AP MACRO Unit 2

Circular Flow Model/GDP

Product Market

“Place” where goods and services produced by businesses are sold to households

3 goals of macro

Promote economic growth, limit unemployment, keep prices stable

National income accounting

Economists collect stats. on production, income, investment, and savings

Resource (factor) market

“Place” where resources (land, labor, capital, entrepreneurship) are sold to buisnesses

Private Sector

Part of the economy that is run by individuals and businesses

Public Sector

Part of the economy that is run by the government

Factor Payments

Payment for the factors of production—namely rent, wages, interest, and profit

Transfer Payments

When the government redistributes income (ex.. welfare/social security)

Gross Domestic Product (GDP)

The dollar value of all final goods and services produced within a country's borders in one year

% Change in GDP equation

Year 2 - Year 1/ Year 1 × 100

GDP Per Capita

GDP divided by the population.

It identifies how many products each person makes. It is the best measure of the nations standard of living. 

Factors not included in GDP

• Intermediate Goods- products that go directly into creating another product

• None Production Transactions- financial transactions (nothing produced) ex. stocks, bonds, real estate

• Non-Market + Illegal Activities- things made at home, household production

Expenduture Approach

GDP= C + I + G + Xn (exports-imports)

Consumer Spending

The total value of goods and services purchases by households for personal use.

Investment Spending

The total spending by businesses on goods and services used to produce future output

(spending that increases productive capacity)

Government Spending

All expenditures by local, state, and federal governments on goods and services.

Ex. salaries for teachers/ police officers/ soldiers, infrastructure projects like roads/ bridges/ schools, military equipment and defense spending, public services such as mail delivery or public health programs

Net Exports

(X-M)

The value of goods and services a country sells abroad (X) minus the value of goods and services it buys from other countries (M)

Nominal GDP

GDP measured in current prices.

It does not account for inflation from year to year.

Real GDP

GDP expressed in constant, or unchanging dollars.

It adjusts fro inflation. 

Unemployment

Workers that are actively looking for a job but are not working

The Unemployment Rate

The percent of people in the labor force who want a job but are not looking

Labor Force

People who are willing and able to work

Unemployment Rate equation

#Unemployed/ #In the labor force x 100 

Labor Force Participation Rate equation

Labor Force/ Working age population x 100 

3 types of unemployment

Frictional, Structural, Cyclinal 

Frictional Unemployment

Temporary unemployment or between jobs

Structural Unemployment

Changes in the labor force make some skills obsolete.

Creative destruction: permanent loss of these jobs

Technical unemployment: where automation and machinery replace workers

Cyclical Unemployment

Unemployment caused by a recession 

Natural rate of unemployment (NRU)

The level of unemployment that exists when the economy is healthy and growing, accounting for frictional and structural unemployment, but not cyclical unemployment.

Full employment output (y)

The real GDP created when there is no cyclical employment

Criticisms of the Unemployment Rate

Discouraged workers: some people are no longer looking for a job because they have given up

Labor Force Participation Rate: percent of the population in the labor force. If people leave the labor force, unemployment rate falls. 

Underemployed workers: someone who wants more hours but cannot is still considered employed. 

Inflation

The rising general level of prices.

It reduces the “purchasing” power of money.

When inflation occurs, each dollar of income will buy fewer goods than before. 

Deflation

The decrease in general prices or a negative inflation rate

Disinflation

When prices increase at a slower rate

Who gets hurt by unanticipated inflation?

• Lenders- people who lend money at fixed interest rates)

• People with fixed incomes

• Savers

Who gets helped by unanticipated inflation?

• Borrowers (people who borrow money)

• Businesses where the price of the product increase faster than the price of resources

How is inflation measured?

Inflation Rate- there percent change in prices from year to year

Calculating market basket

Add up the prices of all items in the basket in a given year.

The quantity in the basket must be the same as the base year. 

Inflation Rate Equation

Year 2 - Year 1/ Year 1 × 100

Consumer Price Index equation

CPS= Price of market basket/ Price of market basket in base year x 100

Problems with CPI

• Substitution bias- as the price increases for a fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket. As a result, CPI may be higher than what consumers are really paying.

• New products- the CPI market basket may not include the newest consumer products. As a result, CPI measures prices but not the increase in choices. 

• Product quality- CPI ignores both improvements and decline in product quality. As a result, CPI may suggest that prices stay the same though the economic being has improved significantly. 

Why is zero unemployment bad?

Some level of unemployment is normal in a healthy economy. Aiming at absolute zero would freeze job mobility and be unrealistic. 

Demand-Pull inflation

Occurs when demand pulls up prices during an overheated economy

Cost-Push Inflation

Occurs when higher production costs increase prices

What happens when the government prints more money to fund their own spending?

There will be more money in the economy, but the amount of goods and services will not have changed with it. Therefore, prices go up, causing inflation.