Economics

Price Level

Price Level

A weighted average of the prices of all goods and services

Price Index

A measure of the price level

Consumer Price Index (CPI)

• A widely cited index number for the price level; the weighted average of prices of a specific set of goods and services purchased by a typical household.

• Calculated (Total dollar expenditure on the market basket int the current year/Total dollar expenditure on the market basket in the base year)*100

Base Year

The year was chosen as a point of reference or basis of comparison for prices in other years; a benchmark year.

Changes in Prices

Calculated by subtracting CPI from the later year and earlier year, dividing the value by the earlier value of the CPI, and multiplying by 100.

Inflation

An increase in the price level and is usually measured annually. The inflation rate is the positive percentage change in the price level on an annual basis.

Real Income

• A person’s nominal income (current income) is adjusted for any price change.

• Is computed as follows: =(Nominal Income/CPI)*100

GDP Implicit Price Deflator

• Is asked upon all goods and services produced in a economy

• CPI is based on a representative group of goods and services purchased by typical household

Unemployment

• The total population of the United States can be divided into two broad groups which are…

• One group consists of persons who are: under 16 years of age, in the armed forces, or institutionalized

• The second group, which consists of all others in the total population, is called the civilian non-institutional population.

• People available for work but not employed in the last 4 weeks

• Job losers, job leavers, re-entrants, new entrants

Employed

• People who did any work for profit

• People who contribute to a family business without pay for 15 hours or more

• People who are temporarily absent from work

Unemployment rate

• Percentage of the civilian force that is unemployed

• This can be found by dividing the number of unemployed people by the civilian labor force

Labor force participation rate

• The percentage of the civilian non-institutional population that is in the civilian labor force

• This can be found by dividing the civilian labor force by the civilian non-institutional population

Discouraged Workers

• They are former workers, not actively looking for employment or looking to work.

• Counted as unemployed

Frictional unemployment

• Unemployment is caused by things that impact the economy and market

• Mostly related to people finding jobs that match their skillset

Structural unemployment

• Unemployment due to the elimination of some jobs which create other jobs for those who are unemployed don’t qualify for

Natural Unemployment

• Unemployment caused by frictional and structural factors in the economy

• Unemployment that exists when an economy is operating at its full capacity

• Frictional unemployment+Structural unemployment

Full Employment

The condition that exists when the unemployment rate is equal to the natural unemployment rate

Cyclical Unemployment Rate

The difference between the unemployment rate and the natural unemployment rate

Gross Domestic Product (GDP)

• The total market value of all final goods and services produced annually within a country’s borders.

• Can be calculated through different approaches (Income, expenditure, and value-added)

• Non-market goods, illegal, sales of used goods, trading of stocks, government payments (Social Security), and leisure time.

Expenditure Approach

• Add the amount of money spent by buyers of final goods and services

• Avoid double counting

• Do not count intermediate goods

• Is the goods in the hands of their final users

• Has 4 sectors (Household, Business, Government, and Foreign)

Double Counting

An error that occurs when a total is obtained by summing gross amounts instead of net amounts

Income approach

• Add the summer of all incomes earned in producing goods and services

• Total purchases equals GDP and total purchases equals total income, GDP equals total income

Value-added approach

Add the value added at each stage of production of all goods and services

GDP and Bads argument

• GDP does not include the negative effects of goods

• Some argue that not including negative effects makes GDP unreliable and overstates our economic welfare

Household Sector

• Involves consumption of household goods

• This can be food, housing, education, investments, savings, etc

• Durable goods, non durable, and services

Business Sector

• Involves investments

• Talks about business investing in equipment, production, profits, and employment.

Government Sector

• Involves government purchases

• Involves the spending of goods and services by the government

• Government investments in infrastructure like bridges, roads, etc

• Transfer payments like social security, unemployment, and welfare are excluded from GDP

Foreign Sector

• Talks about net exports

• Brings up exports, imports, and foreign investments

• Imports are subtracted from the GDP as they represent spending

• Exports are added to the GDP as its income generated

Durable goods

Durable goods are goods that are expected to last for more than 3 years, such as appliances

Non-durable goods

Non-durable goods are goods that are not expected to last for more than three years, such as food

Services

Not physical goods, such as entertainment services

Fixed investment

Newly produced capital goods, business purchases of capital goods, such as machinery and factories

Inventory Investment

Changes in business inventories (stock of unsold goods)

Beureu of Economic Analysis

• Agency of the U.S. department of commerce.

