ECON 202 - Midterm Quiz Review Flashcards

Flashcards covering key vocabulary and definitions from the Macroeconomics Midterm Quiz Review.

Inflation

The rate of growth of the price level.

Economic growth

The growth of total output (GDP).

Unemployment

Fraction of labor force without a job.

Nominal GDP

The sum of all final goods and services produced in the economy, in a given year, using current prices in the national currency.

Consumer Price Index (CPI)

An index number which gives the average cost of living in the economy in a given year.

CPI Formula

Cost of market basket in given year / Cost of market basket in base year × 100

Real GDP Growth (Simple Formula)

GDP Growth ≈ Nominal GDP Growth − Inflation

Real GDP per capita

Real GDP / Population

Goals of Macroeconomic Stabilization

Promote long-run growth, curb unemployment, and stabilize prices (low inflation).

Potential GDP

Real GDP economy would produce with labor force & other resources fully employed.

Unemployment Rate

Unemployed Individuals / # Individuals in Labor Force

Frictional unemployment

Due to normal turnover in the labor market; people who are temporarily between jobs.

Structural unemployment

Workers displaced by automation; their skills are no longer in demand.

Cyclical unemployment

Portion of unemployment that is attributable to a decline in the economy’s total production; rises during recessions, and falls during expansions.

Problems with Inflation

Erodes the purchase power of wages, uncontrolled and arbitrary redistribution of wealth across consumers, harder to forecast future (real) well-being, high inflation lowers the real return from financial investments (and savings).

Real Interest Rate

Nominal Interest Rate − Inflation

Aggregate Demand

Total amount all consumers, business firms, & government agencies spend on final goods and services.

Components of Aggregate Demand

Consumer expenditure (C), Investment spending (I), Government purchases (G), Net exports (X-IM)

National Income

Total income generated by all individuals in the economy (wages, interest payments, rents, profits), excluding government transfer payments, before taxes / deductions.

Disposable Income (DI)

Total income by all individuals in the economy – After taxes (deducted) – After transfer payments (added).

Consumption Function

Relationship between Total consumer expenditures and Total disposable income.

Marginal Propensity to Consume (MPC)

The change in consumption / Change in disposable income that produces the change in consumption; the slope of the consumption function.

Unemployment rate

Share of active population actively seeking jobs that can not get one

Potential GDP

Full-employment level of output

Full employment

everybody who is willing and able to work finds a job (zero cyclical unemployment)

Spending Multiplier

ratio of Change in equilibrium GDP (Y) to the original change in spending.

Aggregate supply (AS) curve

quantity of goods & services, all nation’s businesses are willing to produce, in a specific period, at any given price level

Fiscal Policy

government’s plan for spending & taxation

Federal Budget (𝐹𝐵)

total tax revenues - government spending

Expansionary Fiscal Policy

aims at increasing real activity to close a recessionary gap;

Raise government purchases (“G” up)

Reduce taxes (“T” down)

Increase transfer payments (“T” down)

Limitations of price index (CPI)

Does not account for changing relative prices

Index only for the “average” family

Infrequent basket updating

Limitations of GDP

Not a measure of nation’s economic well-being

Includes only market activity

Places no value on leisure

Counted: “Bads” and “Goods”

Ecological costs are not deducted from GDP

Does not take into account inequalities

Does not distinguish between government expenditure, investments, etc…

Does not take into account political freedom and democracy

Factors that shift the Consumption Function

Financial/Real Estate Wealth

Price Level

Interest Rates

Future Income Expectations

Recessionary Gap

Equilibrium GDP < Potential GDP

Inflationary Gap

Equilibrium GDP > Potential GDP

Closing a Recessionary Gap

Lower Prices (higher consumptions

Higher Wealth (higher consumption)

Exchange Rate Depreciation (higher NX)

Closing an Inflationary Gap

Increasing Prices (lower consumption) Lower Wealth (lower consumption) Exchange Rate Appreciation (lower NX)

Spending Multiplier

1 / (1 - MPC)

Tax Multiplier

-MPC / (1 - MPC)

AS Shifts

Nominal wage rate increase

Prices of other inputs increase

Technology & productivity improve

Higher/better supply of labor & capital

Contractionary Fiscal Policy

aims at lowering real activity to close an inflationary gap;

Reduces government purchases (“G” down)

Increases taxes (“T” up)

Reduces transfer payments (“T” up)

Limits of Fiscal Policy Decisions

Multipliers are not precisely known

The target of full-employment GDP is hard to measure, and might change as well

Fiscal policies operate with some time lags

total output/expenditure

total national income =

C + I + G + (X - IM)

total expenditure =

Determinants of NX

Income levels

• If GDP rises → Imports (IM) rise

• If GDP falls → Imports (IM) fall

• Exports (X) are relatively insensitive to our GDP, while they respond to foreign GDP

Relative prices

• Domestic prices increase → Net exports decrease

• Domestic prices decline → Net exports increase

• Foreign prices increase → Net exports increase

• Foreign prices decrease → Net exports decrease

Why is inflation a problem?

Erodes the purchase power of wages: it is a regressive tax!

Uncontrolled and arbitrary redistribution of wealth across consumers

Harder to forecast future (real) well-being

High inflation lowers the real return from financial investments (and savings)