Economics Unit 3 Test

Economic growth

An increase in real GDP or real GDP per capita over a specific time period; calculated as an annual percentage rate.

Real GDP per capita

Real Gross Domestic Product divided by total population; measures output per person and serves as the primary gauge of living standards.

Rule of 70

A simple mathematical formula (Years to Double = 70 / Annual Growth Rate) used to calculate how many years it will take for real GDP or living standards to double.

Modern economic growth

The historical era beginning with the British Industrial Revolution in the late 1700s, characterized by sustained, ongoing increases in living standards and per capita output. 

Leader countries

High-income, technologically advanced countries that develop original technological innovations, resulting in a steady but limited per-capita growth rate.

Follower countries

Developing nations with lower incomes that can grow rapidly through "catch-up growth" by adopting existing production technologies developed by leader nations.

Catch up growth

The rapid rate of economic growth experienced by follower countries when adopting existing technology from leader countries, narrowing global income gaps.

Supply factors

The four physical inputs that determine an economy's potential production capacity:

• technological knowledge

• human resources

• natural resources

• capital goods stock

Demand factor

The requirement that aggregate demand (total spending) must increase at the same pace as the economy's productive capacity (supply) to realize full employment and prevent overproduction or recessions

Efficiency factor

The requirement that an economy achieve both productive and allocative efficiency while maintaining full employment to reach its potential output point on the production possibilities curve.

Labor productivity

Total real output divided by total labor input hours (Output per Hour of Work}; a major driver of standard-of-living increases.

Labor-force participation rule

The percentage of the working-age population that is employed or actively looking for work, determining available total labor inputs.

Growth accounting

A quantitative framework used to decompose a country's total economic growth (GDP) into the portions driven by physical inputs (capital and labor) and efficiency/technology

Infrastructure

Publicly owned physical capital goods—such as highways, bridges, public transit systems, water works, airports, and power grids—that support private economic activity.

Human capital

The knowledge, technical skill, formal education, and health embodied in an economy's workforce.

Economies of scale

Cost advantages that a business achieves as it increases its scale of production, causing the average cost per unit to decrease

• The cost of making each individual item goes down as you make more of them

Information technology (IT)

The combination of microchips, computers, fiber optics, wireless communication, and software used to process, store, and transmit data.

Start-up firms

Small, newly established, innovative enterprises formed specifically to commercialize breakthrough technological discoveries.

Increasing returns

When a proportional increase in inputs leads to a more-than-proportional increase in output

Network effects

When the value of a product or service increases for each user as the total number of users grows

Learning by doing

An economic concept where workers and organizations become more productive and lower their production costs simply by gaining experience through the repeated execution of tasks

Business cycle

Recurring, alternating increases and decreases in economic activity (real GDP) over a period of time.

Peak

The phase of the business cycle where business activity reaches a temporary maximum and output is near full capacity.

Recession

A phase of the business cycle marked by a period of decline in total output, income, and employment lasting six months or more.

Trough

The lowest phase of the business cycle where real output and employment reach their bottom point during a recession.

Expansion

The phase of the business cycle where real GDP, aggregate income, and employment rise toward full employment.

Labor force

Individuals age 16 and older who are willing and able to work, equal to the sum of employed and unemployed individuals.

Unemployment rate

The percentage of the labor force that is unemployed

(Number of Unemployed/Labor Force) x100

Discouraged workers

Individuals who have left the labor force because they stopped actively searching for work after failing to find a job.

Frictional unemployment

Voluntary unemployment consisting of workers who are searching for jobs or waiting to take jobs in the near future.

Structural unemployment

Unemployment caused by structural changes in the demand for labor due to changing consumer tastes, technology, or geographical shifts.

Cyclical unemployment

Unemployment caused by a decline in total spending during the recession phase of the business cycle.

Full-Employment Rate of Unemployment

The unemployment rate that exists when cyclical unemployment is zero; consists only of frictional and structural unemployment.

Natural Rate of Unemployment (NRU)

The long-term, baseline rate of unemployment thats expected and persists in an economy operating at full potential

Potential output

The total real output (GDP) an economy can produce when operating at full employment (at the NRU).

GDP gap

The difference between actual Gross Domestic Product and potential Gross Domestic Product

(Actual GDP - Potential GDP).

Okuns law

The rule that every 1 percentage point by which the actual unemployment rate exceeds the natural rate of unemployment creates a negative GDP gap of approximately 2 percent.

