Macroeconomics Exam 2 Part 1

Intermediate Good

all the things we ue to make a final good, excluded from GDP

Final Goods

what we get when we buy a good from the store, we account for the value of these goods in GDP

Goods and Services

anything we pay money for

Goods and services only count towards the GDP of

the country they are produced in

CPI (consumer price index)

measures the change in price of goods for a family of 4 in an urban area, based on a basket of goods which is defined using the base year

CPI Formula

[ Price basket current year / Price Basket base year ] x 100

Base year of CPI is always

100

Growth rate in CPI measures

inflation

Growth rate in CPI

[ CPI new - CPI old / CPI old ] x 100

Private Consumption

includes all the final good and services that we buy, 2/3 of U.S. GDP

Goods

physical stuff we buy, doesn’t include used or intermediate goods

(ex: tacos, cars)

Services

intangibles that are provided to consumers (ex: doctor appointment, legal advice)

Investment

• includes Fixed Business Investments + Residential Investments

• does not include Stocks and Bonds

• accounts for 15-20% of U.S. GDP

Fixed Business Investment

• business spending: new factories for a company, new machinery, new equipment, new inventory

• money used by firm to maintain/expand business

Residential Investment

new homes, investment that grows in value

Stocks and Bonds (financial investments) are not counted in GDP because

they do not create value

Government Spending

• almost all money spent by the government

• 15-20% of U.S. GDP

• includes local + state + federal spending

• gov’t must receive something in return for what they are paying (ex: gov’t pays for a bridge)

• does not include Transfer Payments (TR)

Transfer Payments

government spending that doesn’t receive anything in return (ex: SSR, unemployment benefits, etc)

Net Exports (NX)

• value of (X) export -(M) import

• accounts for about -5% of U.S. GDP

Trade Deficit (-NX)

when exports are less that imports

Trade Surplus (+NX)

when exports are greater than imports

Flaws in GDP calculations

Does not account for

• underground economy (ex: $ made mowing lawn or selling weed)

• household production

Gross National Product (GNP)

“Who makes it?”, values the goods and services produced by U.S. companies regardless of where

(ex: Ford makes trucks in China → US GNP but China GDP)

Gross Domestic Product (GDP)

“Where is it made"?”, values all goods and services produced IN the U.S.

(ex: Indian company makes soap in US → US GDP but India GNP)

Nominal GDP

uses current prices and quantities to that time period

Real GDP

accounts for price changes over time, uses target year quantity and base year prices (GDP = PQ)

Economic Growth

the sustainable expansion of production possibilities

Per Capita

“per person”, GDP / # ppl

Growth rate of GDP

[ (GDP current - GDP old) / (GDP old) ] x 100

GDP Per Capita

GDP / population

Growth rate of GDP Per Capita

[ (GDP Per Capita current - GDP Per Capita old) / (GDP Per Capita old) ] x 100

Growth rate in GDP per Capita

GDP growth rate - population growth rate

Rule of 70

time it takes GDP / GDP per capita to double, 70 / growth rate

Income Approach

add up all money made on the sale of final goods and service in the economy

Income Approach finds GDP through sum of

• Proprietors income

• Corporate profits

• Net interest income

• Rental income

• Employee compensation

• Indirect taxes less subsidies

• Depreciation

Net Operating Surplus is the sum of

• Proprietors income

• Corporate profits

• Net interest income

• Rental income

Compensation to Entrepreneurship is a sum of

• Proprietors income

• Corporate profits

• Net interest income

• Rental income

• Employee compensation

Proprietors’ income

small money proprietorship income (ex: lemonade stand income)

Corporate profits

profits made from corporations

Net interest income

make interest on investments

Rental income

money made from renting properties

Employee compensation

healthcare, life insurance, car and phone if paid by company

Indirect taxes less subsidies

paid goods that have taxes on them - money paid by govt to companies

Indirect taxes

paid goods that have taxes on them

Subsidies

money paid by govt to companies

Inflation

increasing prices (CPI rises)

Deflation

decreasing prices (CPI falls)

Cost of Living Adjustment (COLA)

used by govt to adjust social security and govt salaries, increases benefits to counteract inflation

