Ch 18-20, 22, 24-26, 28

Test 3

what is the business cycle

short-run fluctuations in economy

3 major goals of macro

1. maintain employment of human resources @high levels
2. maintain prices @stable level
3. achieve high rate of economic growth aka growth in output per person over time

what is RGDP

real gross domestic product

total value of all final goods & services produced in a given period

what is RGDP used to measure

output/production

what does "real" mean

adjusted for inflation

lower unemployment leads to higher/lower stock prices

higher w

what is the unemployment rate

% of population 16+ willing to work but can’t obtain a job

what is the labor force

# of people 16+ able to work (employed/unemployed)

recession is when there's high/low unemployment

expansionary period is when there's high/low unemployment

high

low

unemployment stats don't include (2 things)

1. discouraged workers: able to work but gave up
2. part-timers looking for full-time

4 main categories of unemployed

job loser, job leaver, reentrant, new entrant

what is a job loser

temporarily laid off/fired (50% of unemployed)

what is the short run costs of reducing unemployment

higher rate of inflation

underemployment (worker too skilled for job)

marginally attached worker

neither working nor looking BUT they want + available and have looked in past 12 months

discouraged worker

subset of marginally attached. job-market-related reason for not looking

frictional unemployment

transitioning between jobs

structural unemployment

mismatch between worker skills & requirement of jobc

cyclical unemployment

unemployment due to downturns in business cycle; recession (worst!!!)n

natural rate of unemployment

frictional + structural at it's max?

unemployment > NRU
unemployment < NRU

cyclical
frictional & structural

at natural rate of unemployment... potential output

all resources fully employed & no cyclical unemployment

resources = labor land capital

obstacles that prevent wages from adjusting (why unemployment exist)

1. minimum wages
2. unions
3. efficiency wage theory

how does min wage affect unemployment

quantity of labor demanded decreases because employers find it unprofitable to hire low-skilled workers @higher wage

demand for labor is inelastic

minimum wage > market wage = unemployment

how do labor unions affect unemployment

wage increase after unions negotiate wages --> wage > equilibrium = higher unemployment

how does efficiency wage theory affect unemployment and what is it

def: theory that higher wages --> greater productivity

wage > equilibrium = higher unemploymentwh

issue w/ unemployment insurance

people not motivated to see new employment = lowers opportunity cost of unemployment

prolonged periods of unemploymentg

good thing about unemployment insurance

better benefits & more job security

unemployment rate is higher/lower in U.S. compared to Europe

lower

how new technology affects unemployment

may replace workers but also create new opportunities

new machines --> higher demand for skilled workers to use it while demand for low-skilled workers decrease

what is price level

average level of prices in economy

inflation rate?

% change in price level from one year to next

disinflation vs deflation

disinflation is when inflation reduces (slowing down)

deflation is when there's a decrease in overall price level

when there's a decrease in overall price level (deflation) then the purchasing power of money ____

increases

what is price index and what's it used for

measure of change in prices for certain group of goods & services (market basket?) over given period

used to measure inflation

what is CPI

consumer price index: measure of average change over time in prices paid by consumers for market basket of consumer goods

GDP deflator?

helps measure average price level

(nominal/RGDP) x 100

issues w/ CPI

difficult to measure changes in CPI

inflationary bias

if not measured correctly important things get distorted (ex. Social Security)

reason for inflationary bias (CPI's overstatement of inflationary rate)

1. substitution bias
2. quality bias
3. new outlet bias
4. new product bias

substitution bias

CPI assumes consumers by fixed basket of goods & services (same things)

doesn't include savings changed in response to price changes

price changes don't change proportionately

quality bias

increase in price may be cuz better quality (which is hard to measure)

new outlet bias

ignores price changes that occur when customers shop at discount stores like Costco

new product bias

new products not introduced into index until they are commonplace items

producer price index?

measure of cost of goods & services bought by firms

CPI for producers

GDP deflator vs CPI

GDP deflator measures goods & services produced domestically

CPI measures goods & services bought by consumers

losers in inflation

anything fixed is bad

ex) fixed rate loan from bank... inflation --> borrower is paying back less than they should because dollars now have less purchasing power and it's not adjusted to inflation

ex) business that sells something w/ a fixed price

lenders = losers

winners

people who borrow & corporations that can quickly raise price of goods

unanticipated inflation distort price signals how?

consumer doesn't know why good became more expensive (due to better scarcity?? don't know!) --> less good decision making

unanticipated inflation --> firm costs why??

menu costs: costs for changing listed price (ex. restaurant makes dish more expensive cuz inflation)

higher inflation rates --> higher/lower nominal interest rate and higher/lower real interest rate

higher nominal; lower real

real interest rate formula

nominal interest rate - interest rate

4 phases of business cycle

1. Expansion: output (real GDP) rising significantly
2. Peak: expansion comes to end; output @highest point
3. Contraction: economy slowing down
4. Trough: output stops declining; business activity @lowest point

depression vs recession

depression is a prolonged recession

unemployment rates can be affected by the season: T/F?

true! ex) summer is when more students work = unemployment rates are higher than shown