Inflation

A general rise in the overall price level in an economy.

Consumer price index (CPI)

An index that measures the cost of a fixed market basket of 300 consumer goods and services relative to its cost in a base period (1982–1984).

Deflation

A general decline in the overall price level in an economy.

Demand-pull inflation

Increases in the price level caused by aggregate spending exceeding society's capacity to produce ("too much spending chasing too few goods").

Cost-push inflation

Increases in the price level caused by increases in per-unit production costs that shift supply curves inward.

Per-unit production costs

The average cost of producing one unit of output, calculated as total input cost divided by total units of output.

Core inflation

The underlying inflation rate derived by excluding volatile food and energy goods from the Consumer Price Index. Focus on more stable prices

Nominal income

The number of dollars received as income during a given period, unadjusted for inflation.

Real income

The amount of goods and services nominal income can purchase; nominal income adjusted for inflation.

Unanticipated inlation

Price level increases that come as a surprise to economic participants and arbitrarily redistribute real income.

Anticipated inflation

Increases in the price level that are foreseen and can be planned for in advance.

Cost-of-Living Adjustments (COLAs)

Automatic pay raises built into labor contracts or government benefits that increase income in proportion to CPI inflation.

Real interest rate

Interest rate, adjusted for inflation.

Nominal interest rate

The interest rate expressed in current dollar terms, unadjusted for inflation; equals the real interest rate plus the inflation premium.

Hyperinflation

Extraordinarily rapid, uncontrolled inflation that exceeds 50 percent per month, rendering money worthless and causing economic collapse.

Real GDP per capita formula

Real GDP Per Capita = Real GDP / Population 

Real GDP vs Real GDP Per Capita

Real GDP shows the overall output and economic power of a nation; Real GDP per capita is the primary metric used to evaluate individual living standards

For living standards to improve…

Real GDP must grow at a faster rate than the population.

Rule of 70 formula

Approximate Years to Double = 70/Annual Percentage Rate of Growth 

Leader countries typical annual growth in Real GDP per capita is

relatively slow and steady because it takes time to invent and implement new technologies

Follower countries typical annual growth in Real GDP per capita is

much faster, through catch-up growth they just adapt what the leader countries created

Strong property rights for promoting growth

Individuals and businesses must be confident that their private property will not be arbitrarily stolen or confiscated by government or criminals. 

Patents and copyrights for promoting growth

Legal protection grants inventors and authors exclusive rights to their innovations, providing a strong financial incentive to invent and commercialize new products.

Efficient financial institutions for promoting growth

Robust banks, stock markets, and credit institutions are necessary to channel private household savings into business investment projects.

Literacy and widespread education for promoting growth

A highly educated and literate workforce is capable of operating complex technologies, advancing scientific research, and adapting to structural changes in the economy.

Free trade for promoting growth

Open international trade promotes economic efficiency by allowing nations to specialize in goods they produce most efficiently and by facilitating the global spread of new technologies.

Competitive market system for promoting growth

Free markets use prices and profits to guide resources toward their most productive uses while encouraging innovation and penalizing inefficiency.

Institutional structures promoting growth

• Strong property rights

• Patents and copyrights

• Efficient financial institutions

• Literacy and widespread education

• Free trade

• Competitive market system

Determinants of Growth

• Supply factors

  • Technology

  • Human resources

  • Natural resources

  • Capital goods stock

• Demand factor

  • Total spending

• Efficiency factor

  • Productive and allocative efficiency

Natural resources

Availability and quality of raw materials, arable land, and natural deposits.

Human resources

Quantity and quality of labor inputs (population size, labor force participation, training, and skill level).

Capital goods stock

Supply of human-made physical assets like machinery, factories, equipment, and infrastructure.

Technology

Scientific, technological, and engineering innovations that improve production techniques.

To reach its full economic potential, an economy must achieve

both productive efficiency and allocative efficiency under conditions of full employment.

Productive efficiency

Producing goods using the least costly combination of resources

Allocative efficiency

Producing the dynamic mix of goods and services most highly valued by society

Growth accounting formula

Real GDP = Labor Hours x Labor Productivity 

Labor productivity formula

Labor Productivity = Real GDP/Labor Hours

Factors Driving Productivity Growth 

• Technological advance 40%

• Capital per worker 30%

• Economies of scale & Resource allocation 15%

• Human capital 15%

IT-driven growth creates

high rates of increasing returns

Sources of increasing returns

• Specialized Inputs: Firms use highly specialized software, labor, and equipment that boost efficiency. 

