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Circular Flow Model
A model showing the flow of goods and services between households and firms.
Households
People who consume products and own the factors of production (land, labor, capital).
Firms
Organizations that use resources to make and sell products to consumers.
Factor/Resource Market
Where firms purchase factors of production from households.
Product Market
Where goods and services made by firms are sold to households.
Gross Domestic Product (GDP)
The dollar value of the final goods and services produced in a country's borders in a given year.
GDP Growth
Signals economic expansion.
Recession
Two consecutive quarters of negative GDP growth.
Intermediate Goods
Resources used to make a final product.
Used Items
Not involved in the production of new goods and services.
Non-Productive Transactions
Transactions that do not create a new product, thus adding nothing to GDP.
Transfer Payments
Government redistribution of wealth (e.g., welfare, unemployment).
Non-Market Activities
Activities with no exchange of money for goods and services.
Expenditures Approach
C + I + G + Xn = GDP, representing total spending in the economy.
C (Consumption Spending)
Money that consumers spend on products.
I (Investment Spending)
Money that businesses spend on products.
G (Government Spending)
Money that government spends on products.
Xn (Net Exports)
The difference between exports and imports.
ΔGDP
Rate of change in GDP.
Nominal GDP
Calculated as P x Q, does not account for inflation.
Real GDP
Calculates present year's production in base year terms, removing inflation as a variable.
GDP Per Capita
Calculated as GDP / Population, providing a measure of economic output per person.
GDP Deflator
Used to adjust Nominal GDP to Real GDP by accounting for inflation.
GDP per capita
GDP / Population
GDP deflator
GDP Deflator = Nominal GDP / Real GDP x 100
GDP Deflator of 100
No change.
GDP Deflator of 110
10% increase.
GDP Deflator of 90
10% decrease.
NeRD method
Anytime you have 2 of the 3, you can find out the other.
Limitations of GDP
Black Market - illegal and legal sales that aren't reported to the government aren't reflected in a country's GDP. 2) Negative externalities - any effects that aren't economic aren't counted. 3) Quality of life - money is not the only thing that makes people happy, but it is the only thing that counts for GDP!
Inflation
A rise in the general level of prices of goods and services.
Quantity Theory of Money Equation
M x V = P x Y
M
Money supply, the amount of money in circulation.
V
Velocity, how quickly people spend and re-spend money.
P
Price Level.
Y
Quantity of output.
Demand-Pull Inflation
A positive demand shock causes demand to increase, but supply to stay the same, leading to higher prices.
Cost-Push Inflation
A negative supply shock causes input costs to increase, but demand stays the same, leading to higher prices.
Consumer Price Index (CPI)
CPI = Current Year Market Basket / Base Year Market Basket x 100.
Market Basket
A collection of goods and services whose prices are examined and compared to earlier years.
Base Year CPI
The base year's CPI will always be 100; the US uses 1982 as its base year CPI.
ΔCPI
NOOO (New - Old OVER Old).
Target inflation rate
2% is the target inflation rate.
Wage-Price Spiral
An overall increase in wages is not always a good thing; to gain real wealth, a worker must see a larger increase in wages than prices.
Nominal vs Real Inflation
Lenders loan money to borrowers with the goal of earning a profit through interest payments.
Nominal Interest Rates
The percentage increase in money that the borrower pays not adjusting for inflation.
Real Interest Rates
The percentage increase in purchasing power that a borrower pays, adjusted for inflation.
Real ir
Nominal interest rate - inflation.
Winners of Inflation
Borrowers - People who take out fixed-rate loans and people looking for work (unemployment usually decreases when prices increase).
Losers of Inflation
Lenders - People who loan out money (at fixed interest rates), people with fixed incomes, and savers.
Cost-of-Living-Adjustment (COLA)
An automatic adjustment to keep up with inflation for many salaried positions and government transfer payments.
Disinflation
Prices are still rising, but not as fast, e.g., going from 10% inflation to 5% inflation.
Deflation
Negative CPI growth indicating falling prices, usually indicating falling demand and often leads to recession.
Hyperinflation
When prices rise at out of control levels, often caused by printing money to pay for war or political turmoil, making money practically worthless.
Adult Population
Individuals 16 years old or older, not retired and who are not military/institutionalized.
Labor Force
The total number of adults who are either employed or unemployed.
Employed
The number of adults who are currently working either full or part time.
Unemployed
The number of adults who are not working but are actively seeking work.
Not in Labor Force
People not in the adult population category, or who are not working or not looking for work, usually military, institutionalized, retired, or voluntarily not working.
Underemployed
A person who is working part-time but wants full time employment or is overqualified for their job, still considered to be employed.
Labor Force Participation Rate
How many adults are actually in the labor force, calculated as Labor Force/Adults x100.
Unemployment Rate
How many of those in the labor force are unemployed, calculated as Unemployed/Labor Force x100.
Frictional Unemployment
When people change jobs, take time to find the right job after schooling, or take time off for various reasons.
Structural Unemployment
When the jobs available don't match the skills of the workers, often due to technological advances.
Cyclical Unemployment
Unemployment based on changing economic conditions, such as workers laid off due to a recession.
Natural Rate of Employment
The unemployment rate considered normal in a properly functioning economy, typically around 5 percent.
Full Employment
The level of employment reached when there is no cyclical unemployment.
Business Cycle
Measures the relationship between Real GDP and Time.
Expansion
Growth in Real GDP.
Peak
The eventual turning point in the business cycle.
Recession
A decline in Real GDP.
Trough
The eventual turning point after a recession.
Positive Output Gap
When a country is outperforming, referred to as an inflationary gap.
Negative Output Gap
When a country is underperforming, referred to as a recessionary gap.
