Unit 2: Economic Indicators and the Business Cycle (Princeton Review AP Macroeconomics 2023 [21st Edition])

GDP

the total value of all final goods and services produced in a year within a country

GDP does not include…

intermediate goods, repurchase of goods, tranfer payments (public and private), underground activity, and financial transactions

GDP increases with…

expenditures on natural disasters, epidemics, war, and crime

National Income

the sum of income earned by factors of production owned by a country’s citizens

What does national income include?

wages, salaries, fringe benefits paid for labor services, rent paid for the use of land and buildings, interest paid for the use of money, and profits recieved for the use of capital resources

Personal Income

the money income received by households before personal income taxes are subtracted

Disposable Income

the amount of money households have available for spending and saving after income taxes have been deducted (personal income minus personal income taxes)

The Two Methods to Calculate GDP

expenditure and income approaches

Expenditure Approach

adds up spending by households, firms, the government, and the rest of the world

Expenditure Approach Formula

GDP = C + I + G + (X - M)

Income Approach

calculates GDP by summing all incomes earned by factors of production

Depreciation

the decline of the value of capital over time due to wear or obsolescence

Why is depreciation part of the income approach?

they are subtracted from corporate profits before the calculation, so they must be re-added to capture the value of output needed to replace or repair worn out buildings and machinery

Subsidy Payments

financial assistance provided by the government to support a business or economic sector, aimed at encouraging production and reducing market prices

Why are subsidies not part of GDP?

subsidies are not included in GDP because they are transfers of money as part of someone’s income rather than payments for goods or services, and thus do not reflect the value of production.

Net Income of Foreign Workers

the total earnings of foreign workers in a country that are not included in GDP calculations, as they represent income sent back to their home countries

If someone were to make a movie in another country, their income would be part of the ___, but the movie would be part of the other country’s _____.

NI (National Income); GDP

Income Approach Formula

GDP = NI + Depreciation - Subsidies + Net Income of Foreigners

Net Domestic Product Formula

GDP - Depreciation

What does NDP represent?

how much output is left over for consumption and additions to capital after accounting for depreciation of capital/used up capital

Circular Flow Model

a model that illustrates how money, goods, and services move through the economy between households and firms

Households supply what to factor markets?

the factors of production (land, labor, capital, and entrepreneurship)

The factor markets supply what to firms?

inputs (the factors of production [land, labor, capital, and entrepreneurship])

Firms supply what to product markets?

goods and services to sell

Product markets supply what to households?

consumer goods and services to purchase

Households supply what to product markets?

expenditures for goods and services

Product markets supply what for firms?

revenues

Firms supply what for factor markets?

wages, rent, interest, and profits

Factor markets supply what for households?

income and employment opportunities

If payments from firms to households for inputs differ from the payments from households to firms for goods and services, the firms are…

experiencing profits or losses

Aggregate Income Formula

Aggregate Income = Aggregate Expenditure = GDP

The equalities of the circular flow model hold true when…

government and international transactions are included

Labor Force

employed and unemployed adults

Unemployed

a participant of the labor force who is able to work and is looking for work in the past four weeks

Labor Force Participation rate

the number of people in the labor force / the working-age population

Unemployment Rate

the number of unemployed workers divided by the number in the labor force multiplied by 100

Frictional Unemployment

unemployed workers and firms search for the best job matches (like being between jobs)

Structural Unemployment

skills mismatch resulting from technological changes or shifts in the economy, leading to long-term joblessness for certain workers

Cyclical Unemployment

downturns in the business cycle resulting in layoffs and reduced demand for workers

Seasonal Unemployment

occurs when workers are unemployed at certain times of the year when demand for their labor is lower, such as agricultural or holiday-related jobs

Discouraged Workers

Individuals who have given up looking for work due to a belief that no jobs are available for them, thus are not counted in the unemployment rate

Dishonest Workers

individuals who engage in deceptive practices or fraud in the work force to recieve unemployment benefits

