ECON 2105 Midterm 2

Gross Domestic Product (GDP)

market value of all final goods and services produced in a nation during a specific period

Per capita GDP

GDP per person

Inflation

is the growth in the overall level of prices in an economy

Real GDP

is GDP adjusted for changes in prices (inflation)

Recession

are short-term economic downturns that typically last about 6 to 18 months.

which gdp is about current prices?

nominal

Price Level

an index of the average prices of goods and services throughout the economy

Federal Debt

the total public debt as a percent of the GDP. Direct correlation.

Per capital GDP

GDP/Population
Compares the people within an economy more accurately than regular GDP

Names of Methods to Calculate GDP

1) Market Value
2)Expenditure Method

Market Value Method

Defining GDP by the market value of all final goods and services produced in a country during a given period.

Market Value \=

price x the quantity of all goods

"final goods and services"

focus on not counting a product twice in the GDP calculation by waiting till dec 31st to count merchandise inventory

"produced in a country"

A product is not counted in the GDP unless it is the country's product made in that country.

"during a given period"

GDP can only be calculated for a specific time period. Typically a year or a quarter (3 months)

The Expenditure Method (\=)

(C) Consumption
(I) Investment
(G) Government Purchases
(NX) Net Exports
\= GDP (Y)

Y\= C+I+G+NX

Consumption

spending by household that can be a Durable good, Nondurable good, or a service.

Durable goods

things that are expected to last over a year
Ex. Furniture

Nondurable goods

things that are either consumed immediately or not expected to last for a year.

Investment

-spending on capital
-physical capital used for future production

Business Fixed Investments

machines, factories, intellectual property.

Residential Investments

-spending by consumers & landlords
-new homes and apartments

Inventory investment

the change in value of all firm's inventories

Government spending examples

Ex. Buildings, tanks , missiles , teachers, trash cans.

Net Export Equation

exports- imports

Exports

goods produced here and sold abroad

Imports

goods produces abroad and bought here

GDP Deflator

is a calculation of price level used to determine the real GDP.

Nominal GDP \=

price x quantity

Real GDP\=

real gdp \= nominal gdp/deflator

GDP Deflator \=

(Nominal GDP/ real GDP) x 100

equations for growth in nominal GDP and growth in real GDP

nom: growth in real GDP+ growth in price level ......real: growth in nominal GDP - growth in price level

Issues with GDP

1) Non- market Goods and Services
2) Underground or Illegal Markets
3)No Value for Standard of Living

Non-Market Goods and Services

Doing things yourself instead of paying services to do them for you does not count into the GDP
ex: not hiring someone to do a home project

No Value for standard of Living

does higher GDP \= better standard of living?/ what are the trade- offs of having a higher GDP

Deflation

decrease in overall price level

Inflation causes issues such as...

1) price confusion
2) cost of holding money
3)Money illusion
4) menu costs
5) wealth redistribution and tax distortion

Inflation & Uncertainty

uncertainty in future prices causes banks to increase interest rates making people less inclined to borrow.

Supply and Demand of Funds Markets

Demand\= people looking to spend money now
Supply\= people looking to spend their money later but save today.

Nominal Interest Rate

interest rate without inflation adjustment

Rule of 70

estimates how long it takes to double, given a constant growth rate
70/ x

Resources and Productions

Natural Resources
Human Capital
Physical Capital
Technology & Production

Institutions of Growth

-property Rights
-Government stability
-Government regulations
-Innovation

Diminishing MP

marginal product falls as input (K) increases

steady state

no new net investments

Convergence

concept that over time, per capita GDP and Real GDP should be equal

how to find % change in real GDP?

% change in nominal GDP - % change in price

6 phrases to remember about GDP

1. market value
2. of all
3. final goods and services
4. produced
5. within a country
6. in a year

three ways to calculate GDP

-Add every dollar of output produced
-Add every dollar of spending
-Add every dollar of income earned

difference between investment and capital

-Capital is stock that can be measured at one point in time
-Investment is the flow of the stock continuing in time

what is the aggregate production function?

total output (GDP) to the quantity of inputs employed

what is labor?

time workers spend

human capital?

skills workers bring

what does physical capital include?

tools, machinery, structures

equation for finding outputs being a function of inputs:

Y \= f (L,H,K)

-includes labor human, physical

causes of more outputs...

1. more workers
2. highly skilled workers
3. has more physical capital

what changed economic growth rates in the past and why?

-industrial revolution
-agricultural advances decreased hunger
-less farm workers needed

capital stock

The total physical capital used in the production of goods and services

perspective one equation

Y \= C +I +G +NX

(GDP, consumption, investment, gov purchases, net exports)

perspective two equation

value added \= total sales - cost of intermediate inputs

what does perspective two say?

gdp measures total output in economy

what type of econ is the usa?

service

what is consumption (c)?

-value of all goods and services bought by household

nondurable good examples

cars, home appliances

investment and capital relationship

investment is spending on new capital

what is government spending?

-all the gov spends on goods/services
-includes investments
-excludes transfer payments

why does gov spending exclude transfer payments?

dont represent spending
-ex. unemployment insurance payments

what is perspective three?

gdp is the sum of all incomes in economy

perspective three equation

total income \= total wages + total profits

what does not count as income?

selling existing asset

labor share

the total income amount going to the workers

capital share

total income going to owners of capital

GDP limitations

1.Prices are not values.
2.Nonmarket activities are excluded.
3.The shadow economy is missing.
4.Environmental degradation isn't counted.
5. Includes benefit of work, but not it's cost
6.GDP ignores distribution.

what does gdp per person measure?

average income in country
(gdp/population)

percent change equation

new-old value/old value

equation for growth rate of quantity

this yr quant - last yr quant/ last yr quant

equation for growth rate of price

this yr price- last yr price/ last yr price

when given base year, which val do you use?

value of base year

nomincal vs real gdp differences

Nominal:
-measures the value of GDP right now, based on current prices.

Real GDP:
-excludes the effect of price changes.
-measures changes in the quantity of output produced.
-used to measure economic growth.

What is economic growth?

Growth of real GDP over time

economic growth equation

gdp+1 - gdp/ gdp

doubling time equation

years to double \= 70/growth rate %

aggregate production function

total output (GDP) related to quantity of inputs

three causes for more outputs

-employ more workers
-better skilled workers
-more physical capital

labor input

total number of hours worked across entire economy

dependency ratio

number of people too young/old to work per 100 working age people

labor productivity

the quantity of goods and services produced by one worker in one hour of work

equation for aggregate production function

Y \= f(L,H,PC)

labor, human capital, physical capital

constant returns to scale meaning

-says that all inputs are inc by the same proportion as outputs are increased

replication argument meaning

says to double input, you can replicate what you're already doing

law of diminishing return

states that if one input is held constant, increases of other outputs will cause smaller increases in output

affect on gdp per worker when capital stock is high?

small change

affect on gdp per worker and production function when capital stock is low?

large change in gdp per worker, small production function

how can poor countries catch up to wealthy ones?

diminishing returns

effect on poor country if they invest in capital

large return

"capital stock will grow as long as..."

investment rises/improves faster than depreciation

as labor & physical capital increases, the difference between investment and depreciation...

decreases

under the solow model steps...

-The capital stock will grow as long as investment outpaces depreciation.

-Because of diminishing returns, the difference between investment and depreciation decreases as (K/L) increases.

-Growth in (K/L) and (Y/L) slows down.

-Capital per worker (K/L) will eventually stop growing.

-Therefore, GDP per person will eventually stop growing as well.

approximate depreciation per year

10%