Interest rates

interest rate on loans are impacted by the percentage of price change

Government expects inflation of about

2%

Real Interest Rate Formula

Nominal interest rate - Inflation rate

Biases in CPI

• Substitution Bias

• Quality Bias

• Outlet Bias

Substitution Bias

when prices of goods go up, we tend to buy other products → CPI is too high

Quality Bias

many goods increase in quality over time, CPI is too high

Outlet Bias

people change where they buy from, CPI is too high (ex: Amazon vs. local store)

Population

everyone in the entire country

Working age population

Anyone age 16 and over

Employed

someone who has worked for pay with the last week

Unemployed

someone who does not have a job but wants a job

• has applied for a job in the last 4 week (OR)

• has signed a contract to start a job in the next 30 days (OR)

• has been laid off and expects to be rehired by previous employer

Discouraged workers

someone who initially wanted to work but then gave up

Labor Force

those who want work, includes employed and unemployed

Not in labor force

does not want to work, includes discouraged workers and unavailable (ex: students, stay at home parents, etc.)

Labor Force Participation Rate

[ # ppl in Labor force / # ppl in Working age population ] x 100

of everyone who can work, how many want to work?

Unemployment Rate

Unemployed / Labor Force x 100

Employment to Population Ratio

[# employed / working age population ] x 100

Frictional Unemployment

• finding the “perfect job”

• good for economy

• generally lasts less than 12 months

• takes time to match your skills with employer’s needs

Structural Unemployment

• people who have lost their jobs due to new technology or businesses

• the economy no longer needs their skills

• good for economy

• generally lasts more than 12 months

Seasonal unemployment

• employees who get work only during seasonal events (ex: Halloween, Christmas, etc.)

• under structural employment

Cyclical Unemployment

• unemployment that happens due to changes in business cycle

• bad for the economy

Cyclical Unemployment > 0

recession

Cyclical Unemployment < 0

expansion

Bureau of Labor Statistics (BLS)

government organization that collects data

Underemployment

people who are not using all their skills or aren’t using their skills to their best ability (ex: doctor working at Starbucks), not covered in the unemployment rate

Natural Rate of Unemployment

• aka full employment

• the rate of unemployment when cyclical unemployment is 0

• frictional + structural unemployment

When the cyclical rate is positive, unemployment is

> than the natural rate of unemployment

When the cyclical rate is positive, economy is in a

recession

When the cyclical rate is negative, unemployment is

< than the natural rate of unemployment

When the cyclical rate is negative, economy is in a

expansion

If you lose your job during a recession, you are experiencing ___________ unemployment

cyclical

If the actual unemployment rate is lower than the natural rate of unemployment, then real GDP is _______ potential GDP

greater than

Economic Growth

calculate the overall growth rates in a country’s potential GDP or in a country’s potential GDP per capita

Potential GDP (Potential Output)

the level of economic output that an economy can produce most efficiently at full employment

Rule of Law

poor laws make it difficult for economic growth to occur

Policies that foster economic growth

• Rule of Law

• Stimulate savings

• Promote research and development

• Invest in education and healthcare

• Promote trade

• Bring women into the workforce

Economic growth in sustainable increases in the

PPF (production possibilities frontier)

Production Function

how much stuff we can produce using a certain amount of capital and labor

Increase in Labor Supply

as more people work, the amount of total production increases

How do you increase labor supply

• increase number of working hours

• increase working age population

• increase employment to population ratio

Increase in Labor Productivity

workers can produce more goods and services over a given amount of time

How do you increase labor productivity?

• increase in human capital (better healthcare, better education)

• Increase physical capital (machinery)

• Increase in savings + research and development

Classical Growth Theory

• economic growth results from population growth

• any increase in real GDP per person is temporary

• DUMB + OUTDATED

Neoclassical Growth Theory

• Real GDP per person growth in the economy happens when technological change improves productivity + increases savings rates

• believes that technology increases due to random chance

• ALRIGHT, NOT BEST

New Growth Theory

• technological advancement is determined by people who are profit driven, not random chance

• emphasizes that innovation and technology are key drivers of economic growth