Studied by 2 peopleCircular flow of economic activity
A model that shows how households and firms circulate resources, goods, and incomes through the economy
Closed economy
A model that assumes there is no foreign sector (imports and exports)
Aggregation
The process of summing the microeconomic activity of households and firms into a more macroeconomic measure of economic activity
Gross domestic product (GDP)
The market value of the final goods and services produced within a nation in a given period of time
Final goods
Goods that are ready for their final use by consumers and firms, for example, a new Harley-Davidson motorcycle
Intermediate goods
Goods that require further modification before they are ready for final use, e.g., steel used to produce the new Harley
Double counting
The mistake of including the value of intermediate stages of production in GDP on top of the value of the final good
Secondhand sales
Final goods and services that are resold
Nonmarket transactions
Household work or do-it-yourself jobs are missed by GDP accounting
Underground economy
These include unreported illegal activity, bartering, or informal exchange of cash
Aggregate spending (GDP)
The sum of all spending from four sectors of the economy
GDP formula
GDP = C + I + G + (X – M).
Consumer spending (C)
Spending done by customers
Investment spending (I)
Investment is defined as current spending in order to increase output or productivity later
Three general types of investment included in GDP
New capital machinery purchased by firms.
New construction for firms or consumers.
Market value of the change in unsold inventories.
Government spending (G)
Purchases made by the govermnet for final goods and services and investments in infrastructure
Net exports (X-M)
X - exports
M - imports
Aggregate income (AI)
The sum of all income earned by suppliers of resources in the economy
Wages + Rents + Interest + Profit
Value-added approach
A third approach to calculating GDP that considers all stages of production of a final good and the value that was added to the final good along the way
Nominal GDP
The value of current production at the current prices
Real GDP
The value of current production, but using prices from a fixed point in time
Deflating the nominal GDP or adjusting it for inflation
Base year
The year that serves as a reference point for constructing a price index and comparing real values over time
Price index
A measure of the average level of prices in a market basket for a given year, when compared to the prices in a reference (or base) year
Real rate of interest
The percentage increase in purchasing power that a borrower pays a lender.
Calculating real GDP with percentages
GDP price deflator
The price index that measures the average price level of the goods and services that make up GDP
Business cycle
The periodic rise and fall in 4 phases present in economic activity
Expansion
A period where real GDP is growing
Peak
The top of a business cycle where an expansion has ended
Contraction
A period where real GDP is falling
Recession
Unofficially defined as two consecutive quarters of falling real GDP
Depression
A prolonged, deep contraction in the business cycle
Trough
The bottom of the cycle where a contraction has stopped
Consumer price index (CPI)
The price index that measures the average price level of the items in the base year market basket
Main measure of consumer inflation
Consumer price index (CPI)
Market basket
A collection of goods and services used to represent what is consumed in the economy
Inflation
The percentage change in the CPI from one period to the next
Annual rate of inflation on goods consumed by the typical consumer
The percentage change in the CPI from one year to the next
CPI
based on a market basket of goods bought by consumers, including products produced abroad
Measure of inflation of only consumer goods
CPI
GDP deflator
includes all items that make up domestic product
broader measure of inflation
GDP deflator
Nominal income
Todays income measured in todays dollars
Real income
Todays income measured in base year dollars
Expected Inflation
When inflation is predictable, people can plan accordingly. The bank adds an inflation factor on the real rate of interest to create a nominal rate of interest that savers receive and borrowers pay.
who does unexpected inflation hurt
Hurts employees if real wages are falling, as well as fixed-income recipients, savers, and lenders.
who does unexpected inflation help
Helps firms if real wages are falling, as well as borrowers. It might also increase the value of some assets like real estate or other properties.
Difficulties with CPI
Consumer substitute
Goods evolve
Quality differences
Consumer substitute
As the price of goods begins to rise, we know that consumers seek substitutes
Goods evolve
The emergence of new products (smartphones) and extinction of others (manual typewriters) is understood by firms and consumers, but the market basket must reflect this or it risks becoming irrelevant
Quality differences
Some price increases are the result of improvements in quality
Employed
A person is employed if they have worked for pay at least one hour per week
Unemployed
A person is unemployed if they are not currently working but are actively seeking work
Labor force
The sum of all individuals 16 years and older who are either currently employed (E) or unemployed (U)
LF = E + U.
Out of the labor force
A person is classified as out of the labor force if they have chosen to not seek employment
Labor force participation
The ratio of the size of the labor force to the size of the population 16 years and older
*LFPR = (LF/Pop)100.
Unemployment rate
The percentage of the labor force that falls into the unemployed category
UR = 100 Ă— U/LF.
Discouraged workers
Citizens who have been without work for so long that they become tired of looking for work and drop out of the labor force
Frictional unemployment
A type of unemployment that occurs when someone new enters the labor market or switches jobs
Seasonal unemployment
A type of unemployment that is periodic, is predictable, and follows the calendar
Structural unemployment
A type of unemployment that is the result of fundamental, underlying changes in the economy such that some job skills are no longer in demand
Cyclical unemployment
A type of unemployment that rises and falls with the business cycle
Full employment
Exists when the economy is experiencing no cyclical unemployment
Natural rate of unemployment
The unemployment rate associated with full employment, somewhere between 4 to 6 percent in the United States
Note 
Flashcard (32)