UNC ECON 101 Midterm 2

Recessions

Periods of economic downturn when output and employment are falling.

Expansions

Periods of economic upturn when output and employment are rising.

Business cycle

The short-run alteration between recessions and expansions.

Business-cycle peak

When the economy shifts from expansion to recession.

Business-cycle trough

When the economy shifts from recession to expansion.

Long-run economic growth

The sustained upward trend in the economy's output over time.

Inflation

The rising overall level of prices

Deflation

The falling overall level of prices

Price stability

When the overall level of prices charges slowly or not at all.

Final goods/services

Goods/services sold to the final user (ex.: a consumer's purchase of a new car from a dealer).

Intermediate goods/services

Goods and services that are inputs of production of final goods/services (ex.: a car manufacturer's purchase of steel from a steel foundry).

Gross domestic product (GDP)

The total value of all final goods/services produced in an economy during a given period, usually a year.

Value added

Value of sales - value of purchases of intermediate goods/services

Aggregate spending

Sum of consumer spending, investment spending, government purchases of goods/services, and exports minus imports.

GDP = C + I + G + X - IM

Aggregate output

The economy's total quantity of output of final goods/services.

Real GDP

The total value of all final goods/services produced in the economy in a given year, calculated using the prices of a selected base year.

Nominal GDP

The value of all final goods/services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced. This measurement has not been adjusted for changes in prices.

GDP per capita

The GDP divided by the population size, equivalent to the average GDP per person.

Aggregate price level

A measure of the overall prices in the economy.

Price index formula

PI = (value of goods in current year)/(value of goods in base year)

Producer price index

Changes in the price of goods purchased by producers.

GDP deflator

the overall level of price changes (inflation or deflation) for all final goods and services produced domestically within an economy

The ratio of nominal GDP to real GDP in that year.

Consumer price index

An index that measures the cost of a market basket for a typical urban American family; measures cost of living

GDP deflator in base year formula

GDPdefb = ((nominal GDPb)/(real GDPb)) x 100

GDP deflator in year t formula

GDPdeft = ((nominal GDPt)/(real GDPt)) x 100

Inflation using GDP deflator formula

Inflation = ((GDPd in current year - GDPd in base year )/(GDPd in base year)) x 100

CPI formula

CPIt = ((value of basket in year t)/(value of basket in base year)) x 100

Inflation using CPI formula

INFLATIONcpi = ((CPIt - CPIb)/(CPIb)) x 100

What are the four biases of CPI?

Substitution bias, quality bias, new product bias, and outlet bias

Substitution bias

The increase in the price of one product in a basket could lead consumers to substitute it for another product. Causes CPI to overstate inflation

Quality bias

The quality and life of some product has increased over time, decreasing the number of products bought/sold in a time span. understates inflation if worse quality, overstates inflation if better quality

New product bias

New products aren't introduced into the index until they become common (ex.: COVID face masks). Causes CPI to understate

Unemployment

The number of people actively looking for work but aren't currently employed.

Labor force

The sum of employed and unemployed workers in the economy.

Labor force participation rate formula

= (labor force / working age population) x 100

Unemployment rate formula

= (number of unemployed workers/total labor force) x 100

Discouraged workers

Non-working people who have given up looking for a job.

Marginally-attached workers

People who have looked for jobs in recent past but not currently looking.

Underemployed workers

People who want full-time work but are currently working part-time.

Jobless recovery

A period when real GDP growth occurs but the unemployment rate is still rising, typically following a deep recession.

Frictional unemployment

The existence of unemployment due to the time workers spend in the job search; short-term

Structural unemployment

fundamental mismatch between the skills workers possess and the skills employers demand, or a geographic disconnect between where workers live and where jobs exist; exists even when the economy is at the peak of the business cycle.

Natural rate of unemployment

The normal rate around which the actual unemployment rate fluctuates.

Cyclical unemployment

The deviation of the actual unemployment rate from the natural rate, caused by business cycles.

Natural unemployment

The rate of unemployment if the economy were operating at full capacity: frictional unemployment plus structural unemployment.

Actual unemployment

Natural unemployment plus cyclical unemployment.

What causes the natural rate of unemployment to change?

Changes in labor force characteristics, changes in labor market institutions, and changes in government policies.

Price level

Aggregate price for all goods/services, usually in the form of an index.

Nominal variables

Variables that measure the monetary value at the current time.

Real variables

Variables that are adjusted for general price level changes over time (inflation, deflation).

Shoe-level costs

The increased costs of transactions caused by inflation and the cost of effort to counteract inflation.

Menu costs

The real cost of changing listed prices.

Unit-of-account costs

Costs from money being a less reliable unit of measurement.

Interest rate

The return a lender receives for allowing borrowers to use their savings for one year.

