Econ Macro Midterm 2

Three Labor Market Indicators

• the unemployment rate

• the employment to population ratio

• the labor force participation rate

unemployment rate

the percentage of the labor force that is unemployed

(number of people unemployed / labor force) * 100

The unemployment rate increases

in a recession

Employment-to-population ratio

the percentage of the working-age population who have jobs

(employment / working-age population) * 100

labor force participation rate

the percentage of the working-age population who are members of the labor force

(labor force / working-age population) * 100

marginally attached worker

a person who currently is neither working nor looking for work but has indicated that he or she wants and is available for a job and has looked for work sometime in the recent past

discouraged worker

a marginally attached worker who has stopped looking for a job because of repeated failure to find one

Unemployment classification:

• frictional unemployment

• structural unemployment

• cyclical unemployment

Frictional unemployment

unemployment that arises from normal labor market turnover, is permanent and healthy for a growing economy

Structural Unemployment

unemployment created by changes in technology and foreign competition that change the skills needed to perform jobs or the locations of jobs, lasts longer than frictional unemployment

Cyclical Unemployment

higher than normal unemployment at a business cycle trough and lower than normal unemployment at a business cycle peak

“Natural” Unemployment

unemployment that arises from frictions and structural change when there is no cyclical unemployment, is all frictional and structural

Potential GDP

the quantity of real GDP produced at full employment

output gap

real GDP - potential GDP

price level

the average level of prices and the value of money

inflation

persistently rising price level

deflation

persistently falling price level

We are interested in the price level because we want to…

1. Measure the inflation rate or the deflation rate

2. Distinguish between money values and real values of

economic variables.

A rise in price, other things remaining the same

decrease in quantity demanded and movement up along demand curve

A fall in price, other things remaining the same

increase in quantity demanded and movement down along the demand curve

Economic Growth Rate

annual percentage change of real GDP

Real GDP per person

real GDP divided by population

How can Real GDP increase?

• The economy might be returning to full employment in an expansion phase of the business cycle.

• Potential GDP might be increasing.

Rule of 70

that the number of years it takes for

the level of a variable to double is approximately

70 divided by the annual percentage growth rate of the

variable.

Economic growth occurs when

real GDP increases

To determine potential GDP we use a model with two

components:

• An aggregate production function

• An aggregate labor market

aggregate production function

how real GDP changes as the quantity of labor changes when all other influences on production remain the same

real wage rate

the money wage rate divided by the

price level.

supply of labor

shows the quantity of labor supplied and the real wage rate

At the labor market equilibrium

the economy is at full employment.

What Makes Potential GDP Grow?

• Growth in the supply of labor

• Growth in labor productivity

Aggregate hours

the total number of hours worked by all the

people employed

Aggregate hours, the total number of hours worked by all the

people employed, change as a result of changes in:

1. Average hours per worker

2. Employment-to-population ratio

3. The working-age population growth

An increase in population

increases the supply of labor.

Labor productivity

he quantity of real GDP produced by an hour of labor, equals real GDP divided by aggregate labor hours

Physical Capital Growth

The accumulation of new capital increases capital per

worker and increases labor productivity.

Human Capital Growth

Human capital acquired through education, on-the-job

training, and learning-by-doing is the most fundamental

source of labor productivity growth.

Technological Advances

Technological change—the discovery and the application of

new technologies and new goods—has contributed

immensely to increasing labor productivity.

Classical growth theory

the view that the growth of real

GDP per person is temporary and that when it rises above

the subsistence level, a population explosion eventually

brings real GDP per person back to the subsistence level.

Neoclassical growth theory

the proposition that real

GDP per person grows because technological change

induces a level of saving and investment that makes capital

per hour of labor grow.

New growth theory

holds that real GDP per person grows

because of choices that people make in the pursuit of profit

and that growth can persist indefinitely

Two further facts play a key role in the new growth theory:

• Discoveries are a public capital good.

• Knowledge is not subject to diminishing returns.

Study of Finance

how households and firms

obtain and use financial resources and how they cope with

the risks that arise in this activity

Study of Money

how households and firms use

it, how much of it they hold, how banks create and manage

it, and how its quantity influences the economy

Capital (or physical capital)

the tools, instruments,

machines, buildings, and other items that have been

produced in the past and that are used today to produce

goods and services.

financial capital

the funds that firms use to buy physical capital

Gross investment

the total amount spent on purchases

of new capital and on replacing depreciated capital

Depreciation

the decrease in the quantity of capital that

results from wear and tear and obsolescence.

Net Investment

the change in the quality of capital

gross investment - depreciation

Wealth

the value of all the things that people own

Saving

the amount of income that is not paid in taxes or

spent on consumption goods and services, saving increases wealth

These funds are supplied and demanded in three types of

financial markets:

• Loan markets

• Bond markets

• Stock markets

financial institution

a firm that operates on both sides

of the markets for financial capital. It is a borrower in one

market and a lender in another.

Funds come from three sources:

1. Household saving S

2. Government budget surplus (T - G)

3. Borrowing from the rest of the world (M - X)

nominal interest rate

the number of dollars that a

borrower pays and a lender receives in interest in a year

expressed as a percentage of the dollars borrowed and lent

real interest rate

the nominal interest rate adjusted to

remove the effects of inflation on the buying power of money.

Real Interest Rate = nominal interest rate - inflation rate

market for loanable funds

the aggregate of all the

individual financial markets

demand for loanable funds

the relationship between

the quantity of loanable funds demanded and the real

interest rate when all other influences on borrowing plans

remain the same

The quantity of loanable funds supplied depends on

1. The real interest rate

2. Disposable income

3. Expected future income

4. Wealth

5. Default risk

supply of loanable funds

the relationship between

the quantity of loanable funds supplied and the real interest

rate when all other influences on lending plans remain the

same

A government budget surplus

increases the supply of funds.

A government budget deficit

increases the demand for funds.

The Ricardo-Barro effect

an economic theory suggesting that demand remains unchanged when a government tries to stimulate an economy by increasing debt-financed government spending.

Net present value

the present value of all the future flows

of money that arise from a financial decision minus the initial

cost of the decision

net worth

the total market value of

what it has lent minus the market value of what it has

borrowed