• Assembles data which is used to calculate GDP

National Income

• Total income earned by U.S. citizens and businesses no matter where they reside or are located

• National income is the sum of the payments to resources (Land, labor, capital, and entrepreneurship)

• Proprietor income + Corporate profits + Rental income + Net interest

Compensation of Employees

Wages and salaries paid to employees plus employers contributions to social security and employee benefit plans, etc

Proprietors Income

Include all forms of income earned by self-employed individuals and the owner of unincorporated business including unincorporated farmers

Corporate profits

Corporate profits include all the income earned by the stockholders of corporations

Rental Income

• Rental income is the income received by individuals for the use of their non-monetary assets (land, houses, offices)

• It also includes returns to individuals who hold copyrights and patents

• Finally, it includes an impute value to owner-occupied houses

Net interest

The interest income received by the U.S. households and governments minus the interest they paid out

National Income to GDP

• Doesn’t include income earned from the rest of the world

• Involves income armed by the rest of the world, indirect business taxes, capital consumption allowance (depreciation, and statistical discrepancy (variations in data)

Depreciation (GDP terms)

• The estimated amount of capital goods used up in production through natural wear, obsolescence, or destruction

Net Domestic Product (NDP)

• Measures the total value of new goods available in the economy in a given year after worn-out capital goods gave been replaced

• GDP - Depreciation/Capital consumption allowance

Personal income

• Equal to national income if…

• Undistributed corporate profits, social insurance taxes, and corporate profits taxes aren’t counted

• Transfer payments are counted

Disposable Income

Equal to personal income - personal taxes

Real GDP

• The value of the entire output produced annually within a country’s borders, adjusted for price changes (Inflation)

• = The summation of base year prices multiplied by current year quantities

• = C+I+G+(X-M)

Economic Growth

is measured by increases in Real GDP

Percentage change in Real GDP

• Real GDP of later year - Real GDP of earlier year, divided by Real GDP earlier year, all multiplied by 100

Business Cycle Peak

• At the peak of the business cycle, Real GDP is at a temporary high

Business Cycle Contraction

Represents a decline in Real GDP

Business Cycle Trough

• The low point in Real GDP, just before it begins to turn up

Business Cycle Recovery

• The recovery is the period where real GDP is rising. It begins at the through and ends at the initial peak

Business Cycle Expansion

• The expansion phase refers to increases in Real GDP beyond the recovery. In the exhibit, it refers to increases in real GDP above Q

Business Cycle Recession

• Two consecutive quarter declines in Real GDP constitutes a recession

• The best way to describe is a continuous drop in the linee

• Can also be identified as a period of time between a peak and a through, lasting months to more than a year

Pareto efficiency/optimality

An economic state is where resources are allocated most efficiently, and it is obtained when a distribution strategy exists in which one party’s situation cannot be improved without making another party’s situation worse.

Pareto Optimal Outcome

• Cannot be improved upon without hurting at least someone else

Pareto improvement

• An action done in an economy that harms no one and helps at least one person.

Aggregate Demand

• The buying side of the economy

• The quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus

Aggregate supply

The producing side of the economy

Short-run aggregate supply

Is the production in the short run

Long-run aggregate

Supply is production in the long run

Aggregate Demand Curve

• A curve that shows the quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus.

• The aggregated demand curve is downward sloping specifying an inverse relationship between the price level and the quantity demanded of Real GDP

Real Balance Effect

• The change in the purchasing power of dollar-denominated assets that result from a change in the price level

Monetary Wealth

• The value of a person’s monetary assets.

• Readily available resources/money

Wealth

• Different from monetary wealth, refers to the value of all assets owned, both monetary and non-monetary

• As this value goes up, consumption increases and so does aggregate demand, as it falls so does consumption and aggregate demand

Purchasing Power

• The quantity of goods and services that can be purchased with a unit of money. Purchasing power and the price level are inversely related

Interest Rate Effect

• The change in foreign sector spending as the price level changes

Change in Quantity Demanded

• In terms of Real GDP

• Result of a change in the price level

• Graphically represented through the movement of a point on the aggregate demand line

• Real Balance, Interest Rate, and the International Trade Effect all have an impact on the change in the quantity demanded

Change in Aggregate Demand

• Graphically shown as a shift in the aggregated demand curve from aggregate demand line 1 to aggregate demand line 2

• Caused by a change in spending

• GDP=C+I+G+(X-M)

C

• Stands for Consumption

• Manipulates aggregate demand through wealth, price, income, interest rate, income tax

• One of the biggest functions in total spending

• Depends on disposable income

I

• Stands for Investment

• Influences aggregate demand through interest rates, future sales, and business taxes

• As interest rates fall, prices of an investment project fall, encouraging aggregate demand and business investment. This works vice versa as well.

G

• Stands for government spending

X

• Stands for Exports

M

• Stands for Imports

Net Exports

• Is the value of exports minus imports

• Influences GDP through foreign real national income and the exchange rate

Depreciation (Exchange Rate)

• A decrease in the value of one currency relative to other currencies

• Occurs when the exchange rate goes down in the market in relation to another currency; less purchasing power

• Countries with floating exchange rates see this phenomenon as their exchange rate is influenced by global investment

Appreciation (Exchange Rate)

• An increase in the value of one currency relative to other currencies

Devaluation

• This happens in countries with a fixed exchange rate when the government decides what the currency is worth in comparison to other countries.

