Macro Exam 1

Adam Smith’s “Invisible Hand”

Prices guide self-interested households and firms to make decisions that maximize society’s economic wellbeing

Market Economy

Allocates resources through decentralized decisions of individual firms and markets as they interact in markets; prices are determined by the interaction between buyers and sellers, and this has proven remarkably successful in organizing economic activity to promote overall prosperity (USA system)

Property rights

Government enforces property rights and maintains institutions that are key to a market economy. People are less likely to want to work, produce, or invest if there is a large risk of their property being stolen, so the government-provided police ensure the protection of this property

Externality

Outside source of market success or failure (ex. pollution leads to market failure for farmers, new garden leads to market success for nearby vendors)

Market Power

Single buyer or seller has substantial influence on market price, such as a monopoly; the government must regulate the prices of Alabama Power, for example

Phillip’s curve

Society faces a short run tradeoff between inflation and unemployment; for example, during covid, the government printed lots of money to stimulate the economy while unemployment was at an incredible high; the printing of more money caused inflation

Productivity Formula

Output/Hours

Productivity percentage change

((productivity 2-productivity 1)/productivity 1) x 100

Inflation formula

((Price level 2 - price level 1)/price level 1) x 100

2 Roles of economists

Try to explain the world (scientific perspective)

Try to improve the world (policy advisor prospective)

Circular Flow Diagram

Visual model of the economy that displays how dollars flow through goods and services markets and factors of production markets among households and firms

Households

Own factors of production (provide land, labor, and capital to FOP market); buy goods and services

Firms

Buy/hire factors of production, produce goods and services to market and receive revenue in return

Markets for goods and services

Buy goods and services from firms, sell them to households

Markets for Factors of Production

Buy factors of production from households; sell to firms

Positive Statement

Descriptive; attempts to describe the world as it is

Normative Statement

Prescriptive; attempts to prescribe how the world should be

Gross Domestic Product

Market value of ALL goods and services produced within a country over a given period of time

Value added formula

Value of output - Value of intermediate good

Gross National Product

Total income earned from any good produced by a US citizen, whether they were within the country or not

Personal Income (PI)

income that households and noncorporate businesses receive

GDP Deflator

Nom GDP/Real GDP x 100

Inflation Rate Formula

((Year 2 Deflator - Year 1 Deflator)/Year 1 Deflator) x 100

Consumer Price Index

Measure of the overall price of goods and services bought by a typical consumer; (cost of basket good in current year/cost of basket goods in base year) x 100

CPI Inflation Formula

((CPI current year-CPI last year)/CPI last year) x 100

Substitution Bias

Consumers substitute towards goods that become relatively cheaper, and CPI misses this

Core CPI

Change in prices excluding food and energy

CPI vs GDP Deflator

CPI uses a fixed basket while GDP includes all goods and serviced produced in the US; capital goods are not reported in CPI while imported gas and oil are not reported in GDP

Correcting Variables

Year T Dollars x (CPI price level now/CPI price level year t)

Regional Differences in Prices

Mainly due to housing services, also due to service prices, and less so due to prices of goods

Indexation

Contractual concept that a dollar amount (like one’s salary) will automatically correct overtime for inflation

Interest Rate

Rate of growth in the dollar value of a deposit or debt (nominal is not corrected for inflation, real is corrected and shows true rate of growth in purchasing power)

Real Interest Rate Formula

Nominal Interest Rate - Inflation Rate