EC 302 Exam #1

- GDP

- Inflation

- Interest rates

- Employment and UE

- Productivity

Economic Indicators of Macro Performance

A variable that measures something over an interval of time, such as your income per week

flow variable

a variable that measures something at a particular point in time, such as the amount of money you have with you right now

stock variable

GNP - NFP

GDP =

C + I + G + NX

Expenditure Approach

Revenue - Cost

Value-Added Concept

Adds up income generated by production (including profits and taxes paid to the government)

Income Approach

household's assets minus its liabilities

Household wealth

sum of all households', firms', and governments' wealth within the nation

domestic physical assets + net foreign assets

National Wealth

Savings by individuals, businesses, and government

What determines wealth (a)

capital goods and land

domestic physical assets

foreign assets (foreign stocks,

bonds, and capital goods owned by domestic residents) minus

foreign liabilities (domestic stocks, bonds, and capital goods

owned by foreigners)

net foreign assets

A change in value of existing assets and liabilities

What causes a change in national wealth

The percentage rate ofchange in the general price level from one period to the next

n - o / o * 100

Inflation Rate

- CPI

- GDP deflator

- PPI

3 measures of price level

PY

Nominal GDP

a ratio measuring prices charged by producers at various stages of the production process

PPI

measures the average level ofprices of all the goods and services that areincluded in GDP

GDP deflator

Nominal GDP/Real GDP) X 100

GDP deflator equation

the interest rate at which banks make overnight loans to each other

Federal Funds Rate

interest rates set by the Fed rather than determined in a market

Administered Rates

Rate of interest banks charge on short-term loans to their best customers

Prime Rate

The interest rate on the loans that the Fed makes to banks

Discount Rate

nominal interest rate - expected inflation rate

Expected Real Interest Rate Equation

- Labor

- Capital

- Natural Resources

Inputs

1. Productivity

2. Inputs (l,l,c)

3. Technology

GDP depends on

Y = A x F (K,N)

Aggregate Production Function Equation

output increases

If productivity (A) increases, how does that affect output

weather events, innovations, government regulations, changes in oil prices

Shifters of Production Function

- Productivity

- Labor

- Capital

What does output depend on

amount of labor firms want to hire at current wage rate, given their current employment of all other factors

Aggregate Labor Demand

maximize profit

Firm's objective

- Market sets the wage

- Workers are identical, no skill difference

Firm constraints

P*Y - W*N

Profit Equation

MB = MC

The firm continues to hire workers until

W/P

w (real wage)

MPN =

MPN greater than or equal to w

Profit Maximizing while hiring workers

labor demand

The MPN curve is the ______ ________ curve since w is beyond the firm's control

- Changes in W or P

w increases, N decreases

w decreases, N increases

- Changes in firm's technology (A) or use of K

Shifters of labor demand curve

increase work, increase real income, increase utility

Benefits of additional work

increase work, decrease leisure time, decrease utility

Costs of additional work

Increase real wage, Increase benefit of extra work, increase Qs

Substitution Effect

increase real wage, increase income from every hour worked, can afford to decrease Qs

Income Effect

Depends on how long wage increase is expected to last

Longer = greater income effect

typically substitution

Does income effect or substitution effect dominate?

ND = NS

Market Equilibrium for Labor Market

Y* = AF(K,N*)

Full-Employment Output Equation

UE/LF * 100

UE rate

LF/WAP * 100

LF participation rate

E/WAP * 100

Employment to Population Ratio

GDP at full-employment

Potential GDP

For each percentage point that the unemployment rate rises, real GDP falls 2 percentage points below potential

Okun's Law

(Y*- Y)/ Y=2(u-u*)

Okun's law equation

Spvt =

(Y + NFP - T + TR + INT)- C

Sgovt =

T - (G + TR + INT)

S =

Sgovt + Spvt

Y + NFP - C - G

What is the largest component of spending

Consumption

Permanent Income Hypothesis

Takes consumption as dependent on current income plus expected future income over rest of life and wealth

Budget Constraint

PVLC = PVLR

Effects of increasing current income

increase PVLR, increases desired current and future consumption, increases desired saving

Consumption Smoothing

occurs when people borrow and save in order to smooth consumption over their lifetime

Effects of increasing future income

Increase PVLR, increases desired current and future consumption, decreases desired saving

Effects of increasing real interest rates

Decreases PVLR and PVLC, substitution or income effect

ra-t

(1-t)i-pie^e

Effect of changes in taxes on interest income

increases expected after-tax real interest rate

Ricardian Equivalence

individuals anticipate future taxes when making spending decisions

What do people do when they experience a tax cut according to Ricardian Equivalence?

They save the tax cut instead of spending it to prepare for higher future taxes.

What is the effect of Ricardian Equivalence on aggregate demand?

When Ricardian equivalence holds, a tax cut does not increase aggregate demand, even in the short run.

What is the second major component of GDP

Investment

Investment depends on...

expectations about the future

Benefit of Investing

expected future MPK

user cost of capital

cost of using extra capital

uc =

(rir * P) + (d * P)

or

(rir + d)P

Shifters of desired capital stock

-Anything that shifts future MPK

-Interest Rates

-Taxes

Shifters of future MPK

Technology

Investment Tax Credit

tax credit given for purchase of equipment

Sd equilibrium =

Id

Sd equation =

Y - Cd - G

Crowding out effect

Government spending increases, causing r to increase

Shifts to Investment Curve

- Change in desired I for any r

Example: technology advancement

MPK

the additional output that occurs when you increase capital stock by 1

MPN =

w