3 main categories of business cycle indicators

1. leading economic indicators
2. coincident economic indicators
3. lagging economic indicators

leading economic indicators

things that change before changes in economic activity

ex) stock market (goes down before recession)

coincident

things that change with RGDP

lagging

things that change after (ex. interest rates, CPI, unemployment rate)

what is GDP

gross domestic product: measure of economic performance based on value of FINAL goods & services produced domestically w/in given period

what are final & intermediate goods/services

final: ready to use
intermediate: inputs/resources; stuff used to produce

GDP includes 2nd hand goods: T/F

FALSE only current/new production

what is double counting

counting intermediate goods/services in GDP

circular flow model shows that

consumer $ spent = producer $ earned

money spent = income

e
BUT income not always spent (gov taxes & savings)

expenditure approach of measure GDP

C I G (X-M)

nondurable goods & durable goods reflect consumer behavior. how?

durable good spending increase when economy expanding & vice versa

nondurables are inelastic so they don't say much

stock market investments count in GDP: T/F

FALSE

investment vs fixed investment vs inventory investment

investment: creation of capital goods used for future production (ex. inputs like machines & tools)

fixed investment: new spending by producers on capital goods aka things used to produce (ex. machinery, buildings, etc.)

inventory investment: business purchases that add to inventory - goods that have bene produced but not sold (stock of goods kept to meet customer demands)

what aspect of GDP fluctuates the most & why's it so important?

investment

directly tied to nation's future production capabilities

transfer payments are/arent included in gov purchases

NO because it's tax money

value-added aka production approach

price sold - price paid for intermediate goods

added value to product (ex. service, shipping, machinery)

gross national product

net income of foreigners - GDP

WRIP approach (income approach) for calculating GDP

adding up factor payments:
Wages + Rent + Interest + Profits

for accuracy deduce depreciation & business taxes

a higher RGDP per capita means....

higher economic welfare

why GDP isn't an accurate measure of economic welfare

doesn't include:
- non-market transactions
- underground economy (unreported income)
- value of leisure (GDP can go down but standard of living doesn't have to)
- positive/negative externalities
- quality of goods

production possibilities curve (PPC) can shift outward w/ improvements in:

land, labor, capital, entrepreneurship

what is the rule of 70

growth rate/70

how many years till nation doubles output @diff growth rates

ex) 3.5% --> 70/3.5 = output doubles every 20 years

even a small growth rate is good because long run effects

what is growth rate?

GDP per capita

physical capital

goods like tools, machinery, factories

investment --> higher labor productivity

as quantity of capital per worker increases, so does output per worker at a ___________ rate

per-worker production function

diminishing

catch-up effect?

increase in capital investment has a bigger effect in developing countries w/ little capital

human capital includes

training, education, health

improvements --> long run economic growth & productivity

technological advancement effects

drives productivity, saves labor & natural resources

what is the new growth theory?

economic growth can continue as long as we come up new ideas MEANING innovation @a rate that offsets diminishing returns

economic growth rates are higher/lower when gov enforces property rights

higher

free trade --> greater output because ____

principle of comparative advantage - both parties benefit & total output increase

what is fiscal policy

deliberate use of gov purchases & taxes to stabilize economy

automatic stabilizers vs discretionary

automatic - gov purchases & taxes that change w/ business cycle

discretionary - gov takes action to change purchases & taxes (deliberate)

how fiscal policies affect short run vs long run

short: aggregate demand of goods & services

long: influence saving, investment, and economic growth ex

increase in gov spending & cutting taxes increase/decrease AD

increase

why does SRAS shift left w/ expansionary fiscal policy

workers & suppliers realize price levels increasing faster than wages + input prices --> demand higher wages & higher prices for inputs

contractionary fiscal policy decrease/increase AD

decrease because gov purchases decrease & taxes increase

contractionary fiscal policy is dangerous because

reducing aggregate demand may lead to higher unemployment... monetary policy better option

what is the multiplier effect & how does it happen

chain reaction of additional income & purchases result in total purchases > initial increase in purchases

ex) gov spending increase --> higher income for people --> consumption spending increases SO total purchases higher than initial increase in gov spending

what is marginal propensity to consume? (MPC)

fraction of disposable/ADDITIONAL income (after tax) household spends rather than save;

change in consumption spending/change in disposable income

the added income from multiplier effect get smaller/bigger through each pass

SMALLER because MPC is a %

how to calculate multiplier

1/(1-MPC)

if MPC is 2/3 and the initial purchase was $10 billion.... what is the multiplier? what is the total purchase increased and additional consumption?

1/(1-2/3) = 1/(1/3) = multiplier is 3

3 x $10 bil = $30 billion in total purchase increase
$20 bil in additional consumption

larger MPC = larger/smaller multiplier effect

larger

do the math

multiplier effect increase/decrease aggregate demand

increase (duh)

tax cut or tax multiplier is bigger/smaller than the government multiplier and why?

smaller because indirect impact on AD while gov purchases have direct impact on AD

3 factors that reduce the size of the multiplier

time lags, savings, and imports