Natural Rate of Unemployment

the level of unemployment that exists when the economy is at full employment, including frictional and structural unemployment but not cyclical unemployment

Full Employment

the situation in which all available labor resources are being utilized in the most efficient way possible, with minimal frictional and structural unemployment (natural rate of unemployment)

Effects of High Rates of Unemployment

reduction in self-confidence, crime, family breakup, and depression

Okun’s Law

for every 1% increase in unemployment, output falls by 2-3%

Inflation

sustained increase in the overall price level

Deflation

sustained decrease in the overall price level

Nominal Salary

the amount of money paid to an employee without adjusting for inflation

Real Salary

the amount of money paid to an employee, adjusted for inflation, reflecting the purchasing power of the salary

Money Illusion

the tendency of people to think of currency in nominal terms rather than real terms, leading to misinterpretations of purchasing power due to inflation through potential excessive spending

Effects of Inflation

stores change prices, incomes that increase at a rate less than inflation lose value, the value of interest payments does not increase when inflation decreases, social tensions, costs of time people are making to hold cash by going to the ATM frequently, the unit of account is unstable, growth in money supply

Who benefits from inflation and why?

borrowers; at fixed interest rates, they pay back money in less value to the bank

Who is hurt by inflation and why?

lenders; the value of money repaid is less than the initial amount loaned, leading to a loss in purchasing power

Consumer Price Index

a measure used by the government that examines the average change over time in the prices paid by consumers for a basket of goods and services, reflecting inflation levels

CPI Formula

Inflatio Between Years Y & Z Formula

(CPI in Year Z / CPI in Year Y) - 1) x 100

Real GDP Formula

(Nominal GDP / CPI) x 100

Why might the CPI overestimate inflation?

the price of goods could have considerably gone up, and improvements or price changes in products not in the base year are excluded

Producer Price Index

an index that measures the average change over time in the selling prices received by domestic producers for their output

GDP Deflator

alternative general price index that reflects the importance of products in current market baskets

GDP Deflator Formula

(nominal GDP / Real GDP) x 100 OR (cost of current basket at current price / cost of current basket at base year prices) x 100

Real GDP Formula

Fluctuations in the Short Run in the Economy

expansion and contraction

Economic Growth occurs in the…

long-run

Business Cycles

fluctuations in aggregate output and employment

Fluctuations in business cycles are caused by…

changes is aggregate supply and demand

Periods between expansion and recession (respectively) are shown as…

a peak with a positive output gap

Periods between recession and expansion (respectively) are shown as…

a trough with a negative output gap

Recessions are shown on the business cycle graph by…

downward slope in real GDP over time

Expansions are shown on the business cycle graph by…

upward slope in real GDP over time

In the long-run, growth occurs despite…

recessions in the short-run

Potential Output

the highest level of economic output that an economy can sustain; when unemployment = natural rate

Potential Output is also known as…

Full-Employment Output

Aggregate Production Function

a mathematical relationship showing the output of an economy (real GDP) based on employment

While real GDP increases along with employment, it experiences…

dminishing marginal returns

Classical Economists

believed that free markets regulate themselves and that economies are self-correcting even though there may be quick fluctuations in wages, prices, and interest rates

Say’s Law

supply creates its own demand; supported by classical economists

John Meynard Keynes’s argument towards classical economists

investment demand depends more on expectations abou the prosperity of the economy than on interest rates

Depression Range

where excess capacity and unemployment allow increases in output and income without forcing the price level to increase; Keynesian

Difference in Classical and Keynesian AS Curves

classical AS is vertical, while Keynesian AS is horizontal as a depression range until it reaches full employment and it turns vertical

Keynes blamed the existence of unemployment and the problem of the economy not self-correcting on…

sticky wages

Sticky Wages

a theory in the short run that suggests nominal wages are slow to adjust to changing economic conditions preventing the labor market from clearing and leading to prolonged periods of unemployment