• Spreading Development Costs: High upfront development costs (such as writing software) are spread over millions of units, reducing per-unit costs dramatically as sales scale. 

• Simultaneous Consumption: Digital products (software, mobile apps) can be consumed simultaneously by millions of users without creating resource bottlenecks. 

• Network Effects: A product becomes more valuable as the number of users increases (e.g., software networks, internet platforms). 

• Learning by Doing: As output grows, workers and managers gain expertise, reducing production errors and unit costs over time. 

Anti growth arguments

• Quality of Life vs. Standard of Living: Growth provides material abundance but does not guarantee psychological well-being or solve deep social problems (e.g., poverty, crime, inequality). 

• Environmental Degradation: Industrial growth generates pollution, greenhouse gases, deforestation, climate change, and habitat loss. 

• Resource Depletion: High growth rates consume finite, non-renewable natural resources at an unsustainable pace. 

Pro growth arguments

• Higher Living Standards: Growth is the primary mechanism for lifting millions out of absolute poverty and raising material well-being. 

• Expanded Capacity to Solve Problems: A wealthier, technologically advanced economy is better equipped to fund environmental protection, medical research, clean energy development, and social welfare programs. 

• Increased Leisure: Growth increases productivity, allowing society to reduce working hours and increase leisure time. 

4 phases of business cycle

1. Peak: The point of maximum economic activity. Real GDP is near or at its maximum output, the economy is near full employment, and the price level is likely to rise. 

2. Recession: A period of decline in total output, income, and employment lasting six months or more. Characterized by falling Real GDP and rising unemployment. 

3. Trough: The lowest point of output and employment during a recession, where economic activity hits bottom before recovering. 

4. Expansion: A recovery phase where Real GDP, income, and employment rise back toward full employment. 

Business cycles are primarily triggered by

Economic shocks and sticky prices (in short run)

During a recession, production of durable goods & capital goods

drop sharply, because purchases of durable goods can be postponed by businesses and households facing economic uncertainty

During a recession, production nondurable goods & services

stay more stable, because people cannot easily postpone buying groceries or medical care

Labor force formula

Labor Force = Employed + Unemployed 

To calculate unemployment, the total population is divided into three distinct groups: 

1. Under 16 and/or Institutionalized: Children under 16 years of age and individuals in penal institutions, mental healthcare facilities, or nursing homes. (Excluded from labor market calculations). 

2. Not in the Labor Force: Adults capable of working who choose not to seek employment (e.g., full-time college students, homemakers, retirees, and discouraged workers). 

3. The Labor Force: Consists of civilians age 16 and older who are employed or unemployed and actively seeking work. 

Unemployment rate formula

Unemployment Rate = (Unemployed/Labor Force) x 100 

Key Criticisms of Official Unemployment Data 

• Involuntary Part-Time Workers: Individuals who work part-time (e.g., 10 or 20 hours per week) because they cannot find full-time work are officially counted as fully employed. This masks underemployment. 

• Discouraged Workers: Unemployed individuals who stop actively searching for work due to frustration or lack of job opportunities are classified as Not in the Labor Force. Excluding discouraged workers lowers both the unemployed count and the official labor force, understating true unemployment. 

3 types of unemployment

• Frictional

• Structural

• Cyclical

Full employment does NOT mean

0% total unemployment

An economy is defined as being at Full Employment when

cyclical unemployment is exactly equal to zero.

Natural rate of unemployment formula (NRU)

NRU = Frictional Unemployment Rate + Structural Unemployment Rate

When the economy operates at the NRU, it produces

its Potential Output, the maximum real output an economy can produce under conditions of full resource utilization.

The economic cost of cyclical unemployment is

the output of goods and services that society forfeits when labor resources are left idle.

GDP gap formula

GDP Gap = Actual GDP - Potential GDP 

Negative GDP gap

Actual GDP is lower than Potential GDP (Actual GDP < Potential GDP)

Cyclical unemployment exists, representing unproduced output.

Positive GDP gap

Actual GDP exceeds Potential GDP in the short run (Actual GDP > Potential GDP)

The economy is operating above its long-run sustainable capacity (causing inflationary pressures).

Okuns law formula

GDP Gap Percentage = (Actual Unemployment Rate - NRU) x -2 

Consumer price index (CPI) formula

(Price of Market Basket in Given Year/Price of Market Basket in Base Period 1982-1984) x 100

The value of the price index in the base period is always

100