and measure economic growth as?

An increase in GDP occurring over some time period or an increase in GDP per capita occurring over some time period

Real GDP per capita formula

Real GDP / population

What does growth lessen the burden of?

Scarcity

What does rule 70 say about approximate number of years needed to double GDP?

70 / annnual percentage rate of growth

What does growth in Canada not account for?

Improved products and services, added leisure, other impacts

What institutional structures promote modern economic growth?

Strong property rights, patents and copyrights, efficient financial institutions, literacy and education, free trade, competitive market system

Six factors directly affecting direct growth rate and quality

4 supply factors, 1 demand factor, 1 efficiency factor

4 supply factors

Increases in quality and quantity of natural resources, increases in the quality and quantity of human resources, increases in the stock of capital goods, improvements in technology

Allocative efficiency

Producing the goods and services that are most wanted by society

Productive efficiency

Use its resources in the least costly way C

Categories of economic resources

Land, labour, capital, entrepreneurial ability

Land

All natural resources used in production, includes forests, mineral, oil deposits, etc

Human capital

Human skills and knowledge

Capital

All manufactured aids used in producing consumer goods/services like factories, tools, and even intangible ideas like software and designs used to produce goods

Investment

Purchasing of capital goods

Production possibilities model

An economic model that shows different combinations of two goods an economy can produce, assuming full employment, fixed resources and fixed technology

What does producing anywhere on the PPC line indicate?

It means the economy produces the max amount of both products, meaning the economy is efficient

What does producing within the PPC curve indicate?

They are attainable, but they are not efficient as full employment and productive efficiency is not realized

What does producing beyond the PPC curve indicate?

They are not attainable due to limited resources and a fixed technology

Optimal allocation of resources

Occurs at the point where both the quantities of both products maximize satisfaction, achieved when marginal benefit of producing one unit equals the marginal cost

What is required to get a growing economy? (note this can be reflected onto the PPC)

Increase in resource availability, improved resource quality, and technological advances

What is an individual nation limited by?

Its production possibility curve (PPC)

How can a nation overcome its limitations from the PPC?

Through international specialization and trade

How can society increase its real output and income?

1. By increasing its input of factors of production (land, labor, capital, and entrepreneurial ability)

2. By raising the productivity of those inputs

Real GDP formula when given values

Worker hours x labour productivity

% change in GDP

% change in worker hours + % change in productivity

Key productivity drivers

Technology, capital, education, economies of scale, resource allocation

What is the concept of no free lunch?

Everything has a cost, even if not directly to the consumer

Opportunity costs

Value of the next best alternative forgone when resources are used for a particular purpose

Utility

Satisfaction derived from consuming a good or service

Macroeconomics

Studies the overall economy’s performance and behavior, aggregates group individual units (like consumers) into larger categories

Microeconomics

Focuses on decision-making by individual consumers, workers, businesses, examines detailed behavior at a closer level

The Economic Problem

Individuals need to make choices because economic wants are unlimited, but the means to satisfy those wants are limited

Factors of production

Land, labour, capital, entrepreneurial ability

Fallacy of Composition

What’s true for one doesn’t always apply to the whole; avoid generalizing

Phases of the Business Cycle

Peak, Recession, Trough, Expansion

Trough

Output and employment reach rock bottom

Expansion

Real GDP, income and employment rise

What are the key drivers of business cycle fluctuations instead of smooth growth?

Sticky prices and economic shocks

Specifically what sources are linked to shocks that cause business cycles?

Irregular innovation, productivity changes, monetary factors, political events, financial instability

What happens when more money is created than expected?

An inflationary boom in output

What happens when less money is printed than expected?

Output decline and lower prices

Who is considered unemployable due to laws/circumstances?

People who are under 15 and/or institutionalized

How is labour force calculated?

The sum of employed and unemployed individuals

Unemployment rate

Unemployed / labour force x 100%

Frictional unemployment

Short-term temporary period of joblessness that occurs when workers are in the process of switching jobs or enter job market for the first time, and happens when there are labor market inefficiencies

Structural unemployment

Workers’ skills become outdated and do not match new jobs, requiring relocation or retraining

Cyclical unemployment

Unemployment caused by economic downturn (decline in total spending), typically during recessions

What worsens cyclical unemployment and how?

Wage stickiness because it prevents wages from being adjusted downwards in response to economic downturn

What does full employment mean the absence of?

Cyclical unemployment

When does full employment exist?

When ONLY frictional and structural unemployment exist

Potential output

The real output an economy can produce when it fully employs its available resources

The natural rate of unemployment

Reflects the unemployment rate consistent with full employment, where potential output is produced

GDP gap

actual gdp - potential gdp

Negative GDP gap

Occurs when unemployment is above the natural rate

Positive GDP gap

Occurs when unemployment is below the natural rate

Okun’s law

GDP gap = -2 x (actual unemployment rate - natural rate of unemployment)

What does high unemployment linked with/lead to?

Mental health issues, personal decline, skill loss, poverty, social tensions

What was Hitler’s rise in Germany triggered by?

Severe unemployment leading to political unrest

Consumer Price Index (CPI)

An index that measures the prices of a fixed market basket of goods and services that a typical consumer buys

CPI formula

( Price of fixed market basket in a given year / Price of that fixed market basket in the base year ) x 100