Nominal interest rate

The interest rate in dollar terms; denoted by i.

Real interest rate

Nominal interest rate - inflation rate; denoted by r.

If actual inflation is higher than expected...

The borrower is better off than expected, and the lender is worse off than expected.

If actual inflation is lower than expected...

The lender is better off than expected, and the borrower is worse off than expected.

Rule of 70

A rule stating the time it takes a variable that grows gradually over tie to double is approximately 70 divided by that variable's annual growth rate.

# of years to double = 70/g

NOTE: if g

How does sustained economic growth occur?

When the amount of output produced by the average worker increases steadily.

Labor productivity

Output per worker

What three factors increase labor productivity?

An increase in physical capital, an increase in human capital, and technological progress.

Aggregate production function

Shows how productivity depends on the quantities of physical capital, human capital, and the state of technology.

Diminishing returns to physical capital

When human capital and the state of technology are fixed, each successive addition to physical capital per worker yields a smaller increase in productivity than the one before.

Real growth rate formula

How is the APF affected by changes in physical capital, human capital, and technology?

Increases in physical capital lead to movement to the right, while increases in human capital and technological improvements shift the APF upwards.

Why do growth rates differ between countries?

Growth rates can differ because of countries' investment strategies, education, and research/development.

Real GDP equation

Y = C + I + G + X - IM

Y = RDGP

C = consumption spending

I = investment spending

G = government spending

X = exports

IM = imports

Aggregate demand curve

A curve showing the relationship between price level and quantity of RGDP demanded by households, governments, firms, etc.

What are the shifters of aggregate demand?

1. Expectations of households/firms about inflation, price level, & interest rates

2. Changes in wealth

3. Policy intervention

Short-run aggregate supply

The relationship between aggregate price level and the quantity of output producers are willing to supply.

What are the shifters of SRAS?

1. Changes in input prices

2. Changes in nominal wages

3. Productivity

What happens in the short run as the price producers can receive for output increases?

Wages and input prices are sticky, so producers will be more profitable and increase production.

Long-run aggregate supply

In the long run, the level of RGDP is determined by the supply of labor, capital, and technology, NOT the price level

What can shift both SRAS and LRAS?

1. Changes in labor force

2. Changes in capital stock

3. Changes in technology

Potential output

The economy's maximum sustainable output, given the supply of resources, technology, and production incentives; Yp is at the long-run aggregate supply.

Currency in circulation

Actual cash in the hands of the public.

Money supply

The total value of financial assets in the economy that are considered money.

What are the four functions of money in the modern economy?

1. Money is a medium of exchange -- it's an asset that is used to trade for goods/services

2. Money is a store of value -- it remains valuable over time

3. Money serves as a unit of account -- it's the commonly accepted measure people use to set prices & make economic calculations

4. Money is a standard of deferred payment -- it can facilitate exchange over time

M1

The most narrowly defined money supply, including only the money in circulation, checkable bank deposits, and traveler's check.

M2

Consists of M1 plus various types of near-moneys, assets that can be easily converted into cash/checkable bank deposits.

Reserve ratio

The ratio of bank reserves to bank deposits that banks must have at all times, mandated by the Fed

Commodity money

Intrinsically valuable objects that were also used as money (ex.: gold, silver, etc.).

Paper money

Money with its value guaranteed by the promise that it could be converted to valuable goods.

Fiat money

The current system of money that we use; money whose value derives entirely from its official status as a means of exchange.

Monetary base

The sum of currency in circulation and bank reserves.

Money supply

The sum of currency in circulation and checkable bank deposits.

What do both the money supply and monetary base include?

Currency in circulation

Simple deposit multiplier formula

Change in total deposits = initial deposit/rr

Money multiplier

Change in money supply = initial excess reserves/rr

Change in money supply = initial deposit - simple deposit multiplier

What is the difference between the US Treasury and the Federal Reserve?

The US Treasury collects taxes and prints money, but the Fed is the US's central bank, which oversees the banking system and controls the monetary base.

Reserve requirements

The Fed's regulations that impose a minimum reserve-deposit ratio on banks.

Discount rate

The rate of interest the Fed charges on loans to banks in need of reserves

If the Fed sets the discount rate higher, then...

The money supply decreases.

If the reserve ratio requirement is low, then...

The money supply increases.

If the reserve ratio requirement is high, then...

The money supply decreases.

If the Fed sets the discount rate lower, then...

The money supply increases.

Open-market operations

A purchase/sale of government debt by the Fed.

Why does the Fed purchase T-bills from commercial banks?

By purchasing T-bills, the Fed increases the reserves of these banks, who then lend out money and increase the money supply.

What happens to the money supply when the Fed sells T-bills to banks?

The Fed decreases the money supply.