MACRO Exam 2

You read that a country's GDP rose 8% last year. Before you can say whether the country actually produced more, you need to know

how much of the increase came from higher prices.

Real GDP is calculated using

base-year prices and current-year quantities.

In the base year, nominal GDP and real GDP are

equal, because the base year's prices are the current prices that year.

If you want to know whether an economy's output is growing, the better measure is

real GDP, because it holds prices fixed and so reflects quantities only.

The GDP deflator is calculated as

(nominal GDP / real GDP) × 100.

You calculate a GDP deflator of 118 for a country. This tells you that, since the base year,

prices have risen.

Which of the following is a reason GDP understates what an economy produces?

Unpaid household work and off-market activity never pass through a market.

We usually compare countries using GDP per capita rather than total GDP because

a country with a large population can produce a large total and still produce little per person.

The consumer price index is

the overall cost of the goods and services bought by a typical consumer, reported monthly by the Bureau of Labor Statistics

We already have the GDP deflator. The reason we also need the CPI is that the deflator

includes goods like factory equipment and jet engines that a typical household never buys.

When we calculate real GDP we hold ______ fixed; when we calculate the CPI we hold ______ fixed.

prices; quantities

Substitution bias, the introduction of new goods, and unmeasured quality change all cause the CPI to

overstate increases in the cost of living

A smartphone that cost $600 in 2015 costs $800 today, but the newer phone has more storage, a better camera, and a longer battery life. If the CPI treats the whole $200 as a price increase, it

overstates the increase in the cost of living, because part of the higher price buys a better phone.

An American household buys a television manufactured in South Korea, and its price rises. This price increase shows up in

the CPI but not the GDP deflator, because consumers buy it but the US did not produce it

Substitution bias is a problem for the CPI but not for the GDP deflator because

the deflator's group of goods changes automatically each year with whatever the economy produced

Nominal GDP in 2022 is

$3,000

Using 2021 as the base year, real GDP in 2022 is

$2,500

The GDP deflator in 2022 is

120

The inflation rate from 2021 to 2022, measured by the GDP deflator, is

20%

Using 2021’s real GDP (2,000) and 2022’s real GDP (2,500).

Real GDP grew from 2021 to 2022 by:

25%

A typical student's basket is 3 textbooks and 40 coffees. Use the table for the next four questions. The base year is 2023.The cost of the basket in 2024 is

$600

The inflation rate from 2024 to 2025, measured by the CPI, is

25%

Coffee rose far more than textbooks, so in 2025 the student buys 3 textbooks and only 20 coffees. Compared with the increase the CPI reports from 2023 to 2025, this student's actual cost increase is

14%, which is smaller than the 50% the CPI reports.

Core inflation is the CPI with food and energy left out. Those two categories are excluded because

their prices swing sharply for reasons that have little to do with the underlying trend in prices.

The main reason economists and policymakers watch core inflation is that

we are trying to identify the long-run trend in prices, and volatile categories obscure that trend.

The inflation measure the Federal Reserve pays the most attention to is

the PCE price index, which covers the consumption portion of GDP.

A job paid $20,000 a year in 1995, when the CPI was 150. The CPI today is 300. Measured in today's dollars, that salary is

$40,000

Which statement correctly describes the two interest rates?

The nominal rate is the rate the bank quotes; the real rate is the rate at which your purchasing power grows.

A savings account pays 3% over one year. Inflation over that same year is 5%. The real interest rate is

−2%

Which statement correctly describes how unemployment is measured in the United States?

The Bureau of Labor Statistics surveys about 60,000 households every month and places everyone age 16 and older into exactly one of three categories.

To be counted as unemployed, a person must

have no job, be available for work, and have looked for work in the last four weeks.

The employed category is broader than most people assume. It includes

have no job, be available for work, and have looked for work in the last four weeks.

The employed category is broader than most people assume. It includes

part-time workers, the self-employed, people working unpaid in a family business, and people temporarily absent from a job.

Someone has no job, would like one, and stopped looking five months ago. This person is counted as

not in the labor force.

An economy's adult population is described below, in millions.

The unemployment rate is

5.0%

The adult population is 250 million. The labor-force participation rate is

64.0%

Now suppose 2 million of the unemployed become discouraged and stop looking for work. Nobody else's status changes. The unemployment rate and the participation rate become

3.8% and 63.2%

We report the unemployment rate and the participation rate together because

the unemployment rate can fall simply because people left the labor force, and the participation rate reveals when that has happened.

Which statement correctly distinguishes frictional from structural unemployment?

Frictional unemployment arises because it takes time to match workers with jobs; structural unemployment arises because the wage is held above the level that balances supply and demand

Minimum-wage laws, unions, and efficiency wages are grouped together in this chapter because each one

holds the wage above the level that balances labor supply and labor demand, producing a surplus of workers.

Efficiency wages differ from minimum wages and union wages in that with efficiency wages

the firm chooses to pay above the equilibrium wage, because doing so raises worker productivity.

What is the difference between microeconomics and macroeconomics?

Microeconomics studies individual decision makers, such as households and firms, and topics such as supply and demand. Macroeconomics studies the economy as a whole

What is this question asking for: Is the economy growing?

GDP

What is this question asking for: Are prices rising?

Inflation

What is this question asking for: Who is out of work?

Unemployment

What three things does GDP measure at once?

1. Total expenditure on final goods and services

2. Total income earned from producing them

3. Total production/output

Why does GDP measure 3 things?