• It isn’t as popular as it demands a strict exchange rate and the country needs to buy and sell its currency to keep a fixed exchange rate

• Popular before the great depression

Velocity

• The average number of times a dollar is spent to buy final goods and services in a year

Short Run Aggregate Supply (SRAS) curve

• A curve that shows the quantity supplied of all goods and services (Real GDP) at different price levels, Ceteris Paribus

• Upward sloping, specifying a direct relationship between the price level and the quantity supplied of Real GDP

• Slopes upwards due to sticky wages and worker misconceptions

• Affected by Wage rates, prices of non labor inputs, productivity, supply shocks

• Non labor inputs, a positive impact will shift the line right, negative vice versa

Sticky Wages

• Refers to wages that don’t adjust quickly enough to compensate for economic conditions such as inflation

• Wages are locked dude to labor contracts, social conventions, or notions of fairness

• An increase in its price level will result in an increase in the output of goods, as the price level rises the quantity supplied of goods and services rises

Real Wage

• This can be found by dividing the nominal wage by the price level

• As it increases the quantity of labor supplied also increases and vice versa

• A Lower wage rate results in a shift of the SRAS line towards the right, and vice versa

Worker Misconceptions

• The works misconception of what their real wage is and how it changes

• This is demonstrated by an upward sloping SRAS curve

• This will ultimately affect production and it will begin to drop

Wage Rates

• Is impacted by the rise or fall equilibrium

• This can be understood through profit per unit price per unit - cost per unit

• Higher wage rates = Higher costs = Less wanting to produce goods works vice versa

Productivity

• The output produced per unit of input employed over some period of time

• An increase cause a rightward shift in the SRAS curve

• A decrease causes a leftward shift in the SRAS curve

Supply Shocks

• Natural or institutional changes that affect aggregate supply

• Could be hurricanes, for example, effecting production or just a general decline in production

• Negative impacts cause a leftward SRAS curve and vice versa

Short Run Equiblirum

Where the aggregate demand and the SRAS curve both meet

Long Run Aggregate Supply (LRAS)

• A vertical line at the level of natural Real GDP

• Is the representation of Economic production after all adjustments have taken place such as misconceptions and adjustments

Long-run Equilibrium

• The condition that exists in the economy when wages and prices have adjusted to their final equilibrium

• Is visualized with the AD line intersecting the LRAS line

• Can also be used to represent the potential output of the economy

Short-Run Equilibrium

• When the SRAS line and AD lines intersect

• When real GDP equals the short run quantity supplied

Classical Economics

• An era of economics during the 1750s-1900s

• Ideas and concepts are still used to this day from this era

Say’s Law

• Supply creates its own demand. The production created demand sufficient to purchase all goods and services produced.

• The law implies there cant be under or over-production, as something is always expected in return for a good or service, which holds more true in a barter economy than in money

• Consumption drops, supply rises; so investment increases subsequently

Recessionary (Contractionary) Gap

• Real GDP is less than Natural Real GDP

• The unemployment rate is greater than the natural unemployment rate

• Usually in short-run equilibrium

• Whenever Q1 is more leftwards in comparison to Qn

Inflationary (Expansionary) Gap

• Real GDP is greater than Natural Real GDP

• The unemployment rate  is less than the natural unemployment rate

• Usually in short-run equilibrium

• Whenever Q1 is more rightwards in comparison to Qn

Long-Run Equilibrium

• Real GDP is equal to Natural Real GDP

• The unemployment rate is equal to the natural unemployment rate

• Q1 = Qn

• The economy is producing its natural real GDP or potential output

Physical PPF (Production Possibilities Frontier)

• Illustrates different combinations of goods the economy can produce given the physical constraints of finite resources and the current state of technology.

• Can never be operated beyond as it is considered the most resources available

• Institutional PPF (Production Possibilities Frontier)

• Illustrates different combinations of goods in the economy given that there are finite resources and with the current state of technology BUT with the addition of institutional constraints 

• Will tend to be lower/smaller than the physical PPF as now there are more overall constraints 

• If the economy operates beyond this, then the unemployment rate in the economy is lower than the natural unemployment rate

• Can always be operated beyond as constraints are never truly effective

• The economy at a natural unemployment rate if located on its PPF, due to the efficient use of resources

Closing Recessionary Gap

• Wage rates fall, SRAS1 moves rightwards to SRAS2

• Price level falls and other factors like real balance, interest rate, and international trade effects increase the demand of Real GDP

• SRAS eventually intercepts at LRAS, creating a long-run equilibrium

Laissez-faire

A public policy not interfering with market activities in the economy

Business Cycle Macroeconomics

Business cycle macroeconomics can be described as changes in real GDP with a fixed LARS curve