AP Econ Macro U2

GDP

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

Value added approach

Adds contributions a country’s firms make to the final goods

(e.g. $8 for fabric → $15 shirt → $20 shirt with graphic = $20-$8=$12 added value for GDP)

Income approach

Rent + wages + Interest + Profit

Disposable income

personal income - taxes

OUTPUT EXPENDITURE MODEL

C+ Ig + G + Xn

C= consumption- consumer purchases of goods and services

Ig= gross investment- businesses purchases of physical capital and changes in inventory (net investment=gross investment-depreciation)

G= government purchases: expenditures by the government for goods and services (NOT counting government social security checks or unemployment compensation)

Xn: net export= exports-imports

Net investment

Gross investment-depreciation

Depreciation: when machines/tools go obsolete or break

What’s not counted in GDP

• used goods

• intermediate goods (count the cabinet, not the wood the carpenter bought to make it)

• financial transactions (purchases of stocks and bonds)

• transfer payments (food stamps, welfare payments, social security, unemployment b/c government is not receiving anything)

Limitations to GDP

• underground economy (no one reports to government)

• non-market activity (household production)

• bads counted as goods (pollution, depletion of natural resources, natural disasters)

• income distribution- GDP doesn’t indicate who gets wealth

inflation

general increase in prices in the economy

=

CPI

tracks price changes in a market basket of products

(current year value/base year value) x100

GDP deflator

tracks price changes in ALL products

(nominal/real) x100

Nominal GDP

all the money spent on goods and services (no inflation)

sum of: current year quantity x current year price

Real GDP

all the things produced (w/ inflation)

sum of: current year quantity x base year price

Converting nominal to real GDP

(nominal/deflator) x100

Macroeconomic goals

1. economic growth: increases of real GDP over time, increase in real income over time → increase in standard of living over time

2. full employment: 0 cyclical unemployment, only frictional and structural unemployment → unemployment rate=natural rate of unemployment (NRU)

3. stable prices: 2% increase in average prices over time, often high during expansions, deflation can occur during contractions

business cycle phases

expansion → peak → contraction → trough

output gaps

• inflationary gap: inflation: actual GDP > potential GDP, unemployment < NRU

• recessionary gap: unemployment: actual GDP < potential GDP, unemployment > NRU

• long-run equilibrium

output gap math

actual GDP- long run potential GDP

the labor force

unemployed + employed

employed

• work for pay/profit for one or more hour

• work w/o pay for 15 or more hours in a family business

• have a job, but didn’t work due to time off

unemployed

not working AND actively looking for work

unemployment rate

(unemployed/labor force) x100

labor force participation rate

(labor force/civilian population) x100

frictional unemployment

in between jobs or looking for first job

structural unemployment

changes in the economy lead to a skills mismatch (e.g. robots/automation)

cyclical unemployment

caused by overall economic downturn (WANT TO AVOID!!)

natural rate of unemployment (NRU)

unemployment rate when economy is healthy

• frictional + structural

• zero cyclical unemployment (subtract total unemployment-cyclical unemployment= NRU)

• when potential GDP = Actual GDP, then unemployment rate=NRU

problems with unemployment

• discouraged worker- without a job and stopped looking for work are not in labor force

  • when discouraged worker increase, unemployment rate falls, making it look like economy is better

• under employed workers- part time employed looking for full time work, counted same way as full time

  • when unemployed workers become underemployed, unemployment rate falls, even tho they are still looking for full time work

• labor force participation rate- unemployment rate falls when people leave the labor force

inflation

an increase in average prices of goods and services through an entire economy

deflation

a decrease in average prices of goods and services

disinflation

a decrease in the inflation rate

nominal variables

values that have not been adjusted for inflation (go up faster than real values)

real variables

values that have been adjusted for inflation

CPI (consumer price index)

(current year value (x market basket quantity if weighted)/base year value (x market basket quantity if weighted)) x 100

calculating inflation between years

((new cpi-old cpi)/oldcpi) x 100

problems with the CPI

• substitution bias: when the price of one good increases, consumers may buy a cheaper substitute

• quality change bias: product quality changes over time are not reflected in the CPI

• new product bias: the market basket doesn’t include new goods and services

cost of inflation

• impact on real wages: inflation decreases real wages

• purchasing power: decreases real value of money

• HELPS: borrowers- pay back fewer real dollars

• HURTS: lenders- paid back fewer real dollars, savers- savings is worth fewer real dollars