These are the same number because every transaction has a buyer and a seller. What one person spends is income to someone else

When you calculate GDP, why can you use the expenditure side or the income side, rather than mixing the two?

You can calculate GDP from either side because total spending equals total income

If Alex pays Jordan $100 to fix a laptop:

• Alex's expenditure = $100

• Jordan's income = $100

• GDP = $100

What is the inventory investment category of GDP, and why is it necessary?

Unsold output that is counted as investment. Inventory investment is necessary so that production equals expenditure.

A manufacturer produces 5 cars.

It sells 3.

How many cars are counted in GDP?

5

What happens to inventory investment when those goods are later sold out of inventory?

The inventory falls, which prevents the same production from being counted twice.

A miller produces flour and cannot sell it, so it sits in inventory. Is it counted at the price of the flour, or the price of the bread it would eventually have become? Why?

It is counted at the market value of the flour, not the eventual price of the bread. Only the flour was produced. The bread has not been produced yet

State the full definition of GDP we wrote in class word for word.

The market value of all final goods and services produced within a country in a given period of time.

Can you explain why each word in the definition of GDP is necessary?

• Market value → gives us a common way to add different goods and services together.

• All → GDP attempts to be comprehensive.

• Final → prevents double counting intermediate goods.

• Goods and services → both physical products and services count.

• Produced → only newly produced goods count; used goods were counted when they were originally produced.

• Within a country → GDP is based on geography, not ownership.

• Given period of time → GDP is a flow measured over a year, quarter, etc.

What is market value?

Provides a common measure that lets us add unlike goods and services.

Does market price need to be stated in terms of price?

It is generally measured using prices. When there is no posted market price, the value may sometimes be imputed.

What are the common ways of measuring market value?

The class summary emphasizes using market prices/value to put different goods and services into a common unit so they can be added together.

What is an intermediate good?

A good used as an input in producing another good

Why is GDP only a measure of final goods?

the value of intermediate goods is already included in the price of the final good. Counting both would double count

What does the word "produced" rule out of GDP?

It rules out used goods that were produced in an earlier period.

What does GDP measure during a specified period?

New production

A TV made in Mexico is sold to a household in Alabama — whose GDP does it count in?

It counts in Mexico's GDP, not U.S. GDP.

GDP is based on where the good was produced, not where it is sold or who owns it.

What is the difference between a flow variable and a stock variable? Which is GDP?

A flow is measured over a period of time. A stock is measured at a point in time.

What kind of variable is GDP?

A flow variable because it measures production during a period such as a year or quarter. It does not measure accumulated wealth.

What is value added, and how do you calculate it at a single stage of production?

Value added = selling price at a stage − what that stage paid for its inputs.

Why does the sum of the value added across every stage equal the price of the final good?

Each stage adds value to the product, and when you add up all the value each stage added, you get the value of the final product.

A farmer sells wheat for $1. A miller sells that wheat and turns it into flour and sells it for $3. A baker turns that flour into bread and sells it for $6. What is the total value added?

$6 ($1 + $2 + $3 =$36.00² $6)

What are the two markets in the circular-flow diagram?

Goods and services market

Who are the buyers and sellers in each one?

Firms are the sellers and households are the buyers

In factors of production market, who are the buyers and sellers?

Households are the sellers and firms are the buyers (the flow moves in opposite directions of the circular-flow design)

Which factors of production do we use in this class?

• Labor — best thought of as labor hours

• Capital — tools, machines, and buildings

What does capital mean?

Physical capital: tools, machines, buildings, etc.

What does capital not mean?

Financial capital such as money or stocks.

What does rent mean?

Payment for capital

What assumption does the circular-flow diagram make about households?

Households own the factors of production, including capital.

What assumption does the circular-flow diagram make about firms?

Firms keep no profit, meaning revenue equals expenses and everything flowing into firms flows back out to factors of production.

In the circular-flow diagram, why do the flows of dollars and goods go in opposite directions?

Because a transaction involves an exchange.

Firms provide goods/services → households.

Households provide labor/capital → firms

Which way do dollars flow?

In opposite directions

What happens when a household buys something?

Money goes to the firm while the good goes to the household.

What should you be able to know with this diagram on an exam on the circular-flow diagram?

• The two markets

• The two agents

• Who sells what in each market

• That households own capital

• That dollars and goods flow in opposite directions

What are you not expected to do with the circular-flow diagram?

You are not expected to memorize the picture itself.

Write the formula for GDP.

Y = C + I + G + NX

What does the Y stand for?

Consumption, investment, government purchases, net exports

What are the 3 ways you can read it?

Output, Income, Expenditure

What is consumption?

Household spending on durable goods, nondurable goods, and services

What are the 3 subcategories of consumption?

Durable goods, nondurable goods, and services

What is an example of durable goods?

Cars, furniture

What is example of nondurable goods?

Food, gasoline

What is an example of services?

Haircuts, healthcare

Why is buying a new house not counted as consumption?

A new house is classified as residential investment, not consumption.

What is investment in the GDP accounts?

Spending on goods that will be used to produce goods and services in the future

What are GDP’s private investments’ three subcategories?

Business-fixed, residential, inventory

Why isn't buying stock an investment?

It is a purchase of a financial asset, not newly produced physical capital

What kinds of spending are counted in government purchases?

Local, state, and federal governments

What are examples of government spending on goods and services?

Roads, Defense, Teachers' salaries

What is a transfer payment?

Money the government gives to someone without buying a good or service in return.

Why is it not included as part of government purchases?

The government is not purchasing a good or service. The recipient's later spending is already counted in consumption