econ u2

circular flow model

• private/public sector

• factor/transfer payments/income

• subsidies

private (businesses) VS public (government)

factor (received via indiv labor) VS transfer (gov programs)

subsidies (gov payments to businesses)

three macroeconomic goals for all countries

1. high economic growth

2. low unemployment

3. stable prices (limit inflation)

gross domestic product (GDP)

dollar value of all final goods/services produced IN a country (annually)

• depends on productivity

GDP per capita (person)

GDP/population → each person produces an avg amt of?

• best measure of a nation’s standard of living

not included in GDP (3)

intermediate goods

• tires of a car don’t count

nonproduction transaction

• financial transactions: stocks, real estate

• used goods

nonmarket/illegal activites

• homemade, drugs, unpaid work

rule of law

fair regulations → political stability → economic growth

calculating nominal GDP - expenditures approach (GICE)

GDP = consumer spending + business investment + government spending + net exports

• Consumer: purchase of final goods/services (sandwiches)

  • durable: fridges, cars

  • non durable: food

  • services: repairs

• Investment: businesses buying tools

• Government: infrastructure, etc. (NOT transfer payments)

• Net exports: exports - imports

calculating nominal GDP - income approach (RIPL)

labor  (wages from work) + rental (property income) + interest (payment after loans) + profit (money after paying costs)

• all FACTOR PAYMENTS (bc each contributed to production)

inventories

goods produced & held for later sale

• counted in GDP the year they’re PRODUCED

unemployment def & calculation

workers actively looking for a job (but not working)

• unemployment rate = 100 *  # unemployed / # in labor force

3 types of unemployment

• frictional

• structural

• cyclical

frictional: temporary/between jobs (HAS transferable skills)

• seasonal, fired → looking for new job

structural: loss of jobs (NO transferable skills)

• technological unemployment, VCR repair

cyclical: lowered demand for goods/services (recession)

• being laid off during great depression

natural rate of unemployment & full employment output (Y)

NRU = frictional + structural

• healthy economy

full output (Y) = GDP where cyclical = 0

why’s 0% unemployment bad?

without choices btwn workers, companies have to pay higher wages AND charge consumers higher prices (who are now buying MORE)

• rising wages → higher prices → demand even higher wages

unemployment rate can misdiagnose actual

• discouraged workers (they’ve given up)

  • lowers # in LF

• underemployed workers (wants more hours)

• race/age inequalities (doesn’t show disparity for minorities)

inflation, deflation, disinflation

inflation: each $ buys fewer goods → reduces purchasing power

• banks don’t lend and people don’t save

deflation: negative inflation (decrease in prices)

• ppl will hoard money and not spend

disinflation: price inc at slower rates

real GDP

100 * nominal GDP / GDP deflator

• GDP deflator measures prices of ALL produced goods

  • includes increases in products bought by gov/businesses

• CPI measures prices of BOUGHT goods

consumer price index (CPI)

CPI = 100 * current MB / base MB

• base index = 100

inflation rate

(new - old ) / old

problems with CPI

• substitution bias: ppl buy more substitutes (not in MB)

• new products: MB isn’t updated to include these

• product quality: ignores changes in product quality

costs of inflation

• menu costs (updating listed prices)

• shoe leather costs (increased cost of transactions)

• unit of account costs (currency is unreliable, uncertainty around spending)

the business cycle

shifts in aggregate supply/demand → short-run fluctuations in